Global North and Global South: Four suggestions to overcome disparate economic responses to COVID-19

Developing nations spend far less of their GDP than developed countries to address the economic consequences of COVID-19 – that could have far-reaching consequences.

COVID-19 will have devastating consequences for developing countries as they are unable to set up robust stimulus packages comparable to advanced economies. Here are some explanations as well as suggestions on how the international community can do better.

Making sense of the multitude of available economic indicators is sometimes hard. While developed countries are estimated to grow the least in 2020 (Figure 1) because of the economic crisis induced by COVID-19, that does not mean that developing countries are per se better off. One aspect which crucially emphasizes this point is the size of the stimulus that countries can set.

Global North and Global South – an outdated dichotomy?

Emerging from the 1955 Bandung Conference, the term “Global South” was used to decsribe a new international order grounded in horizontal forms of cooperation linking between developing and industrialized countries instead of vertical linking.

But the Global South per se does not exist anymore. There are countries in the “Global South” such as China that can recover strongly from the crisis while others that will suffer far more and will eventually need assistance from the global community. As inequality between countries decreased in the last years while inequality within countries increased, it is questionable if that binary concept still holds true.

In times of shared challenges like climate change, free trade, global health, and digital transformation, we probably need a more multi-layered concept. However, the current worldwide economic crisis shows that there is still a difference between the Global North and the Global South: the economic capability of the state to counteract the hardships of an enormous external macroeconomic shock. This is why the world needs to come and act together to help the most vulnerable.

Developed countries can spend far more money than developing countries

While  Europe and North American have experienced a health crisis preceding or accompanying a major economic shock wave, developing countries, for the most part,  have been hit first by the economic repercussions of the COVID-19 pandemic before suffering from rising infection rates and death tolls.

The problem with the current pandemic is that if it is anywhere, it has consequences everywhere. Especially the decrease in commodity prices and the drop in tourism hits some countries harder than others. While high-income countries have set up large rescue packages, low-income countries are often unable to do so. Germany and Italy, for example, have so far used amounts that are more than 25% of GDP on economic stabilization while Malawi, Kenya, and DRC used less than 1%. Even China is currently still reluctant to deploy a bigger economic stimulus to a large extent.

The IMF has set up a policy response tracker to capture all the fiscal and monetary actions taken by the majority of countries around the world. When trying to cluster all the numbers that can be found in the policy response tracker, it is possible to draw a general picture of stimuli  by high-, middle- and low-income countries as a percentage of GDP (Figure 2). The result: advanced economies reacted with strong fiscal and monetary policy measures.

Another crucial aspect is that middle- and low-income countries are often only able to use fiscal measures to a slight extent. India, for example, has announced an overall economic package worth only 10% of India’s GDP. However, only about 1% of that is in fiscal measures. In high-income countries, the ratio is much higher towards the fiscal side.

Why do developing countries have problems setting up rescue packages?

Developing countries cannot set up extensive rescue packages because they simply have limited financial options and face dangerous debt levels. This is why they still rely more strongly on family bonds, clan structures, or religious communities as a mechanism to help and support.

But in the case of such an enormous economic crisis as the one currently induced by COVID-19, the lack of capability by the state becomes deeply apparent as families cannot absorb all the hardships. Even though the debt levels of developing nations are  often smaller than that of developed countries, developing countries often face difficulties setting up significant stimuli because they need to service high-interest payments on their government debt – sometimes up to 20% of their tax revenue while developed countries are only at about 5%. There are three main reasons for this:

• It is an issue for developing countries to conduct broadly expansionary monetary policies to the extent done by developed countries as they then often face risks of high inflation rates. The irony here is that while there was a lot of capital flight in March, money came back because of the expansionary monetary policies by developed countries in the following months.
• The current pandemic again shows that the currencies of developing countries face difficulties coping with stronger currencies like the US dollar or the euro (Fig. 3). Permanent devaluation is caused by current permanent account deficits. This in turn, increases the value of foreign debt, and a vicious circle emerges.
• Developing countries have unstable tax bases. One general takeaway from public finance is that a state should rely on a broad tax base, i.e., that it should collect taxes from diverse sources (e.g., income tax, value-added tax, property tax, and many more). Developing countries, instead, often rely on single sources of income. Some mainly on the income from selling commodities.

All these aspects further limit the creditworthiness of developing countries and make it difficult for them to borrow money for appropriate conditions. Additionally, people in developing countries behave differently on the individual level due to their circumstances. They have fewer opportunities to save money, and in some states, remittances play an even more important role than FDI. This further restricts the ability of the state to counteract the crisis appropriately.

Suggestions for help

• Cut debts: Debt restructuring or deferments are currently likely not enough. Some countries spend much of their money on paying back debts, which makes it hard for them to fund themselves adequately. Better funding capabilities can be achieved by cutting a substantial sum of their external debts. Otherwise, developing countries will face Sophie’s choice: they either increase their external debt and get locked in with high-interest rates or they fail to put together stimulus packages which will cause an even deeper recession.
• Global Green New Deal: The coronavirus is maybe the biggest threat for humanity in the short-term. But in the long-term, climate change is a global issue and could have even more impact – especially in the developing world. Therefore, a Global Green New Deal can be viewed as an option for inclusive long-term improvements. The G20 could be the decisive factor here as they have been during the financial crisis.
• An economic rescue package for all: As the fiscal and monetary stimuli set by low-income countries are the smallest, international organizations such as the IMF could set short-term fiscal stimuli.
• Support for local units: Often, municipalities lack substantial financial resources. That is to say; they need to be better equipped because they are directly responsible for coping with the issues emerging from the health crises and for helping people that face hunger and search for shelter.

As the current situation is deeply multidimensional, a mix of these four suggestions is a way forward to tackle short- and long-term issues in developing countries. Furthermore, they should not be left out when vaccines are available. Advanced economies do not even have to be altruistic when providing help because it is in their genuine self-interest that supply-chains are functioning properly. If this works, we can potentially contribute to narrowing the still persistent divide between countries from the Global North and the Global South.