Uncertainty and economic recovery

In a lecture before the Peterson Institute for International Economics on Jan. 17, IMF Managing Director Kristalina Georgieva said that if she had to identify a theme at the outset of the new decade, “it would be increasing uncertainty.”

Georgieva affirmed the reality of uncertainty in the fast evolving global scenario. We all recall that uncertainty is one of the four attributes of the post-Cold War world, the other three being volatility, complexity, and ambiguity. Such a VUCA world can be traced to a 33-year-old leadership theory by Warren Bennis and Burt Nanus (Leaders: The Strategies for Taking Charge) introduced in the US Army War College.

Uncertainty makes companies less willing to invest in land and capital and hire workers. During the housing bubble of 2005-06, homeowners were forced to walk away from their mortgages. And for the first time in their economic history, during the Global Financial Crisis of 2008-2009, Americans started saving rather than spending their future income. No one had job security. While saving was generally good for US society, consumption expenditure withered and an economic recession took hold of the US for nearly two years.

It is tragic when uncertainty feeds into the psyche of businessmen and consumers and perpetuates a freeze in economic activities. More tragic too when uncertainty is fueled and increased by political strife, threats of war in sensitive regions of the world and climate change.

To get a good handle on the role of uncertainty in economic growth, the IMF constructed a quarterly measure of uncertainty. The World Uncertainty Index covers 143 countries with populations of 2 million or more. The list includes the Philippines, the rest of ASEAN, as well as other advanced and emerging economies. Data was drawn by text mining Economist Intelligence Unit country reports. The index captures uncertainty triggered by economic and political events that have both short- and long-term consequences.

The first chart (Uncertain Times) shows “highs” of the last 20 years. In 2003, the world grappled with the Iraqi War and SARS outbreak. The US recession, 9/11, and the Global Financial Crisis of 2008-09 did not even come close to the high ushered in by both the European sovereign debt crisis, the US fiscal cliff, and the lingering effects of the European debt crisis. The US-China trade tension pushed the 2019-2020 high.

While driving factors originated in specific countries, their impact was global. According to the Fund, global factors are assuming more prominent roles in generating uncertainty across borders.

The data also shows synchronization of uncertainty. Advanced economies tend to move together, experiencing uncertainty almost at the same time. In this country grouping, the strongest synchronization is within the Euro area. Stronger trade and financial linkages explain the large extent of synchronized uncertainty.

Compared to emerging economies and advanced economies, an average level of uncertainty is more greatly felt in low-income countries. Low-income countries are reported to experience more domestic issues like coups, revolutions, and wars. They are also more prone to natural disasters and epidemics.

The Fund also found a U-shaped relationship between uncertainty and democracy. Uncertainty is increased in nations governed by authoritarianism. It declines where there is greater democracy.

Finally, the study found that greater uncertainty foreshadows output decline. The magnitude of the decline is greater in countries with weaker institutions and capacities.

What other factors could push world uncertainty?

Promptly responding to present challenges, the IMF released the World Pandemic Uncertainty Index (WPUI) on April 4.

This chart links various diseases with uncertainty as indicated by discussions about them. The chart has two lines that are both based on “discussions.” One line represents the number of times the pandemic is mentioned. Another line captures the general use of the word “uncertainty.” The relationship shows co-movement.

The diseases included in the study are: SARS (2002-03), Avian flu (2003-09), Swine flu (2009-2010), Ebola (2014-16), and COVID-19 (2020).

On the first measure: “mention of epidemics” within the ASEAN 6, the Philippines is second highest behind Thailand. On the second measure: “mention of uncertainty,” the Philippines is third highest behind Singapore and Thailand.

It is interesting that this finding jives with the theory of how uncertainty has a significant economic impact as illustrated by last April’s World Economic Outlook. The April report predicts Thailand and Singapore to be ASEAN 6’s lowest performing economies. With its more active and vocal press, the Philippines is more “uncertain” with an expected economic performance better than Malaysia’s and Indonesia’s. For some reason, both Malaysia and Indonesia did not show “uncertainty” for the first measure.

It would also be useful to know that a recent working paper by Scott R. Baker, Nicholas Bloom, Stephen J. Davis, and Stephen J. Terry entitled, “COVID-Induced Economic Uncertainty” published by the National Bureau of Economic Research (NBER) in Cambridge, Massachusetts complements this IMF study.

The NBER working paper focuses on three indicators: 1.) stock market volatility; 2.) newspaper-based economic uncertainty; and, 3.) subjective uncertainty in business expectation surveys.

After feeding COVID-19-induced immediate and uncertainty shocks into an estimated model of disaster, the study predicted that by the fourth quarter of this year, US output would decline by 11% to as much as 20%. Half of this projected decline is attributable to COVID-19-induced uncertainty!

While model-generated, this is not a simple foreshadowing of economic contraction. In varying degrees and depending too on country-specific circumstances, COVID-19-induced uncertainty can indeed impinge on economic recovery and growth.

This issue about uncertainty becomes more relevant in the light of the Fund’s June 2020 World Economic Outlook update. The Fund emphasized that “in the absence of a medical solution, the strength of the recovery is highly uncertain and the impact on sectors and countries uneven.”

The update warns of a deeper recession in 2020 and a slower recovery in 2021. Globally, output is expected to drop by 4.9% with a partial recovery of 5.4% in 2021. The loss is expected to accumulate to over $12 trillion.

This means that the global economy will be less hospitable to exports; resumption of economic activities will be more uneven; and the labor market will remain seriously impaired with a negative impact on income inequality and poverty.

Like never before, carefully designed fiscal policy support and monetary action will become more critical.

Lest it be lost on us and our policy makers, the Fund also carefully reminded us that in mitigating uncertainty, “priority is to manage health risks even as countries reopen.”

Diwa C. Guinigundo is the former Deputy Governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001-2003, he was Alternate Executive Director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.