COVID in Emerging Economies

- Summarised from Constantino Hevia and Andy Neumeyer's chapter from COVID-19 in Developing Economies

The authors plotted Google mobility trends for places of work and for retail and recreation like restaurants, cafes etc which showed declines, however, heterogeneity was observed across economies (among both advanced and emerging) despite COVID being a global shock. This was believed to be due to different government policies with regards to social distancing. In economies where there exist effective containment policies, socio-economic interactions weren’t disrupted that much like in Taiwan and South Korea. The distancing measures were much stringent in countries like Italy, Spain and India, therefore, witnessed large mobility changes. In most countries, except for Sweden and the US, the contraction in the time spend working was found to be smaller than that spent on recreational activities. This difference was seen to be larger in emerging economies.

This disruption as observed by mobility data was used to comment on the direct and indirect economic cost. The cost was said to depend on the persistence, depth, ability of society to adjust, access to online activities, depth of financial markets and governments ability to support firms and its citizens.

Buera et al. (2020) showed that in shocks which close 30% of firms for a quarter, a model with borrowing constraints, labour market search frictions and rest unemployment could be a good approximation. Therefore in such situations, it was said that even if lockdowns are short-lived but upon revival, the economic recovery would be slower due to frictions

• The credit-constrained firms lose their working capital due to large fixed costs during shutdown and therefore it takes time to accumulate it again and to restore their scale
• Firms with smaller capital and limited credit, lines might be forced to bankruptcy
• Due to labour market friction, the broken employer-employee relationship during the lockdown takes time to rebuild
• Weak financial conditions might affect them to service their debt thereby reducing bank capital as well. These, therefore, were said to amplify the cost of lockdown
• Along with this, the persistence of lockdown and uncertainty regarding its duration might act as an additional drag to the recovery. This occurs through the channel of increased precautionary savings which decline investment and thereby aggregate demand

Both direct and indirect costs in emerging markets are expected to be larger.

• Due to their large informal labour market restricting government to reach livelihoods
• Relatively a larger fraction of lower level of education labour working in small firms thus restricting the ability to telework increases direct cost
• Shallower financial market restricts the ability to raise money thereby increasing indirect cost of finance
• Economies like the US, Denmark, Peru have announced large fiscal packages, thereby taxing future income and spending today for different benefit programs. However, these economies are credible to tax future income making lenders willing to lend to these economies. Emerging economies lack credibility to pay-back their debt which restricts their fiscal expansion. There exists a negative correlation between income per capita and the ability to tax or rate of interest on debt
• Flight to quality away from emerging markets which further makes it difficult for these economies to issue debt. Looking at credit spreads gives some idea about the same
• Commodity exporters in emerging markets are suffering due to a slump in commodity prices. Similarly, the tourism industry has taken a bit hit thus affecting many tourism-dependent economies
• Unemployment in advanced economies reduces immigrant remittances to their home countries. For many poor countries, remittances were found to be more than 10% GDP

Indeed policymakers of developing economies have a difficult task – on one hand, protect citizens in a weak health infrastructure environment and at the same time being susceptible to harder hits by prolonged lockdowns. IMF and World Bank have jointly pledged $1,160 billion as an aid to emerging markets, which represents around 6.8% of aggregate GDP of low and middle-income countries. These funds would enable countries which face problems to issue debt to be able to navigate through tough times at least in the short run.

COVID is found to put stress on public finance as revenues fall and expenditures increase. On the income side, as per the study, reduction in tax revenue is expected to be 1.2% for each percentage point in GDP and on average these economies collect taxes for 15% of GDP. Thus if GDP falls by 10% (being optimistic), tax revenues would fall by 1.8% (0.012*10*0.15*100) or approx by $300 billion. On the expenditure side, seeing that hours worked have fallen by 30%, it was expected to be compensated for low-income households. So expenditure increases as a result of transferring 30% of averaged per capita income for around 30% of the labour force or approx. $250 billion per quarter.

IMF resources have been said to be insufficient to ensure global financial stability as the emerging markets (Brazil, India, Mexico, Turkey, Indonesia and Poland’s) need to roll over their debt adds up to the total lending capacity of the IMF, that is, $1 trillion.

Policymaker faces a trade-off the problem, whether to not intervene or avoid deaths and pay the cost. Jones et al. (2020) computed the trade-off between the forgone utility of consumption lost due to the increased probability of death and the utility of consumption. Their baseline estimates for the cost of letting epidemic run in the US with no intervention was 25% of one year’s consumption. The cost of 1-year lockdown in less developed countries was expected to be higher.

Therefore some countries are using targeted social distancing that isolates a small subset of the population, thereby decreasing the economic cost. Another strategy is isolating infectious with wide testing and tracing which was successfully implemented in South Korea and Taiwan and having small cost. Another strategy is isolating only high-risk individuals, however, in emerging markets, it might not be possible due to the mixed up demographics.

In conclusion, it was said that COVID pandemic might be the largest macroeconomic shock in the past century and is likely to hit low and middle-income countries harder, while developed economies would be able to sail through. Facing trade-offs between health and wealth, economists and epidemiologists should work together.

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Images were taken from the paper itself