The opening sentence of Tolstoy's Anna Karenina is among the most famous in world literature, but it has a special significance to economists, for whom it represents a principle that can be applied in multiple contexts and fields of study. The Anna Karenina principle states that success requires the comprehensive fulfilment of a set of necessary conditions, and the absence of any one of those conditions will lead to failure. Consequently, successes are all fundamentally similar, as they reflect the presence of the same array of factors, while failures are diverse, with each stemming from its own unique deficiencies.
The global economic crisis surrounding the Covid-19 pandemic inverts the Anna Karenina principle. The causes of the pandemic-induced shock-lockdowns, border closures, the collapse of trade, travel bans, and financial market volatility-were common across countries and regions, while the projected recovery will be marked by the divergent circumstances of each country and the idiosyncrasies of its policy response. Success in the post-pandemic era will reflect a constellation of policies and capacities peculiar to each country, including national vaccination rates, integration into major economic blocks, the ability to provide fiscal and monetary stimulus, and the restoration of solvency in the private sector. While all "unhappy" countries will be essentially alike, each "happy" country will be happy in its own way.
While every national recovery will hinge on country characteristics, the success or failure of major economies and economic blocs will profoundly influence the outlook for smaller economies and developing countries. Recent progress in the vaccination rollout in the United States and other advanced economies has raised expectations for the global economic recovery. According to the Spring 2021 edition of the International Monetary Fund (IMF)'s Word Economic Outlook (WEO), the global economy is projected to expand at a rate of 6 per cent in 2021, up from the 5.5 per cent growth rate projected in January, due to the faster-than-expected recovery of advanced economies. Bolstered by unprecedented fiscal and monetary stimulus, the United States, China, and Western Europe are poised for a swift rebound: annual Gross Domestic Product (GDP) growth in the United States, China, and Western Europe are projected to reach 6.4, 8,4 and 4.5 per cent, respectively, in 2021. Latin America and the Caribbean (LAC) and Europe and Central Asia (ECA) are projected to grow by 4.4 per cent and 3.6 per cent, respectively, albeit with large disparities across countries.
Differences in vaccination rates are driving the divergence in growth projections, as the easing of pandemic-related restrictions and the resumption of mobility, production, trade, and travel all hinge on widespread vaccination. While good progress has been achieved overall, vast disparities in vaccination coverage align closely with national income levels. The slow progress of vaccination efforts in developing countries threatens to hinder their recovery while also exacerbating the global risk of virus mutation. Several countries that are currently facing renewed waves of contagion and/or new viral strains have been forced to re-impose restrictions and delay the return of normal economic activity.
A second driver of divergent recovery trends is the extent of each country's integration into international value chains linked to advanced economies. As global economic activity rebounds, the World Trade Organization (WTO) projects that merchandise trade will grow at a rate of 8.0 per cent in 2021. The reestablishment of global and regional value chains is also boosting trade in capital goods and intermediate inputs. For example, the growth of US industrial output is expected to accelerate the recovery in Mexico's manufacturing sector due to the strong synchronicity between the business cycles of the two countries. Similarly, given the close integration of many developing countries in ECA with the European Union, the restoration of European regional value chains is expected to enhance growth prospects across ECA. As global economic activity recovers, prices for oil, metals, food and other commodities are expected to rise. Recovering commodity prices have already bolstered growth in some ECA countries, including Kazakhstan and Uzbekistan, as well as in LAC countries such as Brazil, Colombia, Chile, and Peru. Although higher commodity prices will be tailwinds for resource-rich commodity exporters, they will be headwinds for net importers, especially developing countries that rely on oil imports. Trade in services will likely remain subdued and is not expected to return to pre-pandemic levels before 2022. The hospitality and travel sectors continue to be the most severely affected by the crisis, and tourism-dependent countries in the Caribbean and the Balkans face a slow and uncertain recovery.
A third source of divergence is in the policy response adopted by fiscal and monetary authorities. Several counties are confronting inflationary pressures that will limit the ability of their central banks to maintain accommodative monetary policies. Expansionary monetary stances, rapid credit growth, exchange-rate depreciation, and rising commodity prices have amplified inflationary pressures in Brazil, Kazakhstan, Mexico, Russia, Turkey, and Ukraine. Many central banks either already hiked benchmark policy rates in Q1 2021 or have signalled the end of their easing cycles. Though necessary to manage inflation, monetary tightening could dampen prospects for a swift recovery by putting pressure on interest rates, spurring capital outflows, or weakening exchange rates. Tighter monetary policies in advanced economies could also worsen financing conditions for emerging markets and intensify the volatility of capital flows, especially to the most vulnerable ECA and LAC economies. Even in the absence of monetary tightening, US 10-year bond yields have risen sharply in Q1 2021, putting pressure on emerging-market exchange rates that may need to accelerate the tightening of their monetary policy stance.
Fiscal pressure has also intensified as governments strive to extend emergency economic support without undermining investor confidence. The pandemic-induced recession has triggered a surge in deficits and debt levels in many economies, especially LAC and ECA countries, many of which had already experienced a rapid debt build-up prior to 2020. Unsustainable debt dynamics could compel governments to rescind vital fiscal support before a broader recovery has fully consolidated. While fiscal deficits are projected to narrow, on balance, between 2020 and 2021, they are expected to remain large by historical standards. Narrowing fiscal space will weaken the ability of many governments to provide further cyclical support, though Chile and Peru are notable exceptions in the LAC region which have some additional room to continue to foster economic activity. In ECA, while fiscal space is narrowing in many countries including the Western Balkans and Ukraine, the EU Recovery & Resilience Facility will provide sizeable grants to Romania, Bulgaria, and Poland. Resource economies in Central Asia can continue to provide stimulus financed by high commodity prices. If public debt trajectories become unsustainable, some countries may resort to financial repression to prevent a surge in borrowing costs, accelerating inflation and weakening their currencies.
A final contributor to the uneven global recovery is the relative vulnerability of each country's private sector. Corporate debt burdens in emerging markets and developing economies (EMDEs) were already at historic elevated levels before the Covid-19 outbreak: with easy access to international credit markets, foreign-denominated liabilities accumulated over the last decade, resulted in a currency mismatch between earnings and debt service that heightened corporates vulnerability to exchange-rate shocks and rising global risk aversion. By the end of 2019, corporate debt levels in Ukraine, Poland, the Slovak Republic, and Slovenia were close to 50 per cent of annual GDP, while in Bulgaria, Russia, and Turkey this ratio had reached more than 70 per cent. Corporate debt levels are relatively low in the LAC region, except Chile, where corporate debt exceeds 100 per cent of GDP. Corporate vulnerabilities in EMDEs have risen sharply during the pandemic, especially among firms with high pre-existing debt burdens and those operating in sectors that were particularly exposed to the economic impact of COVID-19. In the aftermath of the pandemic, policymakers in many EMDEs have focused on preventing firms from being prematurely driven into insolvency through an unprecedented injection of liquidity and the adoption of forbearance measures to enable banks to expand credit to the real sector. However, government forbearance has obscured the line between firms that are illiquid and firms that are insolvent (i.e., "ghost firms"), and nonperforming loan indicators do not fully capture the deterioration of asset quality in the financial sector. High corporate risk premiums indicate an elevated risk of debt defaults, and firms facing large debt overhangs may reduce future investment and grow more slowly over the medium term. The divergence in recovery paths will reflect the relative ability of national policymakers to facilitate smooth debt workouts and ensure that debt-restructuring mechanisms and solvency frameworks function effectively. These conditions are especially crucial in EMDEs, where bankruptcy frameworks are generally weaker and where inefficient debt resolution often leads to the excessive destruction of capital, even under normal circumstances.
The writers are with The World Bank Group. The piece is excerpted from World Bank Blogs. (www.blogs.worldbank.org)
