Question

2. Discuss policy to address the internationalization of risk, given what has been witnessed during the COVID-19 pandemic. What are the policy options (or policy prescriptions) for small open developing economies in the Caribbean region? (500 words)

Answer 1

Most Latin American and Caribbean countries have been hit by the Covid-19 crisis in the context of low potential growth, high inequalities and rising social discontent. Policy reactions to the crisis have been bold, but further measures will be needed. In the immediate term, the priority must be to prevent contagion and support most vulnerable families, workers and firms. In the phasing out of the containment and lockdown measures, continued income support to stimulate consumption and support inclusiveness, as well as investment efforts to promote activity are fundamental to spur a swift economic recovery. In the medium term, the aftermath of this crisis must be turned into an opportunity to redefine the social pact, putting well-being at the centre, based on stronger social protection systems, better healthcare, more robust and inclusive public finances and implementing inclusive development strategies. Co-ordinating a global response to address the impact of the Covid-19 crisis in the region remains vital.

The first cases of coronavirus in Latin America and the Caribbean (LAC) started end-February in Brazil, and since then, Covid-19 reported cases and deaths have continuously increased in the region.1 The actual dimension of the pandemic in the region remains somewhat uncertain, as cases are underreported and accuracy for data collection varies considerably within the region. The digital transformation should provide new avenues to better detect and respond to Covid-19 in LAC.

Countries have gradually implemented social distancing and other mitigation measures to reduce the spread of the virus, starting with El Salvador’s lockdown and travel ban on 11 March. Total and partial lockdowns include measures such as shutting down borders, prohibiting transit for non-essential reasons, cancelling events, closing non-essential business, and stopping or virtualising the classes in schools and universities, among others.While the region confronts the crisis with a demographic structure where only 9% of the population is aged over 65 (vs. 17.2% in OECD countries), the limited capacity of health systems and the high levels of informality in most countries amplify the challenge of fighting this pandemic. The regionspends four times less on healthcare than OECD countries. On average, there are 2.2 hospital beds (per 1 000 habitants), below the average of 4.7 hospital beds across OECD countries. In addition, there are almost 2 doctors and less than 3 nurses per 1 000 population, while the OECD averages are 3.5 and 9, respectively . Finally, the share of population in Latin America satisfied with quality of healthcare services fell from 57% in 2006 to 42% in 2018, below the OECD average of around 70% (OECD et al., 2019.

The Covid-19 pandemic will have strong socio-economic consequences, accentuating the already complex scenario faced by LAC, characterised by significant structural development traps The region enters the Covid-19 crisis with the majority of countries presenting low potential growth and increasing social discontent. Between 2014 and 2019 the region experienced the weakest period of growth since the 1950s, consistently recording lower growth rates than the OECD average. In 2019, growth was practically nil and protests erupted in some countries, confirming that despite past improvements in reducing income poverty, vulnerability and exclusion remain a major concern in the region. Governments need to respond more effectively to the growing aspirations of a rising but vulnerable “middle-class” and continue to include segments of the population that are left behind. Several international organisations have estimated annual GDP growth for 2020 to be negative and these different projections are between -1.8% and -5.5% (ECLAC, 2020[3]; IMF, 2020[4]; Nuguer and Powell, 2020[5]; World Bank, 2020.Uncertainty remains extremely high, and the size of the economic contraction will vary considerably across countries and will depend on (i) the depth and length of the confinements, (ii) the additional measures adopted by countries during the lockdown, both within and outside the region, and (iii) the path of the global economy in the aftermath of the crisis.

Beyond the direct effect of Covid-19 on human health, the socio-economic impact of the pandemic in LAC is – and will continue to occur – through different channels. First, the confinement measures adopted by governments induce a large immediate drop in economic activity, as workers are prevented to go to work and remain locked down at home. Households are also cutting sharply their consumption on most goods and services during confinement. Second, containment measures, restrictions to border crossing, and social anxiety affect key sectors such as tourism and international travel. This will have particular incidence in highly dependent countries as some Caribbean economies, where tourism accounted for more than 20% of GDP in 2018 and where it could fall by around 25% (ECLAC, 2020.Other sectors such as retail trade, wholesale trade and manufacturing sectors will also be heavily affected. Third, the global slowdown (OECD, 2020 and the disruption of global and regional value chains will generate a sharp decline in LAC exports. Fourth, while the collapse in oil prices can be a relief to the oil-importing Caribbean and Central American economies, it affects fiscal and external accounts of several South American countries, as well as Mexico and Trinidad and Tobago. Similarly, Chile and Peru suffer from the decline in copper prices. Finally, financial volatility, the worsening of financial conditions and large capital outflows have brought a strong depreciation of LAC currencies and the reduction of financial assets in debt and equity markets, affecting the solvency of large LAC companies. In contrast to these negative effects, the adoption of digital technologies and the spread of the Internet have been critical to sustain certain continuity in business, jobs or studying from home, although the digital divide, notably the lack of high-speed broadband Internet has prevented from reaping the benefits to all. Going further, digital technologies can play an important role in the recovery, while addressing the persistent challenge of low productivity (OECD et al., 2020

The economic slowdown of previous years coupled with the drop in activity caused by this pandemic is already having negative effects on living standards and well-being. This is in particular true for poor and vulnerable workers, among which around 74% are informal. Regarding both current and future well-being of Latin Americans, the pandemic may touch every aspect of people’s lives with several dimensions

Fiscal policy is playing an essential role in mitigating the negative economic and social effects of the pandemic, and will continue to be pivotal in the subsequent recovery. Weak automatic stabilisers in the region (Espino and González Rozada, 2012[11]), with fragile or non-existent unemployment insurance, high levels of informality and low tax revenues, make discretionary fiscal responses to the crisis even more urgent than in European countries, for instance. At first, the aim of fiscal policy should be to stop the spread of the virus, through support for preventive programmes, detection and treatments, and to support businesses continuity and protect jobs. Most economies of the region have already started implementing such programmes. The measures aiming to mitigate the effects of the Covid-19 crisis should be designed as temporary, in order to not compromise fiscal stability in the future (Izquierdo and Ardanaz, 2020[12]).

Countries’ ability to react with fiscal policy to the pandemic will depend on the starting fiscal position and their access to international markets. Before the Covid-19 crisis, fiscal space in the majority of countries in the region was already limited as many economies were undergoing fiscal adjustments. Fiscal deficits are the norm in most countries of the region, but a large group of countries have implemented fiscal rules, including Chile, Colombia, Mexico and Peru that should allow for some countercyclical policies. Despite high heterogeneity, tax revenues remain scarce at close to 23% of GDP, more than 10 percentage points lower than the OECD average (OECD/ECLAC/CIAT/IDB, 2019[13]). Moreover, fiscal policy has not been sufficiently effective in reducing inequalities and promoting entrepreneurship (OECD et al., 2019[2]; Izquierdo, Pessino and Vuletin, 2018[39]).

Debt levels have been on the rise since 2014 in almost all countries. Public debt-to-tax ratios increased in most countries, leaving them in a weaker position to face the Covid-19 crisis than in 2007, before the 2008 financial crisis (Figure 1). While on-going international discussions on the outstanding public debt obligations, in countries such as Argentina or Ecuador, should affect access to international capital markets, this process of debt restructuring should contribute to restore fiscal space later on. Caribbean countries are highly indebted and may face constraints to borrow. In 2018, 3 out of the 25 most highly indebted countries in the world (measured by gross general government debt levels relative to GDP) were in the Caribbean: Antigua and Barbuda, Barbados and Jamaica (IMF, 2019[36]; OECD et al., 2019[2]). Going forward, tax measures to address the Covid-19 crisis and the consequent economic slowdown are likely to take a toll on tax revenues. Similarly, and despite the limited space for increasing debt, governments will have to access financial markets. Rising interest rates, due to growing risk aversion and sovereign bond spreads (see section below), should make multilateral loans a priority (see section on policy priorities).

The sharp decline in global and regional economic activity in 2020 will have an impact on LAC’s external accounts. Current account balances in Latin America had slightly deteriorated in 2019, following the slowdown in international trade and the correction in commodity prices. However, with few exceptions, current account deficits were financed by foreign direct investment (FDI). The expected slowdown in global and regional economies caused by the Covid-19 crisis will worsen these dynamics. Demand from the rest of the world, due to a fall in consumption, has dropped. Trading partners are postponing investment decisions while the decline in international demand is triggering a dramatic fall in exports from the region. As of early April 2020, oil prices have fallen by 60% since the beginning of the year; copper, iron, soybeans, sugar and coffee prices have also sharply declined. With containment measures expected to remain in place for some time, LAC exports are expected to contract even further (IDB, 2020[14]). For the case of South and Central America, merchandise trade could decline in 2020 between 12% and 31% compared to 2019 (WTO, 2020[15]). On the other hand, strong currency depreciations will make foreign goods more expensive, pushing imports to fall but increasing the competitiveness of the regions’ exports. It remains to be seen which effect will prevail, what seems undisputed is that FDI will deteriorate. On a global scale, FDI is expected to fall between 30% to 40%, decreasing the most in economies that are most severely hit by the pandemic (UNCTAD, 2020[16]). The fall in remittances will also further weaken trade balances, with a likely stronger impact on Central America and Mexico. Conservative estimates show that remittances originating from the United States will fall by 3% in 2020 (Inter-American Dialogue, 2020[17]); this could decrease further due to border-crossing restrictions that will cut back sharply migration flows, such as seasonal workers to the United States (see section below on the impacts on households and firms).

LAC economies will be highly affected by the slow-down in their trade partners, notably the People’s Republic of China (hereafter “China”) and the United States. China has become the main trading partner for many South-American economies (OECD/CAF/UN ECLAC, 2015[18]). China is not only a major importer of raw materials, but also a direct investor and a credit provider to LAC economies, mainly to Argentina, Brazil, Ecuador and Venezuela (Inter-American Dialogue, 2020[19]). On the other hand, the contraction in the United States will mainly affect Mexico, Central America, Colombia and the Caribbean.