Breaking Out of the Double Squeeze: The Need for Fiscal and Policy Space during the COVID-19 Crises

By Kevin P. Gallagher and Richard Kozul-Wright - 26 June 2020
Breaking Out of the Double Squeeze: The Need for Fiscal and Policy Space during the COVID-19 Crises

Kevin P. Gallagher and Richard Kozul-Wright call on international financial institutions to adopt a series of measures to give developing countries the space to fight and recover from COVID-19.

The global economic crisis triggered by the spread of COVID-19 has sent many of the world’s developing and least developed nations into a tailspin.  Inherent weaknesses in the international regimes for trade and finance have been exposed by their inability to prepare for such shocks and to protect vulnerable countries and communities when they hit.   Now, as the number of new cases and deaths continue to rise across the developing world, countries are doubly squeezed by the lack of fiscal and policy space to ‘do whatever it takes’ to address the crisis and harness an economic recovery. 

Developing countries need a large and diversified pool of liquidity alongside debt relief in order to gain the fiscal space to fight and recover from these crises. In addition to a moratorium on COVID-19 related claims falling under the jurisdiction of the World Trade Organization and the thousands of regional and bilateral trade and investment treaties, countries will need to expand and use policy space to ensure development of and global equitable access to COVID-19 vaccines, medicines, diagnostics and other health products.  This is not the time to defend, let alone extend, lop-sided rules and biased governance structures that will need to be fundamentally reformed in the wake of the crisis. 

The Fiscal Squeeze from International Financial Institutions

Thus far the international financial regime has failed to deliver the needed liquidity to mitigate the crises and sow the seeds of a recovery.  For most developing countries, the financial and economic crises came before the COVID-19 pandemic began to rapidly spread throughout their populations.  China and the advanced economies were the first to succumb to the virus, but these countries were also in a position to take bold (if not always prompt) economic actions.  Perhaps most important was the establishment of dollar swap lines and repo facilities through the Federal Reserve Bank of the United States, which was followed by more than $10 trillion in relief and rescue packages.

This unprecedented and enormous safety blanket has not extended to most developing countries who were largely left out of the swap lines and faced tight constraints on the adoption of stimulus packages.   At the first signs of panic in early March, investors were quick to exit developing countries for the ‘safety’ of the advanced economies in general and the US dollar in particular with more than $100 billion in capital fleeing the developing world in that month alone.  Capital flight and low demand weakened exchange rates and ballooned the levels of dollar-denominated debt in many countries.

There has since been some reflux of flows but it has been very uneven and expensive. Still, commodity markets remain very weak and will not provide a way out as they did in 2009, this is even more true of tourism, remittances, and global demand in general.   The World Bank predicts the contraction in developing countries could be as much as five percent in 2020 but with some regions more badly affected.

In April the G20 and the International Financial Institutions (IFIs) fell far short of putting together an adequate multilateral response to the crises.  Both the IMF and UNCTAD estimated that developing countries urgently needed $2.5 trillion in order to mitigate the effects of financial instability and ensure the fiscal space for crisis fighting and recovery.  The IMF and its counterparts only have upwards of $700 billion for developing countries (Gallagher et al, 2020).  Thus, UN agencies and experts called for a mix of new issuances of Special Drawing Rights, debt relief, and grants in order to meet the $2.5 trillion gap (UNCTAD, 2020).

Unfortunately, the multilateral system is yet to rise to these needs.  The G20 agreed to a suspension of official bilateral debt for 76 of the poorest countries, amounting to just $11 billion (IIF) and called on private creditors— the bulk of the lenders—to follow suit.  Thus far only a set of voluntary guidelines for private sector engagement have been forthcoming. Much of the IMF`s lending capacity is still lying idle (Setser, 2020) and the United States blocked a new issuance of SDRs at its Spring meetings.  The Fall meetings and the subsequent G20 gathering in Saudi Arabia will be the last chance to step up to the challenge of global liquidity provision and to save multilateralism.

The IP, Trade and Investment Treaty Squeeze

Developing nations are struggling to create the fiscal space to attack and recover from the virus and its economic impact.  With what fiscal space they can harness, these nations face another potential obstacle given intellectual property protections and investor rights granted in the World Trade Organization’s Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS) and over 2000 trade and investment treaties at the regional or bilateral level. 

The dangers of concentrating production and economic power within global health value chains has been laid all too bare during this crisis.  The global medical supply chain is dominated by a handful of companies in China, India, the United States, and Europe—accounting for over 70 percent of the producers of Personal Protective Equipment (PPE) and Active Pharmaceutical Ingredients (API) related to COVID-19.  Most of the firms are massive oligopolies and household names such Honeywell, Dupont, Shanghai Gangkai, JAL Group for PPEs and TAPI, Dr. Reddy, and SunPharma for APIs (MarketWatch, 2020).  With respect to vaccines and medicines, including for new uses of existing products and development of new products, the multinational giant biopharmaceutical companies like Gilead, Johnson & Johnson, GlaxoSmithKline, Merck, Sanofi, AstraZeneca, Pfizer, and others have monopoly control over both supply and price.

The current IP system has not been well adapted to prepare the world for the COVID-19 pandemic, including with respect to diagnostics, vaccines, and medicines.  Although the COVID-19 genome was shared early on and there was significant sharing of scientific information in the early stages of the response, proprietary companies have a history of abusing such practices (TWN, 2010) and are now pursuing more siloed product development, inhibiting the prospective benefits of more collaborative open science research and product development (King 2020).  At the same time that these companies are receiving significant public and charitable funding for product development and expanded manufacturing capacity, they are cluttering the world with underpowered, uncoordinated clinical trials.  Early entry by the most powerful companies with only moderately effective products can well hinder the development and deployment of superior products from smaller entities.

Such a concentrated supply chain can pose serious bottlenecks.  Both advanced and developing countries have come to the realization that PPEs, APIs, medicines, vaccines, and diagnostics to detect, prevent, and respond to the virus, including future waves, will need to be produced rapidly and increasingly at home, domestically or regionally both to expand supply and to ensure access.  In order to do so, governments have to partner in order to support patent/technology pools like the WHO COVID-19 Technology Access Pool (WHO, 2020) and issue compulsory/government use licenses so that domestic and regional producers can manufacture these essential goods. Partnerships with firms are critical, including as a start through the patent/technology pools like the WHO COVID-19 Technology Access Pool (WHO, 2020). Voluntary licensing models have proven they can promote access, however it requires agreement by the right holders, which may cause delay and may not be possible to obtain on the terms demanded.

To encourage domestic production and revive their economies, the governments will need to provide subsidies, tax breaks, and preferential trade and investment treatment to domestic firms, especially their micro, small and medium enterprises.

Even though efforts to expand and diversify production would make global markets more competitive and keep prices in check, they could be challenged under trade and investment treaties.  For example, protection of foreign investors and, in particular, their expectations of investment-based profits, is a central aim of investment treaties backed up by the investor-state dispute settlement (ISDS) system; already investment lawyers are readying their corporate clients for rent-seeking opportunities emerging from Covid-19 (Olivet, et al, 2020).  Another cornerstone of the trade and investment regime is the notion of ‘national treatment’ which makes it difficult to prioritize the needs of domestic producers, but rather creates preferences and privileges for foreign firms.  Indeed, market concentration and lack of competition is not ordinarily a justification for favoring domestic production even as non-medical companies are being rescued, taxes suspended, and scores of measures are employed to prop up businesses in advanced economies.

There are some exceptions for national security and public health across the WTO agreements and in some regional and bilateral trade and investment treaties that could potentially be called on to help countries protect this policy space for a rapid deployment of manufacturing capabilities, compulsory licences, and importing of generic medicines.  However, these exceptions and flexibilities have not been applied to cases like the current crisis, and there is a general lack of precedent in international trade and investment tribunals even if they were.   Moreover, the burden of proof is on the defendant country, putting further pressure on countries as they are trying to combat the emergency. Furthermore, many developing countries lack the legal capacities to defend their emergency measures, if challenged in the WTO.

At least under the WTO, disputes are settled through inter-state resolution mechanisms where it might be expected that governments would have a mutual understanding of the nature of the crisis and hold off on excessive litigation during the pandemic. The current uncertainties are exacerbated by the fact that the WTO Appellate body is not functioning due to blocked appointments.  However, the ISDS system attached to most bilateral and regional deals grant foreign firms the privilege to directly file claims against nation states which can reach into the billions of dollars and further squeeze government budgets when they already are already under severe fiscal pressure .  Indeed, Peru has already been threatened with an ISDS claim by a US company over its blocking of new toll stations and faces further threats  over suspending tolls on toll roads to ease the economic burden of its population during the pandemic (World Bank, 2020).

Loosening the Squeeze(s)

There is an urgent need for the global trade and financial system to align itself with the global effort to attack the COVID crises and put in place a resilient, inclusive, and sustainable recovery.  As nations attempt to do whatever it takes toward these ends, they should not be squeezed by a lack of international liquidity and purchasing power due to volatile capital flows, nor should they be squeezed by WTO and ISDS claims in trade and investment treaties.  These regimes need major reforms and developing countries should not pay for these inefficiencies that will inevitably be reformed.  We call on the G90, G77, G24, G20 and other international bodies to commit to these four measures in order to obtain the fiscal and policy space they need to ‘do whatever it takes’ to combat the COVID-19 crises and promote economic recovery:

  1. Immediate increase in the fiscal space of nations. The IMF should issue at least $500 billion to $1 trillion Special Drawing Rights, and expand debt relief for those emerging market and developing countries that face balance of payments and liquidity constraints.  These measures will unlock the fiscal squeeze that many emerging market and developing countries are facing as they attempt to combat the crises.
  2. “Peace Clause” on Covid-19 related WTO and FTA cases. No country should face an onslaught of WTO cases as it takes emergency measures to protect the health and security of its people through compulsory licensing and other means.  While countries should quickly adopt and use emergency measures to overcome intellectual property, data, and informational barriers to Covid-19 related health technologies, there should be a permanent standstill on COVID-related claims on all government measures implemented in the context of  COVID-19 and in all fora.
  3. WTO and FTA negotiations should be suspended, and no new commitments should be demanded till the crisis lasts, in order to allow developing countries to reassess the flexibilities they need for their economic recovery.
  4. Moratorium on ISDS cases. Similarly, in the thousands of trade and investment treaties that go deeper than the WTO, there should be an immediate moratorium on all ISDS claims by foreign corporations against governments using international investment treaties, and a permanent restriction on all COVID-related claims (CCSI, 2020; ACAFREMIN Aet al, 2020).
  5. Commitment to reform. This pandemic has laid bare that the international financial and trade regimes need significant reform.  In 2021 nations of the world should begin putting in place processes for major reform of the global economic governance architecture to ensure that it is resilient, socially inclusive, development-oriented and environmentally sustainable.

Unlike the coronavirus, the lack of resilience in the international economic system is man-made. Excessive liberalization and deregulation have been sold to governments on the promise of large (but in practice elusive) gains from “free trade” and locked into rules and practices at the international level that have curtailed their available fiscal and policy space.  Critical areas of governance have, in the process, been ceded to private corporations backed by skewed judicial procedures.

The immediate challenge is to ensure policy makers have the room and resources to respond to the health shock and to mitigate the accompanying economic damage; but whether and how this happens will have direct consequences for whether a fairer, more inclusive and resilient recovery eventually takes hold. There is no better place to begin building a better future than with an overhaul of the rules of a multilateral trading system that have systematically put the profits of the few before the health, wealth and happiness of the many. Adopting new multilateral principles for shared prosperity will be key to building a fairer trading system and a more resilient future (Gallagher and Kozul-Wright, 2019).



Kevin P. Gallagher is professor and director of the Global Development Policy Center at Boston University’s Pardee School of Global Studies. Richard Kozul-Wright is director of the Globalization and Development Strategies Division of UNCTAD.

Photo by Josie Stephens from Pexels



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