A Cambridge economist decodes how Covid exposed global economy's frailties

Kamiar Mohaddes, an economist at the Cambridge Judge Business School, Cambridge University, authored a study along with his peers on the economic consequences of Covid-19. He spoke to Pinaki Chakraborty on the direct and indirect effects within the interconnected global economy:

What is your economic model to gauge the fallout of Covid-19?
The global economy has seen many shocks. This shock is different. It is probably the first time since the Great Depression that we are truly facing a global shock. It affects all economies and it simultaneously disrupts supply and demand. Since World War II, the world economy has become more interconnected. So, this has a very huge effect. As you know, with infections rising it reduces the labour supply. Some of it is by design. Governments say we are closing down some sectors of the economy. In some countries, it has led to job losses and unemployment. Your consumption reduces and then you have a vicious cycle. The third aspect of the global shock is that it is extremely uncertain and we don’t know the magnitude of the shock, how long the pandemic will last. These lead to lower confidence among consumers and businesses, and potentially tighter financial conditions. How do you identify a shock that is unprecedented? How do you account for the non-linear effect?

What is a non-linear effect?
What we show in the paper is that when global volatility goes over a certain level, then impact on economic growth is going to be extremely severe. You can think of a threshold effect. When you hit the threshold, the economic effect will be much more than in a linear model. Covid-19 is an extreme shock – think of climate change.

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You say that pulled by China, rest of Asia will pull out faster than others.
When I looked at China I was a bit surprised. A lot of people said in April that a lot of economies would have a V shaped recovery. Our results show an inverse square root recovery, like a U shaped recovery. China is extremely important to other emergent Asian economies. Why is China different? There are three elements to it. It reopened very quickly in early April when a lot of other economies were going into lockdown. While China is important to other economies, other economies have lower impact on Chinese economy. The third thing and why this is very important is if you look at any other major recession we have experienced, there was a V shaped recovery, the services bounced back very quickly compared with manufacturing. What we observed with this episode is that manufacturing bounced back much quicker than services. That is not weird as services are dependent on social distancing. China is very big on manufacturing. What it shows is emerging Asia with a lag will follow China.

How do governments balance economic recovery amid multiple lockdowns?
It is a health shock and also a multi-country shock. Even if you don’t have a lockdown, people are worried about going on the streets. Sweden shows less stringent lockdown will not result in greater economic growth. Whether it is tourism, supply chain, trade in goods, these linkages are important unless you are a closed economy. In the medium term if you don’t go into lockdowns, the economic effects will be much larger.

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Even without lockdown there are no expenditures in different sectors anyway. I doubt these businesses will thrive if there is no lockdown. It is extremely important to keep schools and education sectors going because these will have long-term effects. It is the human capital of a nation. You need to have a clever design, because situations will differ.

What’s been the impact of Covid-19 on climate change?
I will answer in two parts, the immediate effect and the long term effect. We were coming out of the global financial crisis and then we had the Paris agreement, so everybody wanted to find ways and means to tackle the big challenge. Covid-19 did one bad thing and one good thing. The bad thing it did was delay those responses because governments needed to get into lockdown and sustain livelihoods. Therefore climate change goals were not a priority. What this shows is that the global economy is not very resilient to global shocks and climate change could hit the global economy quite severely. Hopefully, it will wake up those who think climate change risk is not high.

Is a big fiscal deficit a concern for countries?
In the short term governments will have to engage in big fiscal packages. I don’t think we have a choice here. In the medium term, governments will need to have a credible programme on how they reduce their deficit. The debt trajectory is very important. You don’t want to come out of the pandemic and keep spending in such a way that your debt to GDP ratio keeps increasing. That is not feasible.

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