There are a couple of things that economists agree on, though. First, this is both a demand and a supply shock. While the lockdown of production systems across economies will dent incomes, it will also mean shortage of critical goods and services, and, hence, inflation. The path that policymakers need to tread will depend on which of these factors are dominant. The current wisdom is that fiscal and monetary policy have to focus on crumbling demand.
Going forward, the supply and price effects need to be kept in mind. The second — and, perhaps, more important —thing that economists agree on is that Covid-19 will work through two effects.
The immediate, or first round, impact of, say, shutting factories and offices will be on output and income. But the bigger, and more lingering, impact is the second-round impact on the global supply chain — the fact that the manufacture of any product has become extremely fragmented with different countries pitching in at different stages of production.
The implication: the lingering shortage of intermediate goods could keep the economic contagion alive even if the pure biological contagion were to be contained in the bigger economies. The fact that the ‘mother factory’ of industrial inputs, China, has both ‘hatched’ the virus and has been the hardest hit by it, makes the second-round supply chain effect more critical this time.
Finally, researchers find that with the advent of global super-specialisation, substitutes for industrial inputs are difficult to find.
This global value chain (GVC) effect will also determine how quickly an economy recovers from the virus.
The deeper it is ‘plugged’ into the GVC, the more its vulnerability. An economy that is more self-reliant both in terms on input-dependence and export demand will recover faster. From that perspective, India could be better off than its emerging market peers.
The GVC is itself a complex creature. Every stage of ‘value addition’ might belong to a different geography. To take an example, the production of a German car might involve dozens of stages of value addition, starting from ore mined in Australia, to parts manufactured in China, to processing done in Eastern Europe, and finally the assembly and spit-and-polish in Germany itself. Recovery of the German industrial economy depends critically with how every link in this value chain handles the virus impact.
A couple of things need to be recognised about how the GVC has developed over the last few years. Ever since the 2007-08 Great Financial Crisis, economies’ participation in the GVC (that is, its dependence on offshoring) has declined considerably.
Using the Unctad-Eora database, economist Alicia García-Herrero, in her presentation, ‘China and the Transformation of Value Chains’ (bit.do/fzaNC), estimates that the participation rate would have dropped by a good seven percentage points from its 2008 peak.
However, in this period, China has increased its share of intermediate exports to the West. Europe and the US have become more dependent on China for inputs at the expense of its neighbours. Intra-European trade in intermediates and US dependence on Latin America have dwindled.
At the same time, China has become more vertically integrated, producing inputs itself and relying less on its Asian neighbours. The rest of North Asia has aligned more with Southeast Asia. This, in effect, is creating two Asian ‘factories’ — a standalone China industrial complex, and non-China complex that includes the likes of South Korea and Asean.
Given these changes, the optimist may want to conclude a few things. If China is up and running (and, indeed, there are reports of factories getting back to full capacity), the prospect of a prolonged recession in the western hemisphere on the back of an industrial input famine reduces. If the western giants were to revive, they could drive global trade back up.
China’s self-reliance would mean that if the rest of Asia has to lock down if the virus spread is unchecked, China’s industrial production will be relatively unhampered.
However, weakening industrial links between China and the rest of Asia will mean China’s recovery will not bootstrap the latter’s growth rates up. The rest of Asia has to recover on its own to some extent.
Most experts agree that the global economy will go through a sharp slowdown, and all regions are likely to be affected by it. However, any assessment of how long the gloom will continue beyond this year will depend fundamentally on two factors.
The obvious first is the containment of infection. The second is the speed with which the complex GVC machine gets rolling again.
The writer is chief economist, HDFC Bank