Lessons from History: Recovery (or not) post a recession.

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Countries across the globe are on the brink of entering a recession that might be the biggest the world has ever seen since the *Great Depression* almost a century ago. Businesses, economists and governments worldwide are already thinking about ways in which they can provide stimulus to economies and set them on the path of recovery as soon as possible.

There are a host of examples of how countries performed post-recession; on the one hand, there are those that miraculously bounced back to even become one of the strongest economies in the world, while on the other hand, some continued to struggle for years on a path to recovery.

GERMANY:

After World War II, the German economy was in ruins and the country was split into two – West and East Germany. The *"German economic miracle"* or *Wirtschaftswunder* saw Germany become the third largest economy in the world, behind Japan and US in GDP terms by the time Berlin Wall fell and both the parts of the country were reunited.

After the War, Germany adopted a multi-pronged approach. The economist, Walter Eucken developed the “social market economy”, which was a very radical idea at the time. The social market economy promoted free market economy while allowing government to create social policies such as setting up a large social welfare system. This might seem normal in today’s age, but it was a revolutionary idea at that point in time.

This was further taken forward by one of Eucken’s protégé, Ludwig Erhard. As a first step, he played a large role in setting up a new currency that would replace the existing currency that had lost much of its value during the war.

Secondly, as we discussed last week, tax cuts were employed in large measures. The government announced tax cuts were instituted to spur spending and investments.

A large part of the German miracle is also attributed to the *Marshall Plan* instituted by the then US Secretary of State George Marshall. The plan outlined $13b ($130 billion in today’s money) to war torn European countries. A large proportion went to Germany and helped in government spending in building infrastructure such as transportation hubs, agriculture, factories etc. As we discussed last week, government fiscal policies aimed at enhancing government spending helps to re-build the economy and move faster out of a recession. This plan helped create more jobs directly as well as indirectly through the infusion of capital.

GREECE:

Greece is still recovering from one of the deepest depressions in economic history. Between 2009 and 2017 the Greek government’s debt rose from €300B to €318B. However, during the same period the Greek debt-to-GDP ratio rose up from 127% to 179%. Hit with its massive liquidity crisis, the economy was rescued through multiple bailouts by IMF and others and a heavy haircut on the debt owed to private banks. The sovereign debt crisis had resulted in the widening of bond yield spreads and rising cost of risk insurance on credit default swaps compared to the other Eurozone countries, particularly Germany.

In response to the crisis, the Greek governments implemented a few measures including the resolve to raise the tax rates dramatically. A study showed that indirect taxes were almost doubled between the beginning of the Crisis and 2017, which had its own consequences.

In the second quarter of 2019, total gross spending was up almost 5% but both consumption (-0.7) and investment (-5.8) receded. Instead, savings as a percentage of gross income increased, from -7% (Q1) to +0.2% (Q2), as both households and enterprises facing systemic global uncertainties seem reluctant to spend. There are also some other symptoms that threaten to lead the economy into a weak growth path in the coming years. Household spending has decreased in the last five years: €123.6B (2014) to €120.1B (2019). Total spending stood at €165B in 2014 and €159.9B in 2018. This is not a coincidence either. The workforce once stood at 5M in 2010 but decreased to 4.75M by 2018. Worst of all, inflation was negative for the sixth consecutive month (-0.7% in October) and may be at least partly attributed to a persistence of relatively weak demand rather than to productivity, which remains stagnant.

Even with a Fitch’s credit rating of BB stable, the current forecasts suggest that Greece may not be equipped to grow at a rate high enough to allow the repayment of debts far into the future; the country’s economic woes didn’t just disappear even with all the drastic measures taken.

GLOBAL ECONOMY IN THE COVID CRISIS:

Today, in the midst of the Covid crisis, it’s not just a single economy, rather the entire world is at a standstill and has been termed as “humanity’s darkest hour” by the IMF. The combination of economic downturns, capital flights, commodity price collapses, political instability resulting from the social consequences of the epidemic and a pervasive “risk off” sentiment in the markets may in the coming months make it difficult or impossible for some countries to refinance their debts — what the economists call a *sudden stop*.

·       Emerging markets and developing countries have about $11 trillion in external debt and about $3.9 trillion in debt service due in 2020.

·       Of this, about $3.5 trillion is for principal repayments.

·       Around $1 trillion is debt service due on medium- and long-term (MLT) debt, while the remainder is short-term debt, much of which is normal trade finance.

In normal circumstances, the principal amounts would simply be refinanced in global capital markets or offset by new disbursements from existing lenders, but the scenario today is anything but normal. *90 countries have already approached the IMF* to access emergency financing instruments; thus far, India has received the largest loan at $1B. Debt threatens to create a global development emergency in much the same way as the pandemic is creating a global health emergency. Both could result in social unrest and instability.

POTENTIAL MEASURES:

Some of the measures based on past lessons that could help control the crisis are as follows:

·       A debt-shield mechanism would help prevent commercial creditors from potential suing of the government to collect on sovereign debt.

·       Swap agreements between Central Banks in advanced economies and developing countries could be extended, along with access to IMF and multilateral development bank resources, to permit orderly management of the balance of payments over the next few months.

·       Market-specific measures based on a case-by-case debt sustainability analyses, undertaken jointly between debtor governments and the IMF/World Bank, to determine if, and by how much, debt write-off or rescheduling is needed.

Although we would all hope for an “economic miracle”, one does need to take a pragmatic perspective of likelihood, given the statistics at hand. We believe that like COVID-19, there is a need to flatten the curve of debt rescheduling in a timely and urgent manner, so that the peak falls within the capacity of the system to handle them. While how quickly governments should unshackle their economies is a matter of debate, there is a dire and imminent need for the governments to act collectively and decisively in order to stabilize the financial markets.

Source:

https://www.investopedia.com/articles/economics/09/german-economic-miracle.asp

https://www.brookings.edu/blog/up-front/2019/03/06/greek-economy-from-bailout-program-exit-to-recovery/

 https://www.brookings.edu/blog/up-front/2019/12/11/greeces-recovery-bet/

 https://tradingeconomics.com/greece/rating

 https://www.brookings.edu/blog/future-development/2020/04/13/what-to-do-about-the-coming-debt-crisis-in-developing-countries/

 https://ftalphaville.ft.com/2020/03/25/1585171627000/From-coronavirus-crisis-to--sovereign-debt-crisis/

 https://www.cfr.org/backgrounder/coronavirus-how-are-countries-responding-economic-crisis

https://en.wikipedia.org/wiki/Greek_government-debt_crisis

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