The COVID-19 Middle-Income trap


By Masood Ahmed and Mauricio Cárdenas

The coronavirus pandemic has had a devastating impact on middle-income countries (MICs). With the exception of the United States, the ten countries with the highest number of COVID-19 cases to date are all MICs. And the same is true for new daily cases and COVID-19 deaths per million population.

The economic projections for MICs are equally dismal. Household incomes will fall across the board in 2020, including for most of the 100 million additional people globally who will fall into extreme poverty in a downside scenario.

Latin America’s experience is illustrative: the region accounts for just 8.4% of the global population, but 30% of total COVID-19 fatalities to date. The International Monetary Fund estimates that GDP in Latin America and the Caribbean will contract by 9.4% this year, while the World Bank expects a ten-percentage-point increase in poverty in the region.

These setbacks come at a time when waves of social unrest are spreading across MICs. With a few exceptions such as Peru or Ghana, the main drivers of discontent – especially in Latin America – have been lackluster growth, lack of upward mobility, and demands for greater political representation and participation. Even in better-performing economies, like Chile, many feel that their expectations and aspirations have not been met, and that those at the top of the income distribution have captured most of the gains.

To make matters worse, before the COVID-19 crisis, the end of the long commodity super cycle that had boosted MICs’ exports was threatening to reverse rising living standards. Young people feared they would end up where their parents had started a generation ago.

When the pandemic erupted, MIC governments responded with lockdowns and economic stimulus. But the effectiveness of these measures has been limited by high urban population densities, sizeable informal economies that make human contact hard to avoid, and financial constraints that are much more binding than in the rich world.

In Colombia, for example, GDP will shrink this year by approximately 7%, the largest decline on record. The pandemic-induced loss of jobs and income has already increased the share of the population living below the poverty line from 27% at the end of 2019 to an estimated 38% in May, despite the government’s provision of emergency cash transfers. Moreover, inequality has widened, with the income of the poorest fifth of the population falling by more than 50%, compared to a 33% reduction for the top quintile.

The story is similar in other Latin American countries, suggesting that the economic reversal feared by those protesting in the streets last December is already happening. Social unrest, which had been hibernating, will likely return with a vengeance.

MIC governments cannot afford a “whatever it takes” response, and are instead doing whatever they can. But whatever they can do will not be enough, and the international community would be short-sighted to ignore their plight, for at least three reasons.

First, MICs account for 75% of the world’s population, which means there can be no effective global health security infrastructure without their engagement and support. It is therefore essential that these countries have access to an effective COVID-19 vaccine as soon as it becomes available.

But as things stand, it seems that a vaccine or vaccines will go first to the advanced economies that are investing in their development. Furthermore, the World Health Organization, which is leading the COVID-19 Vaccine Global Access (COVAX) initiative together with the Coalition for Epidemic Preparedness Innovations and Gavi, the Vaccine Alliance, is – understandably – mainly focusing on the poorest countries. There is currently no guarantee that COVAX will be able to provide the vaccine volumes that MICs need.

The “missing middle” is unable to invest heavily in laboratories and clinical trials, lacks adequate disease and mortality surveillance, and receives little global aid. MICs’ rates of vaccination against other infectious diseases – already lower than herd immunity requires – have plummeted during the crisis, which will lead to global outbreaks if not addressed.

Second, global economic growth depends on the performance of emerging markets, which account for 60% of the world economy. The recovery from the 2008 global financial crisis was driven by China and, through their impact on commodity prices and trade volumes, by MICs.

That is unlikely to happen this time, so MICs will need to rely on other sources of growth to emerge from the pandemic-driven recession. Unfortunately, MIC governments lack the resources to increase public investment and de-risk private investment, so access to international finance is indispensable.

So far, MICs have had adequate access to global capital markets, but this could change without notice. Deteriorating fiscal and economic conditions have already triggered a cascade of credit-rating downgrades that could worsen. If markets close or become too expensive, MICs will need to rely on official lenders such as regional development banks. But these institutions have limited capacity to lend to MICs, and will require capital replenishment.

Other financing proposals include an issuance of IMF Special Drawing Rights (the Fund’s reserve asset) or the establishment of a special-purpose vehicle to channel the liquidity being generated by advanced economies’ central banks toward emerging markets. Concessional finance via regional institutions is also needed to meet vaccination shortfalls, finance public goods like global health security, and shore up safety nets for the poorest populations.

Finally, the world is trying to move onto a greener growth path. The bulk of infrastructure investment over the next three decades will be in MICs, and the choices they make will determine whether the world achieves zero net greenhouse-gas emissions by 2050.

A protracted crisis in MICs – where emissions are increasing faster than in the developed world – will at best delay such efforts, and could have more damaging consequences. By helping these countries to overcome the pandemic and its economic fallout, the international community will be acting in its own interests, too.

Masood Ahmed, a former senior official at the International Monetary Fund and the World Bank, is President of the Center for Global Development. Mauricio Cárdenas, a former finance minister of Colombia, is Senior Fellow at Columbia University’s Center on Global Energy Policy.

 Copyright: Project Syndicate, 2020.

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