The Pandemic Depression

The Global Economy Will Never Be the Same

By Carmen Reinhart and Vincent Reinhart

September/October 2020

Standing in line at a soup kitchen in Cape Town, South Africa, June 2020
Dwayne Senior / Eyevine / Redux

The COVID-19 pandemic poses a once-in-a-generation threat to the world’s population. Although this is
not the first disease outbreak to spread around the globe, it is the first one that governments have so
fiercely combated. Mitigation efforts—including lockdowns and travel bans—have attempted to slow the
rate of infections to conserve available medical resources. To fund these and other public health measures,
governments around the world have deployed economic firepower on a scale rarely seen before.

Although dubbed a “global financial crisis,” the downturn that began in 2008 was largely a banking crisis
in 11 advanced economies. Supported by double-digit growth in China, high commodity prices, and lean
balance sheets, emerging markets proved quite resilient to the turmoil of the last global crisis. The current
economic slowdown is different. The shared nature of this shock—the novel coronavirus does not respect
national borders—has put a larger proportion of the global community in recession than at any other time
since the Great Depression. As a result, the recovery will not be as robust or rapid as the downturn. And
ultimately, the fiscal and monetary policies used to combat the contraction will mitigate, rather than
eliminate, the economic losses, leaving an extended stretch of time before the global economy claws back
to where it was at the start of 2020.

The pandemic has created a massive economic contraction that will be followed by a financial crisis in
many parts of the globe, as nonperforming corporate loans accumulate alongside bankruptcies. Sovereign
defaults in the developing world are also poised to spike. This crisis will follow a path similar to the one the
last crisis took, except worse, commensurate with the scale and scope of the collapse in global economic
activity. And the crisis will hit lower-income households and countries harder than their wealthier
counterparts. Indeed, the World Bank estimates that as many as 60 million people globally will be pushed
into extreme poverty as a result of the pandemic. The global economy can be expected to run differently as
a result, as balance sheets in many countries slip deeper into the red and the once inexorable march of
globalization grinds to a halt.

ALL ENGINES DOWN

In its most recent analysis, the World Bank predicted that the global economy will shrink by 5.2 percent in
2020. The U.S. Bureau of Labor Statistics recently posted the worst monthly unemployment figures in the
72 years for which the agency has data on record. Most analyses project that the U.S. unemployment rate
will remain near the double-digit mark through the middle of next year. And the Bank of England has
warned that this year the United Kingdom will face its steepest decline in output since 1706. This situation
is so dire that it deserves to be called a “depression”—a pandemic depression. Unfortunately, the memory
of the Great Depression has prevented economists and others from using that word, as the downturn of the
1930s was wrenching in both its depth and its length in a manner not likely to be repeated. But the
nineteenth and early twentieth centuries were filled with depressions. It seems disrespectful to the many
losing their jobs and shutting their businesses to use a lesser term to describe this affliction.

Epidemiologists consider the coronavirus that causes COVID-19 to be novel; it follows, then, that its spread
has elicited new reactions from public and private actors alike. The consensus approach to slowing
its spread involves keeping workers away from their livelihoods and shoppers away from marketplaces.
Assuming that there are no second or third waves of the kind that characterized the Spanish influenza
pandemic of 1918–19, this pandemic will follow an inverted V-shaped curve of rising and then falling
infections and deaths. But even if this scenario comes to pass, COVID-19 will likely linger in some places
around the world.

So far, the incidence of the disease has not been synchronous. The number of new cases decreased first in
China and other parts of Asia, then in Europe, and then much more gradually in parts of the United States
(before beginning to rise again in others). At the same time, COVID-19 hot spots have cropped up in places
as distinct as Brazil, India, and Russia. In this crisis, economic turmoil follows closely on the disease. This
two-pronged assault has left a deep scar on global economic activity.

Some important economies are now reopening, a fact reflected in the improving business conditions across
Asia and Europe and in a turnaround in the U.S. labor market. That said, this rebound should not be
confused with a recovery. In all of the worst financial crises since the mid-nineteenth century, it took
an average of eight years for per capita GDP to return to the pre-crisis level. (The median was seven years.)
With historic levels of fiscal and monetary stimulus, one might expect that the United States will fare
better. But most countries do not have the capacity to offset the economic damage of COVID-19. The
ongoing rebound is the beginning of a long journey out of a deep hole.
A deserted tourist destination in Colombo, Sri Lanka, June 2020
Dinuka Liyanawatte / Reuters

Although any kind of prediction in this environment will be shot through with uncertainty, there are three
indicators that together suggest that the road to recovery will be a long one. The first is exports. Because of
border closures and lockdowns, global demand for goods has contracted, hitting export-dependent
economies hard. Even before the pandemic, many exporters were facing pressures. Between 2008 and
2018, global trade growth had decreased by half, compared with the previous decade. More recently,
exports were harmed by the U.S.-Chinese trade war that U.S. President Donald Trump launched in the
middle of 2018. For economies where tourism is an important source of growth, the collapse in
international travel has been catastrophic. The International Monetary Fund has predicted that in the
Caribbean, where tourism accounts for between 50 and 90 percent of income and employment in some
countries, tourism revenues will “return to pre-crisis levels only gradually over the next three years.”

Not only is the volume of trade down; the prices of many exports have also fallen. Nowhere has the drama
of falling commodity prices been more visible than in the oil market. The slowdown has caused a huge drop
in the demand for energy and splintered the fragile coalition known as OPEC+, made up of the members
of OPEC, Russia, and other allied producers, which had been steering oil prices into the $45 to $70 per
barrel range for much of the past three years. OPEC+ had been able to cooperate when demand was strong
and only token supply cuts were necessary. But the sort of supply cuts that this pandemic required would
have caused the cartel’s two major players, Russia and Saudi Arabia, to withstand real pain, which they
were unwilling to bear. The resulting overproduction and free fall in oil prices is testing the business
models of all producers, particularly those in emerging markets, including the one that exists in the United
States—the shale oil and gas sector. The attendant financial strains have piled grief on already weak
entities in the United States and elsewhere. Oil-dependent Ecuador, for example, went into default status
in April 2020, and other developing oil producers are at high risk of following suit.

In other prominent episodes of distress, the blows to the global economy were only partial. During the
decadelong Latin American debt crisis of the early 1980s and the 1997 Asian financial crisis, most
advanced economies continued to grow. Emerging markets, notably China, were a key source of growth
during the 2008 global financial crisis. Not this time. The last time all engines failed was in the Great
Depression; the collapse this time will be similarly abrupt and steep. The World Trade Organization
estimates that global trade is poised to fall by between 13 and 32 percent in 2020. If the outcome is
somewhere in the midpoint of that wide range, it will be the worst year for globalization since the early
1930s.

This depression arrived at a time when the economic fundamentals in many countries were
already weakening.

The second indicator pointing to a long and slow recovery is unemployment. Pandemic mitigation efforts
are dismantling the most complicated piece of machinery in history, the modern market economy, and the
parts will not be put back together either quickly or seamlessly. Some shuttered businesses will not reopen.
Their owners will have depleted their savings and may opt for a more cautious stance regarding future
business ventures. Winnowing the entrepreneurial class will not benefit innovation.

What is more, some furloughed or fired workers will exit the labor force permanently. Others will lose
skills and miss out on professional development opportunities during the long spell of unemployment,
making them less attractive to potential employers. The most vulnerable are those who may never get a job
in the first place—graduates entering an impaired economy. After all, the relative wage performance of
those in their 40s and 50s can be explained by their job status during their teens and 20s. Those who
stumble at the starting gate of the employment race trail permanently. Meanwhile, those still in school are
receiving a substandard education in their socially distanced, online classrooms; in countries where
Internet connectivity is lacking or slow, poorer students are leaving the educational system in droves. This
will be another cohort left behind.

National policies matter, of course. European economies by and large subsidize the salaries of employees
who are unable to work or who are working reduced hours, thus preventing unemployment, whereas the
United States does not. In emerging economies, people mostly operate without much of a safety net. But
regardless of their relative wealth, governments are spending more and taking in less. Many local and
provincial governments are obliged by law to keep a balanced budget, meaning that the debt they build up
now will lead to austerity later. Meanwhile, central governments are incurring losses even as their tax bases
shrink. Those countries that rely on commodity exports, tourism, and remittances from citizens working
abroad face the strongest economic headwinds.

What is perhaps more troubling, this depression arrived at a time when the economic fundamentals in
many countries—including many of the world’s poorest—were already weakening. In part as a result of
this prior instability, more sovereign borrowers have been downgraded by rating agencies this year than in
any year since 1980. Corporate downgrades are on a similar trajectory, which bodes ill for governments,
since private-sector mistakes often become public-sector obligations. As a result, even those states that
prudently manage their resources might find themselves underwater.

The third salient feature of this crisis is that it is highly regressive within countries and across countries.
The ongoing economic dislocations are falling far more heavily on those with lower incomes. Such people
generally do not have the ability to work remotely or the resources to tide themselves over when not
working. In the United States, for instance, almost half of all workers are employed by small businesses,
largely in the service industry, where wages are low. These small enterprises may be the most vulnerable to
bankruptcy, especially as the pandemic’s effects on consumer behavior may last much longer than the
mandatory lockdowns.
A porter with rations in Karachi, Pakistan, July 2020
Akhtar Soomro / Reuters

In developing countries, where safety nets are underdeveloped or nonexistent, the decline in living
standards will take place mostly in the poorest segments of society. The regressive nature of the pandemic
may also be amplified by a worldwide spike in the price of food, as disease and lockdowns disrupt supply
chains and agricultural labor migration patterns. The United Nations has recently warned that the world is
facing the worst food crisis in 50 years. In the poorest countries, food accounts for anywhere from 40 to 60
percent of consumption-related expenditures; as a share of their incomes, people in low-income countries
spend five to six times as much on food as their counterparts in advanced economies do.

THE ROAD TO RECOVERY

In the second half of 2020, as the public health crisis slowly comes under control, there will likely be
impressive-looking gains in economic activity and employment, fueling financial-market optimism.
However, this rebound effect is unlikely to deliver a full recovery. Even an enlightened and coordinated
macroeconomic policy response cannot sell products that haven’t been made or services that were never
offered.

Thus far, the fiscal response around the world has been relatively narrowly targeted and planned as
temporary. A normally sclerotic U.S. Congress passed four rounds of stimulus legislation in about as many
weeks. But many of these measures either are one-offs or have predetermined expiration dates. The speed
of the response no doubt was driven by the magnitude and suddenness of the problem, which also did not
provide politicians with an opportunity to add pork to the legislation. The United States’ actions represent
a relatively large share of the estimated $11 trillion in fiscal support that the countries of the G-20 have
injected into their economies. Once again, greater size offers greater room to maneuver. Countries with
larger economies have developed more ambitious stimulus plans. By contrast, the aggregate stimulus of the
ten emerging markets in the G-20 is five percentage points below that of their advanced-economy
counterparts. Unfortunately, this means that the countercyclical response is going to be smaller in those
places hit harder by the shock. Even so, the fiscal stimulus in the advanced economies is less impressive
than the large numbers seem to indicate. In the G-20, only Australia and the United States have spent
more money than they have provided to companies and individuals in the form of loans, equity, and
guarantees. The stimulus in the European economies, in particular, is more about the balance sheets of
large businesses than about spending, raising questions about its efficacy in offsetting a demand shock.

Central banks have also attempted to stimulate the failing global economy. Those banks that did not
already have their hands tied by prior decisions to keep interest rates pinned at historic lows—as the Bank
of Japan and the European Central Bank did—relaxed their grip on the flow of money. Among that group
were central banks in emerging economies, including Brazil, Chile, Colombia, Egypt, India, Indonesia,
Pakistan, South Africa, and Turkey. At prior times of stress, officials in such places often went in the other
direction, raising policy rates to prevent exchange-rate depreciation and to contain inflation and, by
extension, capital flight. Presumably, the shared shock leveled the playing field, lessening concerns about
the capital flight that usually accompanies currency depreciation and falling interest rates.

Just as important, central banks have fought desperately to keep the financial plumbing flowing by
pumping currency reserves into the banking system and lowering private banks’ reserve requirements so
that debtors could make payments more easily. The U.S. Federal Reserve, for instance, did both, doubling
the amount it injected into the economy in under two months and putting the required reserve ratio at
zero. The United States’ status as the issuer of the global reserve currency gave the Federal Reserve a
unique responsibility to provide dollar liquidity globally. It did so by arranging currency swap agreements
with nine other central banks. Within a few weeks of this decision, those official institutions borrowed
almost half a trillion dollars to lend to their domestic banks.

The fiscal stimulus in the advanced economies is less impressive than the large numbers
seem to indicate.

What is perhaps most consequential, central banks have been able to prevent temporarily illiquid firms
from falling into insolvency. A central bank can look past market volatility and purchase assets that are
currently illiquid but appear to be solvent. Central bankers have used virtually all the pages from this part
of the playbook, taking on a broad range of collateral, including private and municipal debt. The long list of
banks that have enacted such measures includes the usual suspects in the developed world—such as the
Bank of Japan, the European Central Bank, and the Federal Reserve—as well as central banks in such
emerging economies as Colombia, Chile, Hungary, India, Laos, Mexico, Poland, and Thailand. Essentially,
these countries are attempting to build a bridge over the current illiquidity to the recovered economy of the
future.

Central banks acted forcefully and in a hurry. But why did they have to? Weren’t the legislative and
regulatory efforts that followed the last financial crisis about tempering the crisis next time? Central banks’
foray into territory far outside the norm is a direct result of design flaws in earlier attempts at remediation.
After the crisis in 2008, governments did nothing to change the risk and return preferences of investors.
Instead, they made it more expensive for the regulated community—that is, commercial banks, especially
big ones—to accommodate the demand for lower-quality loans by introducing leverage and quality-of-asset
restrictions, stress tests, and so-called living wills. The result of this trend was the rise of shadow banks, a
cohort of largely unregulated financial institutions. Central banks are now dealing with new assets and new
counterparties because public policy intentionally pushed out the commercial banks that had previously
supported illiquid firms and governments.

To be sure, central bank action has apparently stopped a cumulating deterioration in market functioning
with rate cuts, massive injections of liquidity, and asset purchases. Acting that way has been woven into
central banks’ DNA since the Fed failed to do so in the 1930s, to tragic effect. However, the net result of
these policies is probably far from sufficient to offset a shock as large as the one the world is living through
right now. Long-term interest rates were already quite low before the pandemic took hold. And in spite of
all the U.S. dollars that the Federal Reserve channeled abroad, the exchange value of the dollar rose rather
than fell. By themselves, these monetary stimulus measures are not sufficient to lead households and firms
to spend more, given the current economic distress and uncertainty. As a result, the world’s most
important central bankers—Haruhiko Kuroda, governor of the Bank of Japan; Christine Lagarde, president
of the European Central Bank; and Jerome Powell, chair of the Federal Reserve—have been urging
governments to implement additional fiscal stimulus measures. Their pleas have been met, but
incompletely, so there has been a massive decline in global economic activity.

THE ECONOMY AND ITS DISCONTENTS

The shadow of this crisis will be long and dark—more so than those of many of the prior ones. The
International Monetary Fund predicts that the deficit-to-GDP ratio in advanced economies will swell from
3.3 percent in 2019 to 16.6 percent this year, and in emerging markets, it will go from 4.9 percent to 10.6
percent over the same period. Many developing countries are following the lead of their developed
counterparts in opening up the fiscal tap. But among both advanced and developing economies, many
governments lack the fiscal space to do so. The result is multiple overextended government balance sheets.

Dealing with this debt will hinder rebuilding. The G-20 has already postponed debt-service payments for
76 of the poorest countries. Wealthier governments and lending institutions will have to do more in the
coming months, incorporating other economies into their debt-relief schemes and involving the private
sector. But the political will to undertake these measures may well be lacking if countries decide to turn
inward rather than prop up the global economy.

Globalization was first thrown into reverse with the arrival of the Trump administration in 2016. The speed
of the unwinding will only pick up as blame is assigned for the current mess. Open borders seem to
facilitate the spread of infection. A reliance on export markets appears to drag a domestic economy down
when the volume of global trade dwindles. Many emerging markets have seen the prices of their major
commodities collapse and remittances from their citizens abroad plummet. Public sentiment matters to the
economy, and it is hard to imagine that attitudes toward foreign travel or education abroad will rally
quickly. More generally, trust—a key lubricant for market transactions—is in short supply internationally.
Many borders will be difficult to cross, and doubts about the reliability of some foreign partners will fester.

Yet another reason why global cooperation may falter is that policymakers may confuse the short-term
rebound with a lasting recovery. Stopping the slide in incomes and output is a critical accomplishment, but
so, too, will be hastening the recovery. The longer it takes to climb out of the hole this pandemic punched
in the global economy, the longer some people will be unnecessarily out of work and the more likely
medium- and longer-term growth prospects will be permanently impaired.

The shadow of this crisis will be long and dark—more so than those of many of the prior
ones.

The economic consequences are straightforward. As future income decreases, debt burdens become more
onerous. The social consequences are harder to predict. A market economy involves a bargain among its
citizens: resources will be put to their most efficient use to make the economic pie as large as possible and
to increase the chance that it grows over time. When circumstances change as a result of technological
advances or the opening of international trade routes, resources shift, creating winners and losers. As long
as the pie is expanding rapidly, the losers can take comfort in the fact that the absolute size of their slice is
still growing. For example, real GDP growth of four percent per year, the norm among advanced economies
late last century, implies a doubling of output in 18 years. If growth is one percent, the level that prevailed
in the shadow of the 2008–9 recession, the time it takes to double output stretches to 72 years. With the
current costs evident and the benefits receding into a more distant horizon, people may begin to rethink
the market bargain.

The historian Henry Adams once noted that politics is about the systematic organization of hatreds. Voters
who have lost their jobs, have seen their businesses close, and have depleted their savings are angry. There
is no guarantee that this anger will be channeled in a productive direction by the current political class—or
by the ones to follow if the politicians in power are voted out. A tide of populist nationalism often
rises when the economy ebbs, so mistrust among the global community is almost sure to increase. This will
speed the decline of multilateralism and may create a vicious cycle by further lowering future economic
prospects. That is precisely what happened in between the two world wars, when nationalism and beggar-
thy-neighbor policies flourished.

There is no one-size-fits-all solution to these political and social problems. But one prudent course of
action is to prevent the economic conditions that produced these pressures from worsening. Officials need
to press on with fiscal and monetary stimulus. And above all, they must refrain from confusing a rebound
for a recovery.