Safeguarding governments’ financial health during coronavirus
Safeguarding governments’ financial health during coronavirus: Learning from past viral outbreaks
In the wake of the coronavirus outbreak, governments have taken unprecedented steps to protect the health of their citizens and support their economies. They now need to take extraordinary steps to safeguard their own financial health during what could be a protracted period of economic disruption necessary to contain and eradicate the virus (Baldwin and Weder di Mauro 2020).
While coronavirus is the first global pandemic of the 21st century, it is not the first global public health crisis which requires action from governments around the world. In just over a century, the world has seen major viral outbreaks in the form of the 1918-19 Spanish flu, the 2003 SARS outbreak in East Asia, and the 2014-16 Ebola epidemic in West Africa. In all cases, the outbreaks exacted a heavy toll on people’s lives and also on the economies of the affected countries (see Table 1). New work by Barro et al. (2020) suggests that, based on evidence from the last global pandemic (Spanish flu), the economic damage caused by coronavirus could be significant and long-lasting.
Table 1 Epidemiology and economic impacts of past viral outbreaks
Notes: 1 Number of countries reporting more than 10 cases; 2 In Canada, UK, and US; 3 In China, Hong Kong, Singapore and Taiwan; 4 In Guinea, Liberia, and Sierra Leone.
Source: World Health Organisation, International Monetary Fund, World Bank
During all of these past outbreaks, and even more so during the current coronavirus pandemic, governments played a central role in not only treating the sick and containing the spread of the virus, but also in mitigating its impact on people, businesses, and the economy as a whole. To do so, however, governments have to keep their own finances in good health in the midst of unprecedented pressures on their expenditure, revenues, and traditional sources of financing.
My new paper for the Resolution Foundation (Hughes 2020) explores what policymakers today can learn from how governments coped with the economic and fiscal stresses associated with viral outbreaks over the past century. In what follows, I highlight ten lessons for finance ministries to consider in calibrating their policy response to coronavirus today.
Lesson 1: Economies could face high single or double-digit percentage falls in annual GDP.
The relatively low infection and mortality rates associated with coronavirus are a less important determinant of its economic impact than the public health and social response. According to research by Brahmbhatt and Dutta (2008), these latter factors are estimated to account for over four-fifths of the economic disruption caused by viral outbreaks (see Figure 2). Coronavirus-related public health restrictions have been swifter, stricter, and more global than under any previous epidemic. Annual output losses from coronavirus could therefore be at least as big as the high single- or double-digit peak losses seen during the Spanish flu and Ebola outbreaks, rather than the small single-digit annual losses in GDP experienced following the SARS epidemic (see Figure 1).
Figure 1 Sources of economic losses from pandemic flu
(Percent of total economic loss)
Source: Brahmbhatt and Dutta (2008).
Lesson 2: Economic impacts could last for many months, if not years, if social distancing measures need to be kept in place for protracted periods.
In contrast to the ‘V-shaped’ recovery from SARS in 2003 in East Asian countries, coronavirus is now a global pandemic which has proven significantly more difficult to trace, contain, and eradicate. More appropriate precedents are the economic recoveries that followed the Spanish flu and Ebola outbreaks, during which public health restrictions were repeatedly tightened and loosened in response to successive flare-ups of the virus. These resulted in multiple peaks and troughs in the number of cases and losses of output, spanning several years. Economies did not return to their pre-outbreak levels for three years on average (see Figure 2).
Figure 2 The level of real GDP in countries following a major viral outbreak
(index, year prior to epidemic = 100)
Notes: Chart includes data from Canada, UK and US around the time of the Spanish flu epidemic (1918); Hong-Kong around the SARS outbreak (2003); and Guinea, Liberia and Sierra Leone during the outbreak of Ebola in 2014. The data is annual and the pre-epidemic peak is taken as t = 0. Source: IMF, World Bank, Jordà et al. (2017).
Lesson 3: Government deficits could quickly rise into high single or double digits as a proportion of GDP.
As economic disruptions reduce revenue and tax compliance, healthcare costs spike, and firms and individuals take advantage of existing and newly announced tax reliefs, benefits, salary support, and loans. As a result, governments could see their deficits reach levels not seen outside of wartime. Even West African economies with relatively small public sectors, basic welfare states, and limited fiscal policy responses saw their deficits rise by between 5% and 9% of GDP at the peak of the Ebola outbreak (Table 2). The fiscal policy measures already announced by governments in response to the economic disruption caused by coronavirus are unprecedented in peacetime and likely to require wartime levels of government borrowing.
Table 2 Public finances in countries hit by the 2014-16 Ebola outbreak
(as a proportion of GDP)
Source: Zafar et al. (2016)
Lesson 4: Governments should target financial support and avoid universal or open-ended offers.
Even though welfare states were limited during Spanish flu and Ebola outbreaks, government finances came under considerable strain. Similar fiscal stress may be expected during the current coronavirus pandemic. Promising to prevent all firms from failing or to pay the full salaries of all workers for periods in which they are out of work may not be fiscally credible if social distancing measures remain in place for more than a few months. And one-off universal payments to all citizens are administratively time-consuming, inefficient, and unlikely to stimulate consumption while most retail outlets are closed and global supply chains are disrupted. Instead, fiscal support should focus on plugging holes in the social safety net, ensuring everyone has a minimum level of support, and helping fundamentally profitable firms hold onto people and capital. Broad-based demand stimulus measures should be kept in reserve until public health restrictions are lifted and the supply side of the economy can respond.
Lesson 5: Governments should avoid fiscal policies which unnecessarily exacerbate the supply disruption.
Support to firms should encourage them to maintain safe levels of operation rather than close, if possible. Such measures should also encourage workers to stay attached to their employers rather than become jobless in a dysfunctional labour market. Salary support schemes should avoid incentivising firms to lay-off workers during or after the outbreak and penalise those that do. Business loans should avoid contributing to firm bankruptcies and layoffs by making repayments conditional on the length of the outbreak, the pace of recovery in firms’ earnings, and the continued retention of employees.
Lesson 6: Governments need to prioritise expenditure to fund their healthcare systems and support individuals and firms.
Governments need to conduct a rapid triage of all public expenditure to identify savings that can be reprioritised to fund the health and economic emergency. During the Spanish flu, governments were fortuitously demobilising from WWI, which allowed them to repurpose their warfare states to the fight against the virus. During the Ebola epidemic, governments suspended major investment projects until the outbreak was over, in order to fund their overburdened health services.
Lesson 7: Governments need to look to how they finance themselves for protracted periods in which expenditures are likely to far exceed revenues.
Pension funds who are traditional end investors in government bonds are likely to see steep falls in contributions, significant losses on other investments, and requests for early retirement or withdrawals. Commercial and investment banks which operate as primary dealers in the government bond market are likely to face their own liquidity squeeze due to a rise in non-performing loans and negotiated or government-sanctioned mortgage and loan repayment holidays. Foreign creditors may be reluctant to lend across borders for fear of exchange rate volatility, country risk, new capital restrictions, or possible default. Real-time financial markets data already shows cumulative capital outflows from 20 key emerging markets of over $50 billion since the start of the coronavirus outbreak in late January 2020, which is already twice as large as that seen in the wake of the 2008 Global Crisis (Figure 3).
Figure 3 Cumulative non-resident portfolio flows to emerging markets after global shocks
(time in days, in billion USD)
Source: Lanau and Fortun (2020.
Lesson 8: Central banks may have to provide temporary liquidity directly to governments to finance their deficits.
Faced with a synchronised global liquidity crunch, governments may need to turn to their central banks for the liquidity needed to pay out their commitments while government bond markets are temporarily disrupted. Given current levels of market turbulence and the likely dramatic falls in revenue and increases in expenditure in the coming months, these actions may need to happen sooner rather than later. As long as the liquidity created by the central bank to finance government deficits is temporary and withdrawn once the outbreak is over, the consequences for long-run inflation expectations should be limited. Some amount of short-term inflation may be inevitable and necessary given the need for relative prices to adjust to a significant supply shock.
Lesson 9: Government should resist reintroducing capital controls to protect their financing sources.
Capital controls were introduced during WWI and kept in place until after the Spanish flu outbreak had run its course in the 1920s. It will be tempting for some governments to reintroduce capital restrictions as a means of protecting their national savings and using them to finance their expanding deficits. However, this would be sub-optimal globally as capital controls would further exacerbate the global liquidity crunch, further disrupt cross-border investment, trade, and supply chains, and jeopardise the post-outbreak recovery.
Lesson 10: Regional and international financial institutions have a vital role to play in ensuring governments are able to finance themselves through the pandemic.
The IMF, World Bank, and regional arrangements can help to facilitate the pooling and targeting of global financing to those countries most in need – as during the Ebola outbreak when West African governments benefited from external financial support of between 5% and 10% of GDP at the peak of the outbreak (Figure 4). Assuming the virus moves across the globe in one or more waves, as was the case during Spanish flu, countries whose citizens and economies have recovered from the virus can use these institutions to help support those countries hit in later waves of the outbreak.
Baldwin, R and B Weder di Mauro (2020), Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes, a VoxEU.org eBook, CEPR Press.
Barro, R, J Ursua and J Weng (2020), “The coronavirus and the Great Influenza Epidemic”, CESifo Working Paper 8166.
Brahmbhatt, M and A Dutta (2008), “On SARS-type Economic Effects during Infectious Disease Outbreaks”, Policy Research Working Paper 4466, World Bank.
Hughes, R (2020), “Safeguarding governments’ financial health during coronavirus: What can policymakers learn from past viral outbreaks?”, Resolution Foundation.
Jordà, Ò, M Schularick and A Taylor (2016), “Macrofinancial History and the New Business Cycle Facts”, In M Eichenbaum and J A Parker (eds.), NBER Macroeconomics Annual 2016, Volume 31, Chicago: University of Chicago Press.
Lanau, S and J Fortun (2020), “The COVID-19 Shock to EM Flows”, Economic Views, Institute for International Finance, 17 March.
Zafar, C, C Talati and E Graham (2016), “2014-2015 West Africa Ebola Crisis: Impact Update”, World Bank Staff Reports.