The changing role of government in a vaccinated world

What are the challenges for global markets as the world recovers from COVID-19? And what impact will the rising levels of government debt have on inequality and fiscal policy? In a wide-ranging conversation about the future of the capitalism, Gita Gopinath, Chief Economist at the International Monetary Fund, talks with Professor Elias Papaioannou, Co-Academic Director of the Wheeler Institute for Business and Development and Professor of Economics at London Business School, about the importance of multilateralism and supporting developing countries to ensure a truly global recovery.

With topics ranging from inequality to inflation expectations, four common themes emerged in this latest entry to our series of Rethinking Capitalism. 

  1. There are many similarities and differences between the COVID-19 pandemic and the Great Financial Crisis. However, the divergence between developed and developing nations make the two events largely dissimilar.  
  2. The pandemic is not over, as India firmly demonstrates, despite strong vaccination rates in many advanced economies, the risk to the global economy is still extreme.
  3. Massive debt was required to support and sustain the economy throughout the pandemic, but there is no strong sign of rampant inflation on the horizon. Low inflation and low-interest rates could act as the driver for an expanded role of government in the future.
  4. In the post-pandemic recovery, governments will have to tackle several increasingly salient policy challenges such as climate change, rising inequality, and higher levels of public and private debt.

Lessons in recovery from prior crises

With an initial focus on emerging markets, Papaioannou looks to compare the impacts of the pandemic with those of the Great Financial Crisis (GFC). With the current crisis being the greatest peacetime recession since the Great Depression, incorporating unique restrictions and forced market shutdowns, it is important to draw as much knowledge from prior experiences as possible. Coined as the ‘Great Lockdown’ by Gopinath, the differences between the current economic and global health crisis and the GFC are crucial to understanding how best to apply policy both domestically and internationally. She highlights that the main difference is mirrored rates of recovery, split between developed and developing countries. During the GFC, developed markets were much slower to recover than those in the developing world. This is compared with our current crisis, in which we are seeing much slower rates of recovery in developing nations, as compared with developed countries. 

“[the recovery] varies dramatically across different parts of the world, there are some countries that are recovering much faster, China is already back to pre-pandemic levels in 2020, the US is expected to be there very soon, and then you have many [emerging] countries of the world who are seeing very slow recoveries”Gita Gopinath

She goes on to illustrate this problem with the example of the decrease in per-capita income on an annual basis, relative to pre-pandemic projections. In advanced economies, the drop is only about 2% but rises to a staggering 6% for developing and emerging economies (excluding China). This is compounded by the fact that the developing economies are already starting off at a lower per-capita income base. This is a complete reversal of the impacts of the GFC.

Concluding this critical dynamic of the global recovery, Gopinath points to two main causes. Vaccine access and policy support. Both factors are interrelated in their tangible impact on the economic recovery of countries. Vaccine access is incredibly divergent between developed and developing nations. Israel, the UAE and increasingly the US and the UK are all well on their way to full vaccination, whereas most developing countries have not even vaccinated 1% of their populations. When Papaioannou mentions that despite the record level of vaccination worldwide, we are still seeing record levels of infections and death due to COVID-19, Gopinath points out this is in part due to wealthy nations pre-purchasing the majority of vaccines, only further exacerbating the discrepancy. With regards to policy support, massive fiscal stimulus by wealthy nations has reduced the drop in GDP growth from -9% on average to -3.3%. Although some of this fiscal firepower was targeted globally, most developing nations could not commit such funds to shore up their domestic economies. The combination of these two factors has left a huge divergence between the developed and developing worlds. 

India as an example and hurdle for global recovery

As a second point of discussion, Papaioannou looks to the current second wave of the pandemic in India as a vehicle to discuss whether developing countries could prevent the recovery of the global economy. As the IMF releases their updated growth forecasts for countries in July, Gopinath says that it is likely the current crisis in India will have a devastating impact on growth at least over the next several months, with potential longer-term impacts. 

“With India being 7% of the global economy on purchasing power parity basis, that has implications for the rest of the world”Gita Gopinath

With regards to the world economy, Papaioannou points out that what we are seeing in India could easily spread to parts of Africa, where comparable economic conditions could result in a crisis of similar devastation. Gopinath is quick to emphasize that although the overall fatality rates in developing countries have been lower (as was also mentioned in our prior discussion with Professors Esther Duflo and Abhijit Banerjee), India has recently shown that this pandemic is not over, that the virus variant matters tremendously, and that herd immunity takes time.

Debt as a driver of future recovery and risk 

A common concern, in developed but especially emerging markets, is the massive increases in government debt. Papaioannou’s question about debt and its impacts focused the conversation on what is sustainable and how the current interest rate environment has determined policy. As a simple primer, the higher the level of government debt, the higher the cost of servicing it is. However, if interest rates are low, this can easily help offset this increased cost. That is precisely what happened around the world at the start of the pandemic as central banks lowered rates, essentially to zero, to support government efforts in propping up the global economy. Gopinath speaks to how the massive stimulus plans in the United States and elsewhere are unlikely to cause persistent inflationary pressures but do have the potential for long-term economic risk. She tackles the question of inflation first:

“What is our expectation about the impact of the $1.9 trillion plan on US inflation? …our view is that we don’t see any strong argument for why there would be this persistent overshooting of inflation above the Fed’s targets”Gita Gopinath

The reasons behind this expectation are a function of both historical data and, more specifically, the lack of movement in the inflation rate this past year, especially given significant movements in the unemployment rate. The temporary nature of the stimulus package, in the United States, but also elsewhere in the world, is temporary, and therefore not permanently part of any government’s annual fiscal plans. Gopinath concludes this point by saying that if a government is going to pursue a persistent form of expenditures, which rely primarily on borrowing, that is when inflation expectations can become unanchored, become dangerous for the economy.  

With regards to the consequences of the higher levels of debt, a solid fiscal framework for the medium to long-term is essential for the reassurance of markets and to hold the government to a high standard of fiscal policymaking. Having the ability to generate tax revenue in a non-corrosive manner is part of that framework. Although the increasingly high levels of debt are of concern and worth debate, Gopinath claims that while the world is still in the grips of the pandemic, there are other important factors at play.

Changes in multilateralism and role of the state 

Papaioannou brings up the US-proposed global corporate tax rate and describes it as a statement on the future direction of multilateralism as well as the potentially expanded role of the state in people’s lives. Gopinath confirms this is an aim the IMF supports and infers that in a post-pandemic world the role of governments will naturally expand in their effort to support the recovery.

“We are very much in favour of having a global minimum corporate tax. Countries around the world have to deal with tax avoidance and tax shifting, and if you are going to invest in… physical infrastructure and building human capital and social safety nets you certainly need to have greater revenues for it. So, we think of this as an absolutely promising direction”Gita Gopinath

She is also quick to point out that a global rate is incredibly ambitious and challenging, given the requirement to bring everybody, not just the rich world, to the negotiating table. It is also important to consider that this one goal will not solve every fiscal problem and is simply the first step on a long journey to supporting both the developed and developing world.

In the developing world, this pandemic has wiped away two decades of progress in reducing rates of poverty. Gopinath reports that pre-pandemic, about 50% of emerging market economies were converging towards high income per capita levels, but as we start to see the other side of this crisis, those countries are expected to diverge for the next 3-4 years. In the developed world, we are entering a post-pandemic era of greater automation, which Gopinath mentions leads to higher levels of inequality and that prior policy efforts to address the divergence in prospects have been widely unsuccessful. 

This leads to the discussion about the future role of the state, how large government should be, and what responsibilities it should carry as countries recover from the pandemic. Papaioannou ponders whether this represents a paradigm shift in perspective about traditionally big-ticket items such as universal healthcare and broadband access. Although Gopinath agrees that the crisis has provided a stark example of the risks of inadequate government services and support, she also worries about the increasing rise in nationalism, whether it manifests through trade policy or vaccine distribution. 

Long-run challenges to the world economy

In concluding with the threats to the long-term health of the global economy, Gopinath highlights three main areas, and ties together the big themes of her conversation with Papaioannou. Firstly, rising inequality, as mentioned above and exacerbated by the pandemic, both in terms of personal wealth, but also with regards to the sustainability of small businesses relative to their larger counterparts. Secondly, climate change is an increasing threat, especially to the world’s most vulnerable people. Gopinath mentions two factors at play here, the needs to provide support to a slowly transitioning fossil fuel industry for retraining and the critical role advanced economies will play in support those countries that will be worst hit by the climate crisis. The final long-term threat to the global economy is debt. The recovery will cause significant stress on those countries who were struggling financially before the crisis. The IMF has supported many of these nations with emergency financing, but as Gopinath points out, more needs to be done and the global community has a role to play.

“This crisis is global; it needs global solutions and countries need to work even more closely together to make sure that the world as a whole comes out of this, not in a place of great divergence and all sorts of geopolitical tensions”Gita Gopinath

Elias Papaioannou’s conversation with Gita Gopinath is part of the Wheeler Institute’s Rethinking Capitalism series

Gita Gopinath is the Economic Counsellor and Director of the Research Department at the International Monetary Fund (IMF); on leave of public service from Harvard University’s Economics Department where she is the John Zwaanstra Professor of International Studies and Economics. Gopinath’s research focuses on international finance and macroeconomics. She has authored numerous research articles on exchange rates, trade and investment, financial crises, monetary policy, debt, and emerging market crises.

Elias Papaioannou is a Professor of Economics at LBS, where he also serves as an Academic Co-Director of the Wheeler Institute for Business and Development. His research focuses on international finance, political economy, growth, development, and economic history.

Zachary Day (MBA2021) is the Co-President of the Military in Business club at London Business School. Prior to his studies, he was an officer in the Canadian Armed Forces where he served in various operational and strategic roles from 2015-2019. Zachary is an intern for the Wheeler Institute, contributing to the creation of content that amplifies the role of business in improving lives.

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