Vaccine holds the key to the world's economic recovery

Despite the IMF's early predictions of a meltdown, the global economy is forecast to grow in 2021. But recovery still depends on the successful rollout of the COVID-19 vaccine.

The latest official assessment of the world economy has been provided by the IMF’s January 2021 World Economic Outlook (WEO). The fund estimates that global output shrank 3.5 per cent last year, with real GDP in advanced economies dropping by an even larger 4.9 per cent. The Australian economy is expected to have contracted by “only” 2.9 per cent, making us one of the most resilient of our advanced economy peers. The fund is also predicting that world real output will grow 5.5 per cent in 2021, including advanced economy growth of 4.3 per cent. A conservative 3.5 per cent expansion is forecast for Australia, slower than our peer group, but from a superior starting point.

When the IMF released its January 2020 WEO, the potential economic impact of COVID-19 had barely registered. The fund was then hoping the world economy would enjoy a “modest pickup” in 2020, with growth expected to accelerate to 3.3 per cent before edging slightly higher to 3.4 per cent in 2021. Instead, the world entered the great lockdown, and by the time of the April 2020 WEO, the IMF was warning of the worst post-war recession on record, forecasting that the global economy would shrink three per cent.

The numbers in the June WEO were even worse, with output expected to plunge 4.9 per cent in 2020. Sentiment had improved by the October WEO, but even then, the IMF was still expecting a 4.4 per cent decline, followed by an economic recovery and 5.2 per cent growth this year.

What a difference a year — and a global pandemic — has made. From the perspective of January 2020, the numbers presented in the new January 2021 WEO look terrible, with only the modest consolation that last year’s awful performance is at least expected to be followed by a relatively strong bounceback in 2021, albeit one that will still leave a significant output gap. Yet viewed from the vantage point of, say, mid-2020, these latest IMF figures suggest, despite the economic carnage unleashed by COVID-19, we might escape the crisis with less economic damage than feared.

Risk factors

If so, that will largely be the product of two factors. First, the huge amount of monetary and fiscal firepower deployed by governments and central bankers, with governments in particular spending big. The IMF’s latest (February) estimate is that global fiscal support has reached nearly US$14 trillion. Advanced economies have led the way with US$11.8 trillion of spending, with the average cyclically adjusted primary deficit jumping to 9.6 per cent of potential GDP.

Second, while policy support helped get the world economy through last year, the key source of optimism for this year came from faster than anticipated approval of multiple vaccines and the subsequent launch of vaccination programs in some countries in late 2020. That increase in optimism — along with the growing adaptability of businesses and consumers to a more physically distanced world — meant that international economic activity had already started to recover as the year drew to a close. World trade in goods, for example, had returned to pre-COVID-19 levels by November 2020.

Troublingly, some of the momentum behind that economic turnaround has shown signs of faltering as the world has faced further outbreaks and the emergence of new virus variants while also grappling with significant logistical challenges around vaccine supply.

As a result, the outlook for this year remains hostage to vaccine-related developments. The IMF’s forecast for 5.5 per cent global growth in 2021, for example, assumes there will be “broad vaccine availability” in advanced economies and some emerging markets by midyear, and across most of the world by the second half of 2022. Likewise, it assumes “therapies are expected to gradually become more effective and more accessible worldwide over the course of 2021–22”.

Critical downside risks to the hoped-for vaccine-powered recovery therefore include longer than expected delays in vaccine rollout, lower than anticipated rates of vaccine take-up, shorter-lived immunity results than currently expected, and more limited advances in therapy effectiveness than assumed.