By Maxim Nikolenko.
At no other point since the Second World War was the international order so vulnerable as it is today. The crisis it faces is holistic. Across the developed world, the quarantine measures are having a severe impact on consumption, manufacturing and interstate commerce; across the developing world, where the pandemic has only started, disruptions in world trade and falling commodity prices risk producing an economic disaster. After the health emergency is over, sovereign nations must maneuver in a new environment of convergent and divergent interests. The US and China will enter a more aggressive phase of great power competition; Europe must find a way to deal with the two as its international leverage declines. It took less than a month to put the international system under lockdown; it will take years to open it up.
The future of Trilateral Alliance
North America and Europe are the most-affected regions by COVID-19 pandemic. These are also the main engines of the post-war trilateral alliance, incorporating the United States, Canada, Europe and Japan. The pandemic is causing an unprecedented dislocation in all these countries, threatening to augment old disputes that can fracture the alliance during the recovery period.
While Europe is the epicenter of the global pandemic, New York has become the main cluster of the rapidly spreading disease in United States. With over 25,000 registered cases, life in the financial capital of the existing international system is at the standstill. “Ironically, the more effective you are in reducing exposure and slowing down the pace of the contagion,” the longer it will take to restore things back to normal, admitted Kathy Wylde, head of an elitist Partnership for New York City. Simply put, “the economic damage is inverse to the success in slowing the disease.” This statement should be considered as the governor of California, another important economic area of the United States, issued a statewide order for people to stay home. There are no reliable estimates of how many people have already lost their jobs because of such measures. The situation is rapidly deteriorating across all sectors of the economy. As layoffs occur in the service sector, an announcement was delivered by General Motors on March 18 that the company will begin a “systematic orderly suspension of manufacturing operations in North America…”
Domestic consumption, the hitherto backbone of the US economy, will inevitably suffer as people stay home. Resorting to the Keynesian stimulus package that includes, along with the funds to bailout Wall Street, direct cash transfers to American households, the Trump administration is unlikely to restore demand in the near future. The shock is not only material but psychological. In New York, for instance, 38.9 percent of households do not have savings to cover a single month’s rent after losing their source of income. Gov. Cuomo’s 90-day moratorium on evictions only postpones the looming crisis. Would people, even those who manage to find prudent employment after quarantine, be willing to spend after experiencing such a dramatic disruption?
In Washington, all the stimulus instruments are deployed to combat the fire, not rebuild what was destroyed on its path. On March 3, the Federal Reserve panicked. Trying to reassure Wall Street, it slashed interest rates by 50 basis points to 1.75 percent at the time when there were only 124 COVID-19 cases in the country, reducing its capacity to act when the real storm started. As the sell-off on the markets continued, the interest rates were cut to a range of 0-0.25 percent. Thus, if America and the world fail to recover quickly, the Federal Reserve no longer has the conventional stimulus mechanism to save the day. Currently, the prospect of strong recovery and growth that can facilitate a rate hike only exists in one’s imagination, more especially because of the deteriorating situation in other developed countries.
Before the outbreak, the United States had trade disputes with Europe and a full-blown trade war with China (the latter will be discussed later). The largest export market for American products is the European Union; the largest export market for products of the European Union is America. In fact, one-fifth of all European shipments depend on the US consumer. The prospect of European firms suffering a loss due to falling demand in America is just part of a problem. A dramatic demand disruption in Europe, where the health emergency is even worse, risks hurting US exporter and augmenting the present trade disequilibrium between Washington and Brussels. Basically, the United States buys more than it sells to Europe. President Trump repeatedly mentioned this, complaining that the EU is “more difficult to do business with than China.” Trade tensions could rise dramatically when both America and Europe try to recover their pre-pandemic export volumes.
From all the trilateral countries, Europe was least prepared, both economically and politically, to deal with the crisis. The eurozone is not a single political unit. Twenty-seven sovereign countries, with different levels of economic development, operate within a single ecosystem of trade rules and division of labor. That ecosystem was in trouble even before the outbreak of COVID-19. The decade of modest economic growth, facilitating austerity for the poor and capital accumulation for the rich, saw the European Central Bank cut interest rates below zero. The conventional mechanism was absent as the number of cases skyrocketed across all countries of the Union. The only alternative available is to print more money. But the ECB’s current 750 billion-euro fix will not be enough to cover the expenses of borrowing countries.
The situation is desperate. With combined GDP exceeding $6 trillion, Italy, Spain and France are on lockdown. Such drastic measures can be justified. Over 10,700 individuals have died in these three countries alone. Amidst an unprecedented health crisis, no one rushes to assess how much pain the virus fight will inflict on the economy. An agreement seems to be unanimous that the damage is immense.
It is impossible to prevent the living standards from declining by a printing press. The lockdown on public life prevents tens of millions of people from going to their jobs. Would the enterprises providing those jobs survive the pandemic? Many will not. As an example, while the lockdown might last for no longer than a month, it is unlikely that Europeans will travel a lot for the rest of 2020, a devastating prospect for the tourist industry in France, Italy and Spain. The ensuing bankruptcies will have an impact on the banking sector. Italy is particularly vulnerable in this regard. The Greece-style bailout might not be a realistic option for a $2 trillion economy, not to mention the unacceptable pain it will inflict on the Italian people. Plus, it is still unknown how bad the situation will get in France and Spain.
Declining purchasing power of the population in France, Italy and Spain would have an adverse impact on Germany, the industrial engine of Europe. Deutsche Bank already predicts Germany to shrink 4-5 percent in 2020. The industrial output is expected to contract 10 percent. In the first half of March, there were reports that car demand in Italy would shrink 15 percent this year. As the crisis gets worse, that figure now sounds too optimistic. What about Spain and France? What about Austria, Netherlands and other countries battling the disease?
It is also worth noting that Germany itself has over 30,000 confirmed COVID-19 cases. The lockdown has not yet been instituted at a national level. Nonetheless, things would only get worse unless the current restrictions, forbidding people to leave home unless traveling to work, the doctor and grocery shopping, prove successful at slowing the virus.
There is no way to establishing how long the restrictions will last. Every passing day increases the cost of these preventative measures, augmenting the obstacles Europe will face as it struggles to recover.
Ultimately, every country is negatively impacted in one way or another. Yet divergencies can develop as each must pursue the recovery policies it needs to address its specific problems. Export-driven Germany, for instance, can recover if other members of the bloc start buying its products at pre-pandemic volumes. But can Italians afford to buy when their incomes are falling, and the government debt is rising? What is good for Germany may be bad and unsustainable for Italy and other ‘peripheral’ economies of the bloc. What about external trade? Would Europe, while experiencing a declining consumer demand at home, decide to compensate by pressing on the United States to accept more of its products? How will the “America First” Trump administration react to this? The crisis creates an ideal environment for the rise of economic nationalism across the transatlantic community.
It is also important to note that the crisis reduces Europe’s power vis-à-vis the United States and China. The European demands will remain the same; her power to weight on those demands would decline. In this situation, if countries fail to establish a harmony of interests within the bloc, Brussels would not be able to negotiate prudent trade relations with both Washington and Beijing.
To top it off, harmony within the bloc is essential for the survival of the whole alliance. The American-led system cannot survive without a cohesive and united Europe, yet its national interests do not always act favorably on this cause; Europe cannot survive on the international stage without political unity, yet the national interests of individual member countries can implicate cohesion. The future of alliance ultimately depends on whether general cohesion can survive this unprecedented cataclysm.
The US and China
China was the first country to suffer, and the first one to recover, from the virus. What just a month ago threatened to burry China’s ambition is now causing paralysis to its main geopolitical competitors.
In January, as the pandemic was growing out of control in the industrial city of Wuhan, the government had to take draconian measures to prevent its spread into other areas of the world’s most populated country. The whole Hubei province – where the 10-million Wuhan is located – was sealed off. Tens of millions of workers headed to the countryside for Lunar New Year, were told not to come back until the quarantine is over. After hiding and downplaying the threat, Beijing deployed all the available resources to fight the virus, erecting huge hospitals in Wuhan and exploiting artificial intelligence to control people’s movement.
For a moment, it was conceived in Washington that the pandemic will weaken its main “strategic competitor.” In the end, the problem of how to address the rapid rise of China has existed for years.
The economic impact of such measures is dramatic. Industrial output contracted by 13.5 percent in the first two months of the year. Retail sales are down 20.5 percent. The world’s second-largest economy is expected to experience its worst quarterly decline since the Cultural Revolution. This is happening as Beijing fights a bitter trade war with the United States. Already in January, the latter affirmed that the crisis does not mean it will ease the tariffs imposed on the imports from China. Indeed, “it does a disservice to this whole crisis to bring that into the discussion,” commented White House trade advisor Peter Navarro. That’s because “the tariffs… ensure that we come back for phase two” trade agreement, i.e., exercise greater leverage at negotiations.
By 2020, the divergent interests of the two entered a phase of big power rivalry. The latter, growing into the world’s second economy and the largest exporter of manufactured products, could no longer rely on the structure of the existing order to facilitate its needs. The subsequent trade war with the United States, coupled with a gradual slowdown in the domestic economy, put China in an increasingly difficult spot. The pandemic was the last thing Beijing needed at this point.
Yet as the quarantine measures proved successful, China transformed the weakness into its strength, opening up as a humanitarian power on the mission to save the world from a growing health emergency. After transforming production to fight the virus at home, she now has the capacity to export those supplies abroad. Beijing sends thousands of masks, gloves and test kits to the hardest-hit countries in Europe. Sending a message to these governments, President Xi Jinping declared that “public health crises pose a common challenge for humanity, and solidarity and cooperation are the most powerful weapons to tackle it.” While the mood of solidarity is important at this point, it could evaporate quickly when China moves to make decisions on the economic front.
So far, Beijing has done relatively little to revive the ailing economy. The central bank slashed interest rates by less than 100 basis points to four percent. Unlike the trilateral governments, her conventional mechanism is in good shape. Some stimulus package is expected to arrive in the coming months. As one economist observed to the Financial Times, “There’s a good chance that China was the first to go down and will be the first to come back.” It is quite likely that the stimulus package will be postponed until the quarantine in the West is over. Good timing could place Beijing in an advantageous position vis-à-vis the rest of the world. The Western countries directed their stimulus measures to save the global economy at the time of the outbreak; China finds itself in a position where it can stimulate its revival after the emergency is over. How will America react to this? It is quite possible that we are on the verge of entering a more aggressive phase of great-power competition.
A lot will depend on whether general cohesion survives among the trilateral countries. Japan is unlikely to abandon the US-led system for its prosperity depends on it. Tokyo needs America to balance its relations with a powerful Asian neighbor. Serious problems could, however, arise in Europe. But China also needs to be creative to transform the international order. Before, mutual gain ensured cohesion among the trilateral countries; now, a mutual sense of vulnerability and the need to survive can prevent the alliance from fragmenting. Before, China gained by exploiting the rules of the existing order; now, to gain, Beijing needs a vision where its interests go in harmony with most member countries of the American alliance.
Relations between developed and developing countries
The pandemic is only now reaching developing countries. They will also be the last ones to recover. High debt levels, low commodity prices and government quarantine measures will have an adverse impact on all the peripheral economies. The subsequent political turbulence creates an opportunity for the people in the latter to articulate demands that were suppressed under the normally functioning liberal international order.
Even before cases started to appear in Nigeria, Brazil, Philippines, Indonesia, Burkina Faso, etc., the resource-producing developing economies suffered a blow as global crude prices fell below $30 a barrel. The virus is only partially to blame for this development. As pandemic in China pushed the world prices into the low 50s, the oil producing powers decided to compete for the market share. Russia, whose budget is adjusted to prices as low as $42 a barrel, sought to hurt America’s less flexible shale producers; Saudi Arabia, whose budget needs oil to be above $70, decided to avoid slow peril by risking a price war with the other two. Since OPEC-Russia talks on the production cuts collapsed a few weeks ago, there is no evidence that either the cartel or Moscow is prepared to blink first. Russia’s energy minister Alexander Novak spoke soon after negotiations that the country has enough reserves “to remain competitive at any production price range and keep its market share.”
This happens amidst the demand disruption across the developed world. The quarantine reduces both domestic and international travel while falling incomes and rising unemployment can perpetuate this trend for many months to come. Subsequently, it is safe to say that oil will remain cheap for a lengthy period. The poorest oil producing countries – Nigeria, Venezuela, Angola, Indonesia and Algeria – already suffer because of this. Those with high debt – Venezuela, Nigeria and Angola –are facing severe difficulties.
Making payments on external debt is going to be a major challenge across the developing world. As we entered this crisis, a growing number of those countries already had to deal with the rising debt burden. The Jubilee Debt Campaign estimates that the average debt payments for 63 poorest nations are set to increase by somewhere between 133 and 216 percent before 2022. That’s with the assumption that they would experience high economic growth, which is unlikely.
Debt is not a novel issue for the peripheral economies. The structural inequality of the international system facilitates a relationship where the surplus production of industrial countries always ends up disturbing the trade balance somewhere in the developing world, resulting in a debt crisis the latter periodically suffers. Hence, the 1980s could repeat all over again. It is unclear, for instance, how indebted Argentina will be able to cope, more especially since it had to institute a lockdown to stop the virus. Turkey is another weak spot. Borrowing heavily to foster economic growth following the 2018 crisis, it now has over 1000 cases and could face a quarantine.
While the recovery in the peripheral economies will be difficult, it also provides an opportunity for a fundamental change in the way these countries interact with the rest of the world. A sudden disruption of consumer demand in industrial countries, if to last long enough, could force the peripheral owners of the means of production and capital accumulation to look for ways to substitute the export-driven economic growth model. Domestic political pressure, if successful, could facilitate this process. It is worth remembering that the import substitution and industrialization policies gained popularity in Latin America at the time when the core economic powers fought bitter tariff wars and endured the Great Depression.
