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By Alison Buckholtz
Homi Kharas, Interim Vice President and Director of the Global Economy and Development program at the Brookings Institution, has spent his career—including 26 years at the World Bank—examining the events, policies, and trends that influence economies. IFC Insights reached out to discuss the scope of the economic shock following the COVID-19 pandemic, what should worry the private sector the most, and why he believes the biggest winners should be the principles of sustainability and inclusiveness. This interview has been lightly edited for length and clarity.
Q: You referred in a recent paper to the “triple economic shock” of the COVID-19 pandemic. Could you elaborate on this?
Usually when there is a recession, people think of it as being driven by one of three things. Sometimes there is a demand shock, as with the confidence crisis following 9/11, when there was a reduction in spending. Sometimes there’s a supply shock; as with the supply shocks of the 1970s when oil prices suddenly rose and a global recession followed. Sometimes there’s a financial shock, as in 2007-2008, when banks and financial markets seized up.
The distinctive thing about this crisis is that all three shocks are present at the same time. We obviously see demand collapsing; we see all kinds of supply shocks because people aren’t allowed to go to work; and we see financial markets seizing up because there isn’t enough cash in the system. All three are happening at the same time. It’s a perfect storm.
Q: What will be required for an eventual economic recovery?
The key to recovery is that so many governments have to some extent learned from past crises—most recently, the economic crisis of 2007 and 2008—and have responded to this emergency quite quickly. We already have something like $8 trillion of stimulus that has been put on the table by G20 governments. That’s over 10 percent of their GDP. Not all of that can be spent instantaneously, but it gives you a sense of the size of the response that is taking place and that’s quite encouraging.
Q: Why is the collective commitment of the G20 so crucial?
If one country tries to do a fiscal stimulus by itself, typically what happens is that the impact is reduced because as its economy starts to expand, the trade deficit starts to expand, and the stimulus “leaks out”—it becomes a stimulus for other countries rather than for the country that’s enacting the stimulus. When everybody does it together, then each country is receiving not just the benefit of its own stimulus, but the spillover benefits of the stimulus of the other countries. So the coordinated impact, historically, has been much larger than the impact of a single country moving forward.
But there is an additional reason: any kind of a stimulus package requires a lot of internal political debate in countries. When there is a global agreement, the voices that are pushing for a stimulus tend to be strengthened and the size of the stimulus becomes larger. We saw that in 2008, with the coordinated package that allowed finance ministers to come back to their countries and be persuasive about the size of the stimulus, and overcome the reluctance of some leaders.
Q: Are there ways that the recovery from the 2007-2008 financial crisis should not be a model for what’s happening now?
Yes, there are also negative lessons from the most recent financial crisis. When there is so much money on the table, there is a desire that we should “build back better.” I would say that in the last crisis even though there was a lot of money on the table and people said those words, we didn’t change economic structures to any major degree. Banks held a little more capital and there was some strengthening of regulations but by and large the structure of the global economy remained the same. This time, it would be really helpful if we learned the lesson that our current global economic structures are just not that strong. They need to be changed.
Q: How would you like to see the world “build back better” after this crisis passes?
I can answer you with two words: Sustainability and inclusiveness. I really hope that these trillions of dollars that are being put on the table will encourage us to take a fresh look at what is sustainable and inclusive growth as well as strong growth.
With regard to sustainability, what we’re finding is that as our footprint is expanding, changing the health of our planet, the economic give-and-take changes, too. Everyone’s talking about the joys of being able to breathe clean air or see the stars right now. I hope that as we move forward we’ll recognize that these are really valuable things and not just a small price that we have to pay for our material comfort. All of the science about economics says that we can have the same degree of material well-being with far less damage to the planet if we restructure.
When it comes to inclusiveness, it’s clear that countries that have better safety nets are much better positioned to deal with this current crisis. It’s all very well to tell people to stay at home and not work but you need mechanisms whereby they get unemployment checks and health insurance. I think inclusion will become a much more significant part of what one calls a robust global economy.
Q: What’s the best way the private sector can contribute to this robust global economy?
The private sector is going to come up with the innovations that will allow us to move to sustainable and inclusive growth. This is not going to be driven by governments. Governments might shape the environments, but it’s the private sector that’s going to come up with the actual products, and inevitably there will be an acceleration in innovation because of the magnitude of the shift that’s taking place in the economic structure. If you think about the new technologies that emerged after World War II, or technologies that emerged from the space program, it’s clear that when very large events happen in the world it provides a real spur to innovation. I think that we’re going to see that here.
Q: What will be most challenging to the private sector as it emerges from this crisis?
Because we are experiencing a supply shock right now, the private sector across the board is really suffering and is trying to stay afloat until demand kicks back in. In the meantime, in advanced economies the private sector is calling for and receiving considerable amounts of state aid. It is going to be very interesting to see how the private sector responds once the crisis starts to abate—because historically when the private sector receives preferential treatment, they quite like it, and try to maintain those levels of state support. It would be a large distortion if that competitive arena in the future were to be dictated by the levels of state support that was being offered, rather than the efficiency and competitiveness of the companies themselves. Returning to the principles of a competitive environment is going to be challenging for policymakers and the private sector.
What’s your perspective on the role of IFC and the World Bank right now?
This is a time when IFC and other multilateral financial institutions have a really important role to play. There are a number of things IFC can do in terms of its ability to introduce liquidity through trade credits, its influence on banks where it has some stakes, and its ability to engage with the World Bank on the policy reforms that will be required as countries move forward. IFC could take a very proactive role in the discussions that are going to take place.
Overall, IFC will need to think very carefully about how it responds to the question of state aid to the private sector. Will IFC encourage the businesses in which it has invested to take advantage of any sources of state assistance that are offered, or will IFC encourage them to remain as private operations? There are big issues to grapple with.
What should IFC advise companies that are offered state aid—especially those that may face collapse?
Companies should take state aid if it is offered, depending on the situation. Their competitors will, so it would be doubly unfortunate if the most efficient companies go bankrupt because they don’t take aid, while less efficient companies survive. But if a company has alternatives, including an investor like IFC, it should turn to those investors first, and make the case that the company is worth saving as a going concern.
Published in April 2020