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The pandemic will structurally change the global economy more than we think

Summary:
It is time to rethink many of the basic principles of our economic model to mitigate the impacts of the COVID-19 pandemic. Those who say there are no letters left in the alphabet to describe the evolution of the world economy after the pandemic are absolutely right. It is abundantly clear now that we cannot expect to see a rapid V-shaped recovery — nor should we expect a complete stagnation or a L-shaped recovery. The square root-shaped economy The newest version of recovery, the K-shape, reflects the increasing disparity between the winning and losing sectors, including the middle class. So rather than suggest a letter, I would like to call for a different shape recovery in a post-COVID world: the square root. A square root begins with a strong upswing, much like the one we are

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It is time to rethink many of the basic principles of our economic model to mitigate the impacts of the COVID-19 pandemic.

Those who say there are no letters left in the alphabet to describe the evolution of the world economy after the pandemic are absolutely right. It is abundantly clear now that we cannot expect to see a rapid V-shaped recovery — nor should we expect a complete stagnation or a L-shaped recovery.

The square root-shaped economy

The newest version of recovery, the K-shape, reflects the increasing disparity between the winning and losing sectors, including the middle class.

So rather than suggest a letter, I would like to call for a different shape recovery in a post-COVID world: the square root. A square root begins with a strong upswing, much like the one we are experiencing now, even as the pandemic still lingers.

However, this rapid recovery is immediately followed by a structural slowdown. In other words, the problem is not so much a sudden collapse in activity, but the negative impact that follows.

The big question is: Why would the pandemic bring lower growth? There are several reasons.

4 reasons why COVID brings lower growth

Firstly, companies will be less profitable and will react by cutting fixed asset investment.

Secondly, the distribution of income will worsen worldwide. In fact, the pandemic has caused a serious deterioration in business profitability throughout the world. Similar to the global crisis in 2008, companies will want to recover their profitability and profits, for which they will have to reduce employment and wages. This will worsen the already battered distribution of income worldwide.

In other words, greater downward pressure on unit labour costs, and therefore on household purchasing power, seems inevitable. To make matters worse, the asset price bubbles stemming from ultra-lax monetary policies are bound to increase the divide between the working class and those able to invest in financial assets.

Thirdly, state intervention in the economy is leading to a much larger share of zombie companies. The fact that interest rates are to remain low will make it possible for governments to continue to finance such unproductive companies and their related misallocation of savings.

It is time to rethink many of the basic principles of our economic model to mitigate these impacts caused by the COVID-19 pandemic.

Alicia García-Herrero
Alicia Garcia Herrero is a Senior Fellow at Bruegel and a non-resident research fellow at Real Instituto El Cano. She is also Chief Economist for Asia Pacific at NATIXIS. Alicia Garcia Herrero is currently adjunct professor at City University of Hong Kong and Hong Kong University of Science and Technology (HKUST) and visiting faculty at China-Europe International Business School (CEIBS).

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