Border closings, confinement, and other social distancing measures to retard the spread of COVID-19 have brought the global economy to a near standstill. Forecasts of output losses and unemployment rates have increased as governments face a crisis that is like no others. The economies of developing countries have been hit as hard as, or even harder than, those of developed countries even though their lockdowns have not been as stringent. Developing economies are suffering the indirect effects of COVID-19 on external demand from China and advanced economies, resulting in a commodity price bust and reduced tourism, remittances, and capital inflows.
In the face of such an overwhelming crisis, many have rightly called for doing “whatever it takes” to stem the advance of the disease and mitigate its economic consequences. Because they can borrow in their own currencies at low interest rates, most advanced economies have used fiscal and monetary policies to finance the health response, provide relief to businesses and people, and inject liquidity into their financial systems. Where inflation is not an issue, helicopter money (essentially printed by a central bank) has been used, as has quantitative easing or direct purchase of sovereign debt by central banks.
Developing countries, on the other hand, face massive constraints on their ability to do whatever it takes to stop the spread of the virus and provide relief to their people—many of whom work hand-to-mouth in the informal sector. What is more, the poor in developing countries are disproportionately affected by infectious disease, so the need for government intervention is not just efficiency but equity. To finance efforts to contain the virus, avenues such as raising taxes, printing money, or borrowing are limited. Because of the prohibitively expensive borrowing costs most developing countries face in international markets and the already high level of debt denominated in foreign currencies, the international community plays a critical role.
Perhaps the COVID-19 crisis will galvanize governments to act on leakages, creating fiscal space to serve better while setting the stage for recovery and sustained economic growth.
The lockdowns and curfews have placed a huge burden on poor people, especially the 70 percent or so in the informal sector who depend on earnings from daily work. To mitigate the burden, some 190 governments have introduced or scaled-up social assistance programs, many of which provide cash grants to those who are unable to earn a living. But many social assistance programs have a checkered history, due to administrative constraints or political capture (or both).
Another source of leakage is the so-called curse of monopolized imports. In many countries, including in the Middle East and Africa, import dependence leads to persistent twin deficits; a budget deficit drives the trade deficit. Imports of universally subsidized goods are widely inflated. The excessive imports are either smuggled into other countries or used as an input in industry, which as a result garners an artificial advantage when the import is not sold at world prices. That is especially the case when the government is in the business of buying the import and selling it.
Thus, in addition to having difficulty financing the COVID-19 response, developing countries face substantial fiscal policy challenges from leakages during—and likely after—the pandemic. Some countries are prematurely touting the idea of fiscal consolidation to return to a sustainable path. Such consolidation should be postponed until a recovery is well underway. Recent studies have shown that fiscal contraction hurts a country’s standing in financial markets when fiscal stress is severe.
When fiscal consolidation is appropriate, it too will benefit from stricter control of corruption. The cost of corruption in developing countries has been estimated at $1.3 trillion a year, three-quarters of sub-Saharan Africa’s GDP. Perhaps the COVID-19 crisis will galvanize governments into action to reduce leakages, creating fiscal space to serve the poor better while setting the stage for recovery and sustained economic growth.
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