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Vanguard Chief Economist: We’re Already in a Global Recession, but Expect a Robust Recovery

Chief Economist of the Americas at Vanguard

The world entered a recession in March. That’s the verdict of Vanguard’s chief economist of the Americas, Roger Aliaga-Díaz, who spoke with BRINK editor Antoun Issa about the global economic impact of the coronavirus.

The conversation takes a deep dive at vulnerabilities and responses across the world, with a focus on the U.S., China, Brexit, the eurozone and Latin America. Aliaga-Díaz assesses the effectiveness of stimulus packages and argues the need for governments to protect “sources of employment,” not just hand out checks. 

The eurozone is the region that worries Aliaga-Díaz the most, with a lack of fiscal coordination and stimulus a troubling sign. China can say farewell to high growth in the near future, while the U.S. could see as many as 12 million workers unemployed. 

Recovery is expected to be robust, but could be complicated, Aliaga-Díaz warns, by dormant global economic issues that could return with a vengeance — the unresolved U.S.-China trade war, Brexit and eurozone vulnerabilities.

The Global Recession Began in March

ISSA: Are we in a global recession yet? And if we are, how long will it last?

ALIAGA-DIAZ: Unfortunately, after the longest expansion on record, the global economy most likely entered a recession in March. It’s truly the impact of the pandemic. Its impact on the global economy is really a function of the extreme, unprecedented nature of the measures taken — the lockdown, the social distancing measures — to contain the spread. This type of shock is unprecedented in magnitude. 

The International Monetary Fund, for example, defines global recessions as when global growth falls below 2.5%. Normally, the growth is about 3.5%. We’re estimating that this year, we may get negative GDP growth globally. For reference, in the global financial crisis, the world economy grew at 0%. So in some sense, in terms of the magnitude, this year could be even deeper than the global financial crisis in terms of growth. Now, of course, the silver lining is that we do expect the recession to be much shorter than the global financial crisis. In that sense, it’s different, so I’m not sure the comparison is fair, there. We also expect the recovery to be much more robust. 

ISSA: We are seeing a lot of models come out right now trying to determine and calculate projections based on the severity of the social distancing measures and the duration of them. So, for example, if we have social distancing for several months, then we can contain the virus in a short amount of time and that might precipitate an economic recovery. What are your projections in terms of when we can expect an economic recovery based on current social distancing measures?

ALIAGA-DIAZ: That’s actually the key aspect of where we can put all the effort and research, is to try to understand, what is a reasonable scenario for when these measures will be lifted. Essentially for when the full cycle of the virus will play out and the world has been able to basically leave the extreme lockdown measures that we have seen. Of course, there’s a lot of uncertainty about the epidemiology of the virus at this point. 

The baseline scenario we’re working with right now is one in which the new cases peak sometime in the second quarter. And under this scenario, some of the most extreme long-term measures are lifted by the end of the second quarter. Of course, we are expecting and factoring in our models that, even after the measures are lifted, there will be still a little bit of fear, uncertainty and lingering effects that will render into social distancing. So people are not going to jump immediately into planes and go to the Caribbean in July. But even accounting for that, we expect our recovery under this scenario will play out through the second half of the year. 

I would say that we’re not that optimistic as others in terms of a massive jump on July 1. We think that if the unemployment rate increases significantly through to the second quarter and we see business bankruptcies and solvency issues, we may see some bleed-through to the rest of the economy. 

We’re hoping that would be somewhat helped by the stimulus package, but that means that the recovery may not be as strong as many expect. We’ll see a robust recovery, but it will be more toward the end of the year probably. Now, the one caveat is that we do work with the probabilistic framework and there is a non-negligible likelihood that the scenario is worse than that. So we have a more pessimistic scenario in which the measures remain in place, the virus continues spreading into the second half of the year, and that, of course, is a much more dire scenario for the U.S. and global economy. 

The U.S. Could See As Many As 12 Million Workers Lose Their Jobs

ISSA: Let’s talk about the U.S. more specifically. You said that the global recession already began in March, and we’ve seen unemployment start to jump in the U.S. What are your thoughts on the U.S. economy in terms of how it can weather the storm and which sectors will be most hit?

ALIAGA-DIAZ: We are trying to track the sectors that are most affected by the social distancing measures and, as of now, we are estimating that those measures are impacting around 60% of the economy. So as we go through all the different sectors, from services to manufacturing businesses, these are affecting 60% of the total economy. In some cases, the shutdown is for pretty much 100% of the sector. So to the best of our abilities, we’re trying to keep track and assess the degree of slowing activity in each sector. 

Under this scenario, we estimate that the pandemic shock may create losses for the economy amounting to about 15% to 20% of GDP, and all that will come in between Q1 and Q2. That’s why this is so, so extreme. What are the job losses from that? We wouldn’t be surprised if we see 10 million to 12 million workers losing their jobs through this process. 

And of course, sectors that are most affected. We have been calling the face-to-face service sectors the front line, but at the point when governments started mandating stay-at-home orders and shutdown of nonessential businesses, that expands to other sectors, and that’s where the fiscal response is critical. It’s not to stimulate the economy, but more to contain the damage and the pain and see if we can navigate through this storm the best we can. 

Dormant Global Economic Issues, e.g., US-China Trade War, Could Complicate Recovery

ISSA: I want to shift now to talk about how Vanguard already saw the global economy prior to COVID-19. Toward the end of last year, you had already lowered your global economic growth projections for 2020 and were citing factors like uncertainty on policy level, a slowing of demand and supply and low inflation. How will the fallout from COVID-19 affect the economic fundamentals in the near term?

ALIAGA-DIAZ: Yes, we were — we were very different from the consensus in terms of our 2020 outlook. We were more pessimistic about the global and U.S. economies. Of course, we did not expect a fully blown recession, much less this type of shock that we’re now experiencing. 

But we really don’t agree with the view that everything was perfectly fine until the outbreak of the epidemic, either. In our view, the economy was already slowing. The key sources of the global policy uncertainty that we refer to in our report remain largely unresolved and, by the way, they will be there after the pandemic crisis subsides. Actually, they may even come back with some revenge. So naturally, nobody is thinking about those things right now, but the truth is, the trade war has not ended, the Phase 1 trade deal is in limbo, Brexit has not been solved, concerns about the integrity of the euro area remain, geopolitical ambitions of China in the war remain, etc. So those things are still in place.

It is most important for governments, in this particular type of shock, to maintain the source of employment, the source of jobs in the economy, keep them as intact as possible.

What happened is that all those considerations are entirely overwhelmed by the magnitude of the shock of this pandemic. The type of losses we’re seeing for the U.S. and the global economy are orders of magnitude larger than anything that just uncertainty would have done. We’re talking about something much deeper than anything related to the normal fundamentals of the economy. But it’s something not to lose sight of. On the other side of the shock, even as the economy recovers, we may all wake up to those dormant issues and they will be important then.

Stimulus Packages — Governments Need to Protect the ‘Source of Employment’

ISSA: When I was reading Vanguard’s global outlook for 2020, it interestingly noted that consumer spending remained consistent in times of recession, and there were comparisons with previous recessions over the last few decades. With people in most parts of the world now confined to quarantine, we’re seeing a dip in consumer spending. How does this new variable in this recession play out today?

ALIAGA-DIAZ: Yeah, that’s the critical difference, I would say, in terms of what we were expecting for 2020 and what’s actually happening. It’s true, normally in recessions people tend to deplete their emergency savings to try to maintain living standards as much as possible. So people go into credit card debt and perhaps don’t pay some bills, but they continue sending their kids to school. That’s why consumer spending — particularly in services and non-durables — is the less cyclical component of GDP. We see a lot of durable big-ticket items, those are cyclical, but services are very smooth. 

People try to resist as much as possible giving up on living standards. But as you say, you’re totally right, this time is completely different. I mean, this is not about consumer choice. This is the whole system shutting down. So consumers don’t have the option to maintain things, and with consumer spending being 70%-75% of the economy — and non-durables and services being the majority of that — that explains in large part the magnitude of the shock. Through these lockdown measures, you are impacting the core of the engine of growth in the U.S. economy. That’s where you go from maybe 3%-4% losses in a normal recession to 20% — you’re virtually shutting down the main engine of growth.

ISSA: The flip side to that is that you might expect a surge in consumer spending after the quarantine measures are lifted. Do you expect that to be the main driving force in the economic recovery? 

ALIAGA-DIAZ: Yes, that’s the main logic behind that idea of a very deep fall, which is followed by a very strong rebound if the system remains more or less healthy. That is, if you don’t see massive unemployment and particularly small business bankruptcies and solvency problems. If the system remains more or less in place, then once the economy reopens, you have this pent-up demand. People go back to their lives and may spend on things that they postponed or couldn’t do during the lockdown. 

We have to be careful about the lingering effects. We have seen in cases, for example, after major terrorist attacks and other pandemics in the past, for example, 9/11, people get slowly back to their normal habits. Sometimes it takes time, so even if the economy opens, we may not see an immediate jump, but certainly a change compared to where we will be in Q2. Because just a simple matter of days of a jump in consumption will be very important and can hopefully help get us back on our feet quickly. 

ISSA: Should the focus of governments then, in terms of their stimulus packages, be on ensuring small businesses don’t go under? If the key is to prolong their survival so we can get to a point where small businesses are still operating after quarantine measures are lifted, and there’s a surge in consumer spending able to resuscitate the sector, then is this where the focus should be? 

ALIAGA-DIAZ: We’ve been studying these as quickly as we can and following very closely the U.S. stimulus act and all the debate around it. I would say that I very much agree with your initial statement. 

And the question is basically, to me, what is most important for governments to do in this particular type of shock — this type of recession, which is deep, short-lived and we expect a normal recovery on the other side? It’s to maintain the source of employment, the source of jobs in the economy, keep them as intact as possible through three, four, five months. Then it may pay off, and when the economy reopens, the economy comes back roaring.

Obviously, you need to take care of unemployment and having enough cash for basic needs like food. That’s helpful, but really, the backbone of the policy response should be about maintaining the source of employment. So we think about the idea of employment insurance as opposed to unemployment insurance. It would be much better to keep people in their jobs through the crisis even if they are not working, which would be a type of wage subsidy, but conditional on maintaining employment versus paid and unemployment insurance. 

This shock is very much a liquidity crunch for businesses. What you have to do is prevent a liquidity crisis from becoming a solvency crisis. You have to shore up funding for businesses to keep employment and keep paying their rent and other bills through this three, four months.

ISSA: We’ve seen governments, like Australia and Canada, provide wage subsidies and financial incentives to companies to make sure they don’t scale down employment-wise. Is that the kind of model you’re thinking of? 

ALIAGA-DIAZ: Definitely, and in the U.S., the CARES Act has a whole chapter on payroll protection, which essentially talks about these loans to small businesses that become grants. So basically, the loans are conditional on businesses maintaining payroll and even rehiring workers they may have already laid off. All that is great. 

The question is, though, will these businesses get the money on time? Time is of the essence here. Even when the policy is well-designed, the questions are, a) whether it will be enough for every business, and that’s why I would think that you would want to put more resources into these types of programs. And b), how fast can businesses access this money? Because through the normal channels of small business lending, it may take too long, and the money may come too late. 

China Can Say Goodbye to High Growth for the Near Future

ISSA: As Vanguard already noted, there was a slowdown in China’s manufacturing sector pre-coronavirus. We’re seeing some recovery now since their containment measures were taken. What does COVID-19 mean for the Chinese economy in the short- to medium term?

ALIAGA-DIAZ: It’s similar to the U.S. and to the rest of the global economy. China usually has higher levels of growth, but the effects from COVID-19 are similar. They’re similar dynamics in the sense that the virus overwhelmed all other fundamentals of the economy. Yes, the economy was slowing down from 6% to 5.8% for 2020. Now, we’re talking about perhaps growth rates for the year under 2%. That’s very much what we used to call a hard landing for the economy. This is the Chinese version of a recession.

But you’re right that in China, things started early on and things have gotten under control based on the official numbers. All this shock that we expect in the rest of the global economy and the U.S. to play out in the second quarter with some timid recovery in the third quarter, in China may actually be more in the first quarter. So we expect a very bad first quarter number for GDP growth with very significant losses, because they applied the same sort of measures. 

Now what is important for China is that it’s so dependent on the rest of the world via exports that actually, because the global economy is going to be affected more in the second quarter, the recovery for China may be not as robust as you would think it would be in the U.S. Because right when China is ready to rebound, that’s exactly when the U.S. is falling deeper into the recession, and the rest of Europe, too. So we may see a little bit of a delay there, which will make things worse. 

They have their own share of the virus shock impacting more in Q1, but then they have more of a backlash from the rest of the world in Q2. Hopefully we may see that rebound, that recovery in the second half of the year. But yes, we’re talking for the whole year, a very low growth rate, something that we have not seen in China for decades, really. 

ISSA: What does this low growth in China mean going forward? The manufacturing sector Vanguard observed was already slowing down. Is that going to exacerbate that situation looking at 2021? Where do we see China going?

ALIAGA-DIAZ: The manufacturing sector in China, which is very much linked to the large state-owned enterprises and all the strategic sectors of the economy, are the ones that are receiving the most of the stimulus. One thing we have learned over the last couple of years, and even now in this crisis, is that for all the policy schemes that China can actually implement very efficiently, it doesn’t really help the “new economy,” i.e., the small enterprises, the part of the economy that works more like a capital market economy.

China’s manufacturing sector will continue to be heavily sustained and stimulated by the government. But we’re seeing that this isn’t a sustainable model medium- and long term. 

What we are going to see is some recovery in the China economy to some lower growth rates than the past. We’re not going back to 6, 7 or higher and will continue to see the manufacturing sector lose ground relative to the service sector — a rebalancing of the Chinese economy that has been happening slowly. We may now see an acceleration of that after the shock. These crises tend to accelerate trends that were already there. 

The UK Will Recover, but Long-Term Growth Is Impaired by Brexit

ISSA: Let’s skip to the U.K., which was already in dark waters because of Brexit. There’s been a stall in U.K. business investment for the last four years since the Brexit referendum took place, so needless to say, the U.K.’s going to feel a pinch from coronavirus. Where is the U.K. going to feel the economic impact from the coronavirus the most?

ALIAGA-DIAZ: One of the key elements in our outlook, as we were talking about policy uncertainty and the impact on growth, was the example of the U.K. with Brexit since 2016. We have seen it play out, almost textbook, how uncertainty can impair business decision-making. And again, as I said earlier, I think once the shock of the virus passes, the Brexit uncertainty may return with a vengeance in terms of its impact on growth and investment in the U.K.

We may see working from home going mainstream and even business travel versus video conference jumping up in a post-coronavirus world.

Now again, the problem with the virus is that its orders of magnitude overwhelm the effects of policy uncertainty. And the lockdown is really affecting, again, the service sector. So the U.K., to be honest, is not too different from the U.S. and other developed markets in the response. In terms of the effects, as of now, we’re talking about Q1 and Q2 impacts at the same magnitude as we’re seeing in the U.S. That’s more the short term, but compared to that, in the medium term looking into 2021 and the end of 2020, we may see an accentuation of the trends of investment that we saw before.

ISSA: Which means the U.K. might be an outlier compared to the rest of the world in terms of recovery, right? Brexit might complicate the U.K.’s ability to recover at a similar pace with the rest of the world. Is that a fair assessment? 

ALIAGA-DIAZ: The rebound, when businesses open and people go back to their lives, probably the bulk of that recovery may be similar. But certainly when we talk about the long-term growth prospects for the economy, it may be impaired because of Brexit. 

It ends up being pretty much what we’ve been calling a hard Brexit, going back to WTO rules and things like that. Our teams in London have estimated more permanent effects on the trend growth for the U.K. relative to Europe and the U.S. 

The growth numbers are not that big because of elements like Brexit, but it’s one of those things that experts in economic growth will tell you: Yeah, there are 20, 30, 40 basis points of growth that add up over 10, 15 years, and they add up to a lot in terms of well-being and standards of living.

The Eurozone Is, Economically, the Most Vulnerable Region to the Pandemic

ISSA: Europe was the epicenter of the virus before it shifted to New York. The southern European countries have been severely hit; the whole continent’s pretty much in lockdown. Your prior projections already noted a slowing of the economy in the eurozone. How long is it going to take Europe to recover from this? And how is it going to fundamentally change the European economy going forward, if it is at all?

ALIAGA-DIAZ: The euro area is the region that worries me the most in terms of the long-term sequels and effects of this shock because, as I said before, this type of crisis tends to accelerate things that were in place.

What was in place in Europe was basically uncertainty about the European project itself. So it worries me that we see a very limited response from a fiscal perspective in Europe, not even close to what we’re seeing in other countries, and much less than the U.S. We’re also seeing very limited coordination of policies.

So it’s a lack of fiscal coordination and inflexibility to use the budget to mitigate the temporary consequences of this virus. It’s difficult to say, but clearly any action can polarize members of the European Union into very firm, opposite positions — either for deeper transformation and finally push toward a fiscal union that is very much needed, or the other extreme, a questioning of the whole validity of the Europe project. The latter is especially so when we think about members like Italy and Spain, where the suffering has been great on top of a very hard last 10 years. And the U.K. leaving the European Union right now doesn’t help either. 

I really worry about what we’re going to see. I mean, it’s more of a binary result. Either this crisis shakes all the rigidity in Europe and finally, they move to a full integration with a fiscal and banking union, which is very much needed, or we may see more questions about the whole project.

ISSA: You mentioned before that Europe hasn’t responded with the same kind of fiscal stimulus that we’re seeing in other parts of the world. Why is that? Why are European governments withholding the purse strings to try and shore up their economy?

ALIAGA-DIAZ: Importantly, one of the limitations for countries to do fiscal responses like the U.S. has done is when basically the market for government debt, for bonds, is not deep and not as reliable. That happens when you don’t have control of your own currency. 

That’s not too different from emerging markets, where they cannot afford a massive stimulus because they simply don’t have a market for the depth to finance that fiscal stimulus, and that’s the problem that Italy and Spain have. 

It’s not up to them to decide how big the stimulus should be, even though the situation on the ground demands it. If there were a response coordinated by the European Union, that would actually remove that barrier, because the eurozone as a whole owns the currency, and deciding on the fiscal package for the whole area would have backstop from the monetary side, from the central bank. But unfortunately that’s where the crux of the discussion is happening, even before the crisis when Europe was pretty much in stagnation and facing the risk of deflation. Even then, there was not willingness to move toward a strong fiscal response, because there is this idea that a fiscal response will be one part of Europe bailing out another part. And this idea is something that cannot go through writing in certain countries.

But all this comes from a lack of a framework to coordinate fiscal responses and ultimately the lack of a fiscal union. It’s as if in the U.S., there was the discussion on how much money is being funneled to North Carolina versus New York. You could fall into this argument, but nobody questions that because there is a well-functioning federal government on the fiscal side. That’s basically what we don’t have in Europe, and as a result, the fiscal responses are not sufficient right now. 

Discrepant Responses to the Crisis Among Latin America’s Big Economies — Brazil, Mexico, and Argentina

ISSA: So, I want to talk about Latin America for just a moment, because we haven’t really seen a huge impact in terms of the pandemic on Latin America compared to other regions of the world. But there are concerns that it could hit with some delay compared to everywhere else in the world. But so far, we’ve seen quite disparate responses from Latin America’s biggest economies. You’ve got Brazil and Mexico, both led by populist governments evading containment measures, and on the other side, you’ve got a country like Argentina, which is pretty much in lockdown. How do you see these varying responses from the economic leaders of the region playing out in these big Latin American economies? Is Argentina going to come out looking better because Brazil and Mexico aren’t taking coronavirus as seriously?

ALIAGA-DIAZ: That’s really interesting that some Latin American countries were slightly in better shape from the standpoint of fiscal accounts and their external position. Mexico and Brazil were in better shape prior to the pandemic, but have been less strict with containment measures. While countries like Argentina were in a much more difficult economic situation before the virus, but are more forthcoming with the measures. 

It’s also interesting that in spite of those differences, the number of cases are ramping up in Brazil and Mexico much faster because of the delayed responses compared to Argentina or Chile. But I think the impact of the shutdown will not be too different across the economies, eventually. It will wreak havoc on these economies no matter what we have seen. 

For instance, the markets, the currency markets, which are kind of a barometer to see how things are going on domestically in each one of those countries, have reacted indiscriminately. Countries that are in better or worse shape, regardless of whether they’ve been more preemptive about the pandemic or not, they’ll all be hit pretty much the same way from a market perspective. But I think clearly the humanitarian crisis will be, of course, better contained in countries that have been more proactive, no question about it. 

Now my concern is that countries that have a better fiscal position actually have a better ability to enact policy responses, and they’re not. If the government can step in to help certain sectors of the business to stay afloat until the recovery comes and buy time that way, then things look much better on the other side of the recession, and that’s why I worry about countries like Argentina. They have been extremely proactive in containment measures, but I wonder what’s going to happen in terms of not being able to implement a fiscal support policy like we’ve seen in the U.S. So that’s where we may see differences. The fundamentals will matter for the shape of the recovery on the other side, the vitality of the recovery, and that’s something we continue to track closely.

Post-Coronavirus World: The Gig Economy Might Be Here to Stay

ISSA: I want to wrap up by asking: What other economic vulnerabilities should we be on the lookout for in the world right now because of the coronavirus?

ALIAGA-DIAZ: In terms of regions, the eurozone really concerns me, in terms of the responses on the other side of the shock. 

In terms of sectors, I would say that, similar to what we’ve been talking about throughout the interview, is the expected accentuation of pre-virus trends. Before coronavirus, we were moving away from brick-and-mortar retail stores. If anything, this accelerates this change. We may see working from home going mainstream and even business travel versus video conference jumping up, and those may have significant consequences for commercial real estate, for construction. 

So those are trends that we’ve been analyzing and ones we’ve always been treating as long-term trends — the rise of the gig economy and the implications for infrastructure needs and, for example, the commercial real estate sector. This may actually accelerate that and bring forward changes that would have happened over the years. 

Similarly, it’s been amazing the move toward online education. It has been almost instant. I’m very close to that at the university level, but also in schools for my kids. It’s been almost seamless. So what are the consequences for infrastructure and construction if things don’t go back to the old normal? Those are the big questions that we have, and certainly we’re looking at how that evolves. 

Now, the other thing is government debt, and I think it’s important because once the shocks fade away, at some point, we will be left holding the bills. So lots of questions about what would it mean for government deficits — will they double, triple this year, against already high levels? The U.S. deficit was already $1 trillion dollars, and now we’re talking about $3.5 trillion dollars this year, essentially. So tripling, in that case. 

These are the questions that are critically important. 

Roger Aliaga-Díaz

Chief Economist of the Americas at Vanguard

Roger Aliaga-Díaz, Ph.D., is chief economist, Americas, and a principal in Vanguard Investment Strategy Group. His areas of expertise are monetary policy, international macroeconomics, and finance.

Mr. Aliaga-Díaz has published studies on investment and macroeconomic issues in peer-reviewed academic journals and has presented his research at various industry and academic conferences including the Board of Governors of the Federal Reserve System and the American Economic Association.

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