If past is prologue, then we know that global crises are the crucibles for major changes in the global financial architecture. The post-World War II arrangements forged in Bretton Woods, New Hampshire, proposed to rebuild Europe by creating new multilateral institutions, while the response to the 2008 financial crisis expanded prudential regulations of banks and non-bank institutions and heightened central-bank policy coordination. There is little doubt, then, that COVID-19 will be the catalyst for significant change in our societies. Our collective challenge is to ensure that this change creates a world that is more stable and sustainable than before.
The economic consequences of COVID-19 are widespread—IMF (International Monetary Fund) projections are for a 3-percent drop in global GDP (gross domestic product) in 2020. The repercussions will test both the financial guardrails established after the 2008 financial meltdown and the ability of economies to rebound. For economies that are less resilient and less well-off, the recovery will be more difficult, since they often lack public services and safety nets, have weaker private sectors and more limited civil-society participation. The KPMG Change Readiness Index 2019 captures this reality in a simple measure that demonstrates the greater susceptibility to negative shocks for poorer countries and their lower resilience in the face of change [Figure 1]. (Countries in the lower left-hand section are least ready to deal with shocks.)
What is different this time?
Looking ahead, in an increasingly uncertain world, we need to be better prepared for global shocks—whether caused by disease, climate events or economic dislocations from structural factors such as ageing populations or skills shortages (surpluses) arising from technological disruptions. Businesses and markets must be remade to address the consequences of these events and be more proactive in preventing their recurrences and negative impacts.
Although it is too early to draw definitive lessons for navigating the post-crisis world, there are a few that have been highlighted by the crisis. These are the drivers that can spur business innovation, new models for collaboration and greater access to capital to meet society’s goals. Some of the most evident lessons are:
- Addressing inequality and poverty at scale. The global lockdown will likely worsen income inequality and poverty and thus has raised the stakes for addressing gaps that existed prior to the crisis. Estimates show that globally, 40 to 60 million people will enter extreme poverty as a result of COVID-19, with Sub-Saharan Africa the most affected (23 million)[i]. This will increase poverty levels worldwide for the first time since the Asian Financial Crisis in 1998 and will erase some of the recent gains in poverty reduction. More than ever, policies and programs that scale up solutions to reduce inequality and achieve inclusive growth are critically important to offset the impact of the coronavirus and ensure a sustainable recovery.
- Patching up the social safety net. The crisis has underscored the weaknesses of existing health systems, which, in many cases, failed to provide adequate coverage. We have seen how the shock has put strains on supply chains, creating low inventories of critical supplies, equipment and medications, while overwhelming medical infrastructure. Prior to this health crisis, our colleague Mark Britnell, Global Head of Healthcare, Government & Infrastructure at KPMG, wrote about the pending shortfall in health workers worldwide[ii], a situation that has only been worsened by events. He recently noted, “…every country has belatedly realized that a well-staffed health system is not only good for patients and health professionals but critical to the economy as well.”
- Mind the gap. More broadly, the need for new investment in emerging economies has never been greater. In the pre-COVID-19 world, estimates were that the United Nations’ SDGs (Sustainable Development Goals) required trillions in new financing for emerging economies to bridge gaps in infrastructure, health services, education, food security and other areas that are essential for a sustainable recovery and long-term, equitable growth. In infrastructure, emerging economies will see current projects delayed by difficulties in accessing finance, labor and materials, and future projects shelved because cash-constrained governments will no longer be able to afford them. Richard Threlfall, Global Head of Infrastructure at KPMG, has observed, “It is a cruel irony that emerging markets that most need new infrastructure investment will emerge from the COVID-19 crisis least able to afford it. Our aspiration to achieve the SDGs will be set back a decade unless the world reconfirms its collective purpose to raise all countries to those minimum standards of quality of life.”
- Risk on/risk off. The ability of capital markets to “turn on a dime” was demonstrated with breath-taking speed as liquidity in emerging markets dried up—going from a sanguine 2019 to a rush-for-the-doors performance at the end of the first quarter in 2020. The impact of capital reversals is greatest where government deficits are large, debt levels high and local capital markets weak and underdeveloped. While the debt moratorium announced by the G20 offers some breathing room, it will not bring back needed capital flows given the underlying risk-return calculus of those seeking safer assets. New approaches to encourage investment and risk-taking should be at the forefront of the discussions for a sustainable recovery.
- Technology as a tool for good. The rapid adoption of technology to test and trace the spread of the virus offers a stark lesson in how we must balance personal freedom and social benefit. At the same time, it provides an opportunity to expand the use of new technologies such as blockchain to share private information for these efforts securely. Business-travel choices are being recalibrated against the health risks, and the distance between work and home is being bridged by wider adoption of communications technologies. For the delivery of international aid and development assistance, the need to “localize” the provision of services is even greater today, and new technological approaches will be needed. Finally, mobile payment systems—already widely adopted in emerging economies in Africa and Asia—have demonstrated an additional health benefit of a cashless society, along with playing a role in making cash transfers to poorer communities.
It’s about how not why.
The Marshall Plan was a lifeline to war-torn Europe that accelerated recovery in the aftermath of World War II. Through loans, grants and open-door economic policies, European economies recovered quickly and set the foundations for greater economic and political integration. A similar opportunity faces us today as we move from the Great Lockdown to the Great Reboot. How we make this transition is consequential. Some elements that can form the foundation of a new approach include the following:
SDGs: a new global vaccine. The global commitment to the Sustainable Development Goals (SDGs) in 2015, calling for nations to reach 17 aspirational goals by 2030, is a roadmap to better social and environmental outcomes for all countries, rich and poor. In hindsight, we can argue that the SDGs are figuratively a global immunization for the planet and civilization against adverse outcomes in health, poverty, inequality and the environment. The measures embodied by the SDG targets represent the forward-thinking goals that can forestall natural calamities such as COVID-19 and help in the recovery from those that cannot be prevented. These goals and the related targets should become a litmus test for decisions on investment by public and private actors.
Tap capital markets. The goal of reaching scale requires tapping global capital markets, both debt and equity, for sources of long-term finance. Global bonds have targeted “green economy” projects, SDGs, education and a host of other socially beneficial activities. However, twin challenges remain: how to measure impact to validate the use of proceeds (more on this later), and how to widen access to this funding model to citizens and larger pools of funds. The trend of widening sources of finance is already evident. Asset managers offer investment vehicles, such as exchange-traded funds (ETFs) that have social-purpose goals and promise financial returns. Mike Hayes, Global Head of Renewables at KPMG, and the World Economic Forum (WEF) have developed an equity model that uses blended finance to target breakthrough climate innovations that reduce CO2 (carbon dioxide) emissions by combining public and private investments for emerging technologies in energy storage, carbon-based products, energy efficiency and biomass/bioenergy. A number of asset managers have adopted these ideas and are now in the course of establishing many climate-tech platforms globally.
Risk bearing, not just sharing. Scaling up markets and funding governments to reach the SDGs will rely on multiple actors. We need to explore new institutional approaches with new public- and private-sector risk-takers.[iii] The use of blended finance that combines capital from investors who have differing risk appetites and return expectations is one viable approach. To scale these efforts, it is essential to structure products that tap risk-taking capital from those investors who place an intrinsic value on social return in addition to financial returns, and the increasing number who view environmental, social and governance (ESG) factors as inextricably linked to sustainable financial returns. New valuation techniques can be designed to capture these social and environmental gains. For example, in public bids for transport projects, authorities can include the social gains from increased access for women and minorities to jobs among the valuation factors, along with costs.
The power of impact. Foundational to the new “business as usual” (BAU) is enhanced identification, management and disclosure of factors related to the ESG performance of companies and how they address the expectations of their stakeholders and society. Already credit-rating agencies are valuing environmental and social impacts as they affect businesses and other rated entities. Making these measures more transparent and comparable is essential. Although ESG has become a common consideration in investment decisions, there are still a variety of ways this information is presented and evaluated that results in frustration. To address the issue, KPMG and other Big Four accounting firms prepared a proposal with the WEF setting out common ESG metrics and disclosures, which has been endorsed by more than 140 of the world’s largest companies. A cornerstone of the new BAU models and financial innovation will be hard-nosed and transparent social and environmental return data on assets.
Whether countries are resilient to or businesses are well prepared for shocks is no longer an academic exercise or a concern unique to management consultancies. The prospect of future global shocks and the immediate need for an effective recovery from COVID-19 require new skills and tools. Chief among these is the ability to identify, measure, mitigate or transfer risks as core competencies for the new BAU. What is critically needed are partners and institutions willing to invest at scale in the SDGs and raise capital that can bear the necessary risks and, at the same time, adequately value the social and environmental returns.
References and End Notes
[ii] Human: Solving the global workforce crisis in healthcare, Oxford University Press, 2019
[iii] A similar approach was adopted with publicly funded political-risk insurance to foster foreign direct investment in emerging economies—by taking risks that private investors could not. A risk-taker of first resort is needed to address many of the underlying risks in emerging markets.