Borrowed time: The lifesaving link between debt, distancing, and vaccines

Intuitively, most of us regard debt as a sign of dependency—at best, a necessary evil.

In the context of a global pandemic, however, soaring debt can be a signal of strength. In 2020, government debt in the United States rose 25 percentage points as the federal government pulled out all the stops to support American businesses and households. Across advanced economies, according to the International Monetary Fund (IMF), government debt rose nearly 20 percentage points.

Not so in developing and low-income countries, where debt rose by considerably less, and from a lower base (Figure 1). While governments and businesses in the U.S., Japan, and Western Europe have ample access to credit from domestic and international sources, “most developing economies are on the opposite side of the financing divide,” the IMF points out, “facing limited access to funding and often higher borrowing rates.”

Less borrowing correlates with harder conditions on the ground. As 2022 began, the director-general of the U.N.’s International Labour Organization warned of an “uncertain and fragile” global outlook “driven largely by differences in vaccination coverage and economic recovery measures, (with) developed economies recouping significant elements of their employment and income losses, while emerging and developing countries continued to struggle.”

First-world problems

In a pandemic, the connection between debt and well-being hinges on something many Americans view as a pain—but which, from another angle, looks like a privilege: social distancing.

Minneapolis Fed Assistant Director of Policy Cristina Arellano places the debt/distancing connection at the heart of economic models that she has refined throughout the pandemic to understand the experience of low-income and developing countries. The latest update to this work—with Yan Bai at the University of Rochester and Gabriel Mihalache of Stony Brook University—enhances the model with vaccines and a delta/omicron-type second surge. The researchers calibrate the model using data from Latin America, though the insights could apply around the world.

Until vaccines arrive, a country like the U.S. can borrow as much as needed to put a stimulus check in every mailbox and extend forgivable loans to shuttered small businesses (some of which can also access private lines of credit to bridge a period of downtime or depressed sales). Irritating as it might be when we can’t work side-by-side with colleagues or linger in our favorite coffee shop, these measures have the crucial benefit of keeping citizens in well-off nations from breathing on each other—while smoothing household incomes through a rough patch.

Countries already straining to pay back sovereign debt, or otherwise considered risky, do not have the same luxury to borrow what they need at low rates and call a time-out to stop the spread. “It’s really not sustainable, before the vaccines arrive, to contain the epidemic” through social distancing, Arellano said. “You have to go to the market to sell your products. There’s less of a possibility of working from home; the internet doesn’t work so well. There are more limitations to using financial markets and technology in the economy to move to working from home and not getting the disease.”

The difference leaps out in the descriptive data, where countries with higher debt levels experience a lower rate of excess coronavirus deaths (Figure 2).

“The fiscal packages that the developed world could pass were orders of magnitude higher than what the developing countries have done,” said Arellano. “As a class, they have done much better in terms of COVID than, say, Latin America.”

When credit is a literal lifeline

The economists’ model compares two hypothetical countries. One government has ample access to international credit. The other, a “financially constrained” government, cannot borrow abroad and must rely on its own resources.

The country with access to credit shuts down twice as much of its economy, using borrowing to support its citizens’ incomes. The financially constrained economy, on the other hand, cannot afford to slow down and socially distance. This country suffers a death rate nearly four times as large.

The latest version of their model brings vaccines into the picture. In the real-world data, developed financial markets and vaccination levels show a strong positive relationship (Figure 3). In the model, the country with access to credit spends 50 percent more on vaccines and ultimately vaccinates 45 percent more of its citizens.

It’s not simply that the first country can afford more vaccines; aside from the lowest-income countries, the researchers find that vaccine price is not a major factor. Rather, vaccines reach more people because the broader economic shutdown pre-vaccine keeps people from catching the virus in the first place.

In the financially constrained countries, “many people … are going to get infected with COVID before the vaccines arrive,” said Arellano. “When the vaccines arrive, they’re not as useful, so there’s not as much uptake from the vaccine.” The researchers find that vaccines are twice as effective at reducing deaths in a country that has the ability to borrow and can afford to social distance.

All told, the cost to the well-being (what economists call “welfare cost”) of the financially constrained country in the model—factoring in economic activity and excess deaths—is almost twice as large.

What a difference a loan makes

The economists then simulate a loan for the constrained country, equal to 7 percent of annual gross domestic product. In the model, this loan increases vaccinations by 14 percent, reduces deaths by 19 percent, and lowers the total welfare cost of the pandemic by almost a third. A loan later in the cycle does not provide the same benefit but is still helpful.

The World Bank and International Monetary Fund have undertaken record levels of lending since 2020—more than $300 billion as of January 2022. Through the Debt Service Suspension Initiative, both institutions are helping low-income countries suspend debt payments to their public creditors, and encouraging private creditors of struggling governments to do the same.

These kinds of sovereign loans typically come with many strings attached. “Usually, the IMF and other organizations are very fiscally austere,” Arellano said. “They say to the countries: You have to put your fiscal house in order and pay the debt—more flexibility in labor markets, better collection of taxes, and so forth.”

In the face of COVID-19, however, the usual rules have been relaxed. International financial institutions “had this sense that it was an exception, an unforeseeable crisis, and they moved back from this fiscally austere view,” said Arellano. “They’re going to support countries with these programs and with these loans for them to manage the pandemic and their mitigation strategies, and ultimately the vaccine access.”

Emergency lending—or billions in outright grant-making, in the case of the World Bank—can help break what Arellano and her co-authors label a “feedback loop” for indebted countries: An epidemic increases default risk, which makes it ever harder to borrow, which leads to a more painful epidemic. It also limits the “collateral damage,” in Arellano’s words, of a post-COVID debt hangover that could otherwise stretch for decades.

Despite these significant efforts by international financial institutions, the proportional difference in borrowing to-date between high- and lower-income countries during the pandemic puts the latter at a distinct disadvantage. As in the economists’ model, high-income-style social distancing has been a fantasy in much of the developing world.

On balance, international capital has continued to flow heavily into the U.S. and other high-income, low-risk countries, supporting massive stimulus efforts. That stimulus has fed into increased savings of households. Those savings are a potential, but largely untapped, source of credit for other areas of the world that are struggling: “During the COVID-19 epidemic, savings rates of richer households skyrocketed, especially in wealthier countries like the United States,” the economists write. “These savings can constitute a potential source of funding for all countries in the world.”

Bad credit … first for vaccines?

Access to credit isn’t everything. Factors like culture and geography influence excess deaths and vaccination rates. As of early 2022, Portugal—no financial powerhouse—joins countries like Singapore and the United Arab Emirates as a world leader, with two doses for 91 percent of Portuguese. Meanwhile U.S. vaccinations have plateaued; we now lag most developed countries and many middle-income nations, including much of Latin America (Figure 4).

Nonetheless, the global vaccine rollout has largely been a story of haves and have-nots. COVAX, the World Health Organization initiative to distribute vaccines to developing countries, sputtered out of the gate, reaching just half of its 2 billion-dose goal for 2021.

Meanwhile, wealthy countries inked contracts directly with manufacturers, obtaining doses quickly and even throwing out millions they did not use. On top of this, vaccines from Moderna and Pfizer-BioNTech appear to be more effective than the varieties often available to low-income countries.

The ongoing research by Arellano and her co-authors suggests that the uneven global vaccine rollout—while hardly a surprise—was backward. Factoring in access to credit implies that vaccines should go first to countries that lack the financial wherewithal to buy time.

“Vaccines are useful for everybody,” Arellano said. “But those developing countries need the vaccines the most because it’s really hard for them to do mitigation with social distancing.”

The demonstrated capacity of this coronavirus to evolve means the lessons of the research remain highly relevant, even to the current pandemic. Wealthier nations and international organizations can prevent deaths by supporting lower-income and less creditworthy countries when they need to slow their economies.

“When variants and waves are blazing through, we’re back into social distancing—even with the vaccines,” said Arellano. “Even though we’re late in the pandemic, citizens in these (developing) countries are going to need these resources to weather the wave.”