The Dark Side of the Moon. Responding to the COVID-19 Crisis in Developing Economies

By: Agustin Redonda

Besides China and Iran, the impact of the coronavirus has until now been most severe in advanced economies including France, Germany, Italy, South Korea, Spain and the US. This is unlikely to remain so. As the virus continues its spread around the world it will increasingly hit developing economies, where many households lack access to water, and economic as well as health systems are considerably less resilient to cope with the impact of the outbreak.

Coping with Constrained Fiscal Space

Shifting government spending towards the health sector is a critical first step. Mitigating the economic impact that the crisis will inevitably trigger follows closely thereafter.

In rich countries, there is widespread agreement to spend now and spend big with a debate on the specific response strategies to deal with the crisis. The scenario for poor economies is far more complicated. Regardless of whether governments decide to stick to traditional fiscal measures (e.g. tax reliefs or cash transfers) or opt for more heterodox policies (e.g. rent and evictions suspensions as implemented in France, or waivers on utility bills such as the one currently being debated in Pakistan), the bulk of the cost will likely be socialized, and the burden will fall on already devastated public coffers.

Against this background, the lack of fiscal space is a key constraint that these countries need to cope with. Emergency packages such as the EUR 750bn program that the German government just adopted are out of reach for countries in the developing world. Tumbling commodity prices and capital outflows further aggravate the challenge.

Given this context, external constraints that limit fiscal space must be reviewed. Argentina, for instance, has been on track towards meeting the primary deficit target agreed with the IMF in the context of the Stand-By Arrangement approved by the Fund in 2018. Yet, the response package recently announced by the government will boost public spending and make it unlikely that the target will be reached. As debt negotiations proceed, the role of the IMF and private debtors in facilitating access to international capital markets will be crucial in helping the country to mitigate this shock.

International donors must also move fast to mobilize additional resources to help poor economies come through this storm. The recent call by the World Bank’s President, David Malpass, for G20 leaders to suspend debt repayments from poorest countries is a promising step in this direction.

It’s Informality, Stupid!

Another crucial difference between rich and poor countries lies in the size of the informal economy. The share of informal employment in total employment amounts to 90% in developing countries, close to 70% in emerging markets and under 20% in the developed world, with some rich countries showing shares below 5%. The implications of these differences are significant.

First, as recently pointed out by Eduardo Levi Yeyati, in countries where the informal sector plays a larger role, GDP provides only a partial picture of the economic impact of the crisis. Second, informality reduces the tax base (i.e. the number of individuals that pay taxes), which further reduces the fiscal space and, at the same time, diminishes the number of people that can be supported through tax reliefs. Indeed, any measure implemented through the tax system will not reach informal workers. Third, informality has a compounding effect on inequality since the more vulnerable sectors are likely to be overrepresented in the informal economy. Indeed, as discussed by in a 2018 ILO report, poverty is both a cause and a consequence of informality since “ … the poor face higher rates of informal employment and [] poverty rates are higher among workers in informal employment.” Moreover, as indicated in the same report, women are more exposed to informal employment in most low- and lower-middle income economies, which exacerbates gender inequality. Fourth, and equally crucial for the design of response measures, informality poses challenges in providing cash transfers such as universal basic income programs, e.g. by making it more difficult to identify and reach all potential beneficiaries. Relying on mobile phone, internet and other service providers to target beneficiaries might be an effective approach to address this challenge.

Context-specific response strategies

Most policy responses that are currently on the table are focused on advanced economies. Yet, sooner than later, the coronavirus outbreak will hit poor countries. And the impact will very likely be significantly larger. Yet, these countries will not be able to mimic the response policies implemented by rich nations. Policy makers must increase their efforts to anticipate the impact of the outbreak in the developing world and come up with effective, context-specific response strategies. In many cases, the role of international organizations such as the World Bank and the IMF through mobilization of resources and the provision of technical support will be crucial to help developing countries to weather the storm ahead of them.

Originally published on the CEP website on March 25, 2020.