Developing world has lessons for handling fallout

For at least the third time in the last 10 years, advanced economies are getting sudden and accelerated exposure to something that is much more familiar in the developing world. The hope is that, in the process of coming up with the right policies to deal with the effects of the spread of the coronavirus, they also internalise the emerging countries’ lessons more quickly and fully this time.

The coronavirus has touched off an accelerating series of economic and social disruptions around the world, such as cancelled work trips, a growing number of school closings and panic buying that has emptied store shelves. These actions inadvertently spread fear and sometimes misinformation, amplifying the negative economic and social effects.

For the economy, the resulting simultaneous blows to supply and demand undermine all but one of the chief drivers of economic activity: consumption, investment and trade but not government spending.

Also, by undercutting corporate earnings, the shocks impact financial markets, fueling volatility and opening up the possibility of further economic damage because of sharp asset price drops amplified by pockets of distressed selling and liquidity stress.

It is rare for advanced countries to suffer simultaneous supply and demand shocks that hit both manufacturing and services, have both internal and external spillovers and are not particularly responsive to the traditional economic measures. (In this case, the establishment of a solid economic bottom requires medical advances pertaining to virus containment, treatment and immunity.) Even in the developing world, such simultaneous shocks are rare except for fragile and failed countries where armed conflict and civil unrest disrupt production and, because of a severe sense of insecurity or outright impoverishment, devastate consumption as well.

When it comes to economic and policy lessons from developing countries for the advanced world, there are two other examples in the last decade.

The first was in the immediate aftermath of the global financial crisis when, once financial market failures were overcome, the policy approach took an excessively cyclical orientation and failed to appreciate the structural challenges to growth. The conventional wisdom at the time, which proved to be incorrect, was that the negative growth shock was quickly reversible and that, unlike their developing counterparts, advanced countries had to be more concerned about cyclical forces than structural ones. Consider also the previously prevailing notion that the Japanese experience — with its ultra-low yields, increasingly ineffective monetary policy and stubbornly low economic growth — “could not happen here”.

The second was in Europe during the region’s debt crisis when, particularly in the summer of 2012, contagion from Greece and other more financially distressed countries spilled over and threatened to turn other countries’ liquidity challenges into solvency problems. Let’s hope that in the current predicament, policymakers in advanced economies do a better job of internalising the lessons from the experiences of developing countries. A particularly important one for restoring economic activity is not to waste the limited policy flexibility on actions that don’t address the underlying drivers of economic dislocations and insecurity. Instead, policy interventions should be focused on protecting the most vulnerable segments of the population and favouring those economic segments that are critical to the recovery. And when it comes to the important task of relieving stress in the functioning of the financial system, use laser-targeted measures rather than soaking the system with general liquidity.

Effective action is critical to maintaining trust and confidence in economic authorities, and the advanced countries under siege from the virus cannot afford to repeat the mistakes known all too well by the developing world.

Mohamed A. El-Erian is a Bloomberg Opinion columnist.