Mohamed A. El-Erian, president of Queens’ College at the University of Cambridge, is a professor at the Wharton School of the University of Pennsylvania and the author of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse
Big shocks to the global economy, such as Russia’s invasion of Ukraine, understandably capture the most attention. But a new worldwide pattern of little fires everywhere may be equally consequential for longer-term economic wellbeing. Over time, these small fires can coalesce into one that is just as threatening as the initial large fire that acted as the catalyst.
In addition to causing widespread death and destruction, and displacing millions of people, the Ukraine war continues to stoke strong stagflationary winds throughout the global economy. The resulting damage — whether in the form of higher food and energy prices or new supply-chain disruptions — cannot be easily or rapidly countered by domestic policy adjustments.
For most countries, the war’s immediate economic consequences include higher inflation (which erodes purchasing power), lower growth, increased inequality, and greater financial instability. The multilateral system, meanwhile, now faces greater obstacles to the type of cross-border policy coordination needed to deal with pressing global problems such as climate change, pandemics, and life-threatening migration.
The challenges are particularly acute for fragile commodity importers in the developing world, especially when compared to the problems facing advanced economies. It is the difference between legitimate worries about the cost-of-living crisis in the United Kingdom, for example, and fear of famine in some African countries.
The United States’ higher trade and budget deficits appear considerably less problematic than potential defaults by heavily indebted low-income countries. And while the recent decline in the yen’s value may be attention-grabbing in a Japanese context, a disorderly collapse of poorer countries’ exchange rates could fuel widespread financial instability.
As Michael Spence, the Nobel laureate economist and an expert on growth and development dynamics, pointed out to me recently, the probability of simultaneous growth, energy, food, and debt crises is worryingly high for too many developing countries. If that nightmare scenario materialises, the effects will be felt far beyond individual developing countries — and will extend well beyond economics and finance.
It is therefore in advanced economies’ interest to help poorer countries reduce the mounting risk of little economic fires everywhere. Fortunately, there is a rich historical record, especially from the 1970s and 1980s, to draw on in this regard. Effective action today will require policymakers to refine proven solutions and support their sustained implementation with strong leadership, coordination, and perseverance.
For starters, a preemptive multilateral debt restructuring and relief initiative is needed to provide essential space for overly indebted countries and overstretched creditors to achieve orderly outcomes on a case-by-case basis. A multilaterally-coordinated approach is also crucial in order to reduce the disruptive — and sometimes paralyzing — risk of free riders, and to ensure fair burden-sharing among official creditors, as well as with private lenders.
Reinvigorating emergency commodity buffers and financing facilities is critical in order to reduce the risk of food riots and famines. Such measures can also play a useful role in countering some countries’ understandable but short-sighted inclination to ban agricultural exports and/or engage in inefficient self-insurance through excessive stockpiling.
Finally, rich-country governments will need to provide more official development assistance to support individual countries’ reform efforts. This aid should be extended under highly concessional terms through long-maturity, low-interest loans or outright grants.
Absent more rapid progress in these areas, the little fires everywhere phenomenon will damage global economic wellbeing by further weakening growth, increasing the risk of a recession, and fueling additional financial instability. This would add to current migration challenges, impede efforts to tackle the climate crisis, and delay the worldwide vaccination drive that is key to living more safely with Covid-19. Moreover, all these problems would promote geopolitical instability at a time when the global system is already subject to growing fragmentation pressures.
The rich world has shown impressive unity in helping Ukraine counter the Russian invasion. It now needs to demonstrate the same level of resolve to protect the wellbeing of its own citizens and of the world in the face of mounting economic and financial challenges.
Policymakers must aim to ensure that the many economic fires fueled elsewhere by the Ukraine conflict do not end up causing a second devastating inferno that destroys the lives or livelihoods of many of the world’s most vulnerable people.
This article was first published by Project Syndicate