Extensive research has examined the economic impact of the COVID pandemic on both advanced and developing economies. Much of this focuses on the most direct, visible effects of the pandemic, often with the aim of assessing financing needs during the immediate 2–5-year recovery phase. Less attention has been paid to the medium- to long-term implications of the damage to health and human capital caused by the pandemic, although there is growing evidence of longer-term harm to children’s health and education, caused by school closures, reduced vaccination rates and increased malnutrition. This is expected to have devastating long-term effects on human capital. According to the World Bank, real GDP could permanently decrease by 4 per cent in less developed countries, unless these effects are quickly reversed.  

In our new paper, we develop a dynamic general equilibrium model to explore the macroeconomic and welfare implications of this damage to health and human capital. The model explores the trade-offs between rebuilding human capital and investing in the recovery of livelihoods and macroeconomic sustainability. Our analysis shows that without significant and sustained external financing, the loss-of-learning impact on labour productivity is likely to make the post-COVID recovery in low-income countries longer and more expensive than much contemporary analysis suggests.  

Modelling COVID's impact on economic performance and welfare 

COVID generated a complex set of shocks of unprecedented proportions to trade, productivity, capital flows, health and education. To quantify their impact and evaluate alternative policy responses, our model tracks the paths of growth, inequality, unemployment and underemployment, public debt and real wages in the short, medium, and long terms in an archetypical small, open, low-income country. The model pays particular attention to the links between public spending on health and education, human capital and productivity growth, especially for low-skilled labour.  

We apply the model to three contexts, starting with a baseline scenario in which the government tries to ride out the pandemic without fundamentally changing domestic public policy, even as conditions worsen and the domestic tax base shrinks. This gives us a benchmark against which to later assess the impact of public investment. As expected, our baseline scenario results in brutal short-term economic repercussions, which conform to the prevailing narrative for the short-run economic impact of COVID in low-income countries.  

We then consider two scenarios in which the government seeks to repair the damage done to the country’s human capital by ramping up investment in health and basic education in the short and medium terms. In the first, we assume official creditors make available sufficient concessional loans to finance the entire investment programme, at a constant and highly subsidised interest rate. In the second, external concessional finance meets only half of programme costs, with the balance falling on domestic fiscal instruments, such as tax increases or adjustments to recurrent or investment expenditure. 

The need for recovery investment 

We examine the implications of these alternatives for welfare – in particular, that of the poor. The welfare costs of the COVID shock itself are very large, and therefore so are the welfare costs of not responding. The poor are disproportionately hurt by this shock, and even when recovery reforms are in place, the recovery is relatively favourable to the non-poor. It follows that the more that adjustment can be financed externally, the less severe the welfare cost. This is particularly so if domestic fiscal choices are so heavily constrained that the authorities are forced to cut back high-return infrastructure spending in order to restore fiscal balance.  

An important implication of this work is that, from a social welfare perspective, a sufficiently far-sighted view on public investment in health and education “justifies” the accumulation of external debt above the prudent limits associated with conventional analyses of debt sustainability. Our analysis highlights four points central to the public policy debate around responses to the COVID crisis for low-income countries:  

• Despite a rapid response from some global institutions, notably the IMF and the World Bank, the brutal direct and indirect short-run economic effects of the pandemic have been highly concentrated on low-income countries, to a degree disproportionate to the direct health costs of the pandemic. 
• If left unaddressed, the damage to health and human capital caused by the pandemic risks turning a sharp short-run recession into a severe medium-term economic decline. Increased public investment in education and health can repair the damage done to human capital. However, this is likely to be more difficult and more expensive than commonly thought. It may take more than a decade for per capita incomes, formal sector employment and the real wages of the poor to return to pre-pandemic trends.  
• If the public investment required cannot be financed externally through lending, a substantial and attenuated fiscal adjustment burden will fall on already stressed domestic public finances, further delaying the eventual post-pandemic recovery. Clearly, the larger and more rapid the disbursement of concessional finance, the less severe the fiscal adjustment need be – although this incurs the cost of an external debt profile that remains elevated for longer. 
• There are limits to the amounts of fiscal adjustment low-income countries can shoulder. In many, this capacity was already highly constrained before the pandemic, and has been worsened by post-pandemic events. Sustained public investment in pandemic recovery must therefore entail a rapid increase in external and total public debt in the short- to medium-term. This risks derailing recovery, as governments are forced to scale back “regular” public investment, raise domestic taxes or sharply expand domestic borrowing. To avoid this, creditors should increase their tolerance of countries having otherwise uncomfortably high external debt burdens over time.  

As the micro-economic evidence improves, we will be able to further refine our core simulations. However, the analysis indicates that although the necessary investment in post-COVID recovery is expensive, the welfare gains relative to doing nothing are substantial – especially where policymakers attach significant weight to the welfare of the poor. 

Further information

Edward F Buffie, Christopher Adam, Luis-Felipe Zanna and Kangni Kpodar (2022) 'Loss-of-learning and the post-Covid recovery in low-income countries', Journal of Macroeconomics 75