Markets are the building blocks of a functioning economy. Competitive markets often produce goods and services satisfying a large variety of human needs that are offered at the best possible prices. There are, however, cases when markets fail to produce the best outcomes, particularly when there is concentrated market power, incomplete information, or externalities. For instance, the 2008 global financial crisis showed that markets are inefficient when an entity has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. In such cases, regulations or public interventions are required to prevent or correct these failures.
Over the past decades, not only has efficiency eroded as new sources of market power and externalities arose, but the inability of markets by themselves to contribute towards sustainability and inclusion objectives has also become increasingly evident. The 2020 pandemic exacerbated some of these trends. This section examines the evolution of product markets, financial markets and international trade as well as the role of new industrial policies in providing a new direction for market outcomes. Section 3.1 uses historical data to show trends in these dimensions, pointing out issues that already required policy attention before the pandemic. Section 3.2 provides a set of priorities for policy interventions to strengthen financial systems, competition and support to the private sector to revive growth (1-2 years) while embedding sustainable and inclusive prosperity principles. Section 3.3 offers policy recommendations for the longer run (3-5 years) that hardwire positive social and environmental outcomes into the functioning of the markets of tomorrow.
Financial systems after the 2007–2008 crisis have become sounder but continue to have some sources of fragility, including increased corporate debt risks and liquidity mismatches, and are not sufficiently inclusive.
The 2008-2009 financial crisis have led policy-makers to introduce new regulations and macro-prudential policies. Thanks to these interventions, financial systems strengthened worldwide (Figure 3.1). By pushing banks to deleverage, increase capitalization and reduce non-performing loans, banks have emerged from the financial crisis stronger, and were overall sounder in 2019 than they were in the past 12 years. (Table 3.1, Column A).26
During the same timeframe, banks, supported by accommodative monetary policy, eased credit conditions, granting better access to capital to both large firms and SMEs. For instance, in the United States and large Eurozone countries, an increasing number of loan managers reported having eased standards for granting business loans between 2008 and 2018. By the same token, business leaders answering the World Economic Forum’s Executive Opinion Survey have reported an improvement in access to credit for SMEs in their countries over the past five years (Table 3.1, Column B).
Loose monetary policy and easier access to credit has benefitted the economy on the one hand but introduced new issues on the other. First, low rates have reduced monitoring incentives and lending standards. As a result, corporate debt has risen over the past few years, which may become challenging with the emergence of the COVID-19 crisis. According to the IMF, at-risk corporate debt in 2019 was already high in systemically important countries, including the United States, United Kingdom and China. Although banks have learned to resolve bad loans faster, and most banks remain well capitalized, during the COVID-19 crisis several banks will “approach minimum capital levels”.27 A second issue driven by extra-loose monetary policy is stock market volatility and misalignment between market prices and fundamentals. Prices lose their signalling role and create incentives for diverting funds from investments (e.g. R&D, human capital, new facilities, pollution abatement) towards short-run profits, such as large-scale open-market repurchases.28
Furthermore, millions of households are still excluded from financial services and credit. For instance, according to the IMF’s Financial Access Survey, in most Sub-Saharan African countries there are less than four bank branches per 100,000 people, while in most European and North American countries there are between 20 and 50.29 Even within advanced economies some communities are significantly excluded from financial services: for instance, in the United States, almost half of black American households are un-banked or under-banked, versus about 20% of white American households.30
Market concentration has been on an increasing trend in advanced economies, with large productivity and profitability gaps between the top companies and all others in each sector.
Business leaders in advanced economies assess that, on average, the extent of market dominance has increased significantly since 2008. In developing and emerging economies, market dominance has increased less, but has remained persistently higher than in advanced economies. (Figure 3.2). These trends date back several decades. For instance, there is evidence that US market power started to increase in the 1980s, as mark-ups rose by 40 percentage points (reaching 61%), and profit rates increased from 1% of sales to 8% between 1980 and 2014, driven primarily by reallocation towards already high-mark up firms.31
In this context, the outbreak of the COVID-19 pandemic is likely to exacerbate concentration as it may force smaller and fragile companies to exit the market or lose market share in some sectors and reinforce ‘winner-take-all’ outcomes in other sectors, reducing space for innovation and new entrants as well as potentially reducing consumers’ benefit.
Innovation has also become concentrated. Only a handful of countries generate the bulk of new inventions, supported by a few smaller or regional innovators. Most other countries produce only marginal innovations or local adaptation of existing technologies. Over the past 20 years, large cross-country innovation divides have not diminished. Just five countries today produce together over 70% of global patent activity, and the top 10 countries generate over 85% of global patent shares (Figure 3.3). These levels of concentration have remained in place for the past 20 years, with the exception of China and Korea (Figure 3.4).32
The geographic distribution of innovation, while it may be the result of typical cluster development and the benefits of agglomeration, also highlights large intra-country innovation divides. Thus, innovation activity takes place overwhelmingly in metropolitan areas, leaving rural areas behind.33 This adds to the widening of the productivity divide between top companies and the rest—and leading to economies that are increasingly polarized and unequal.
Trade openness and the international movement of people have been on a declining trend since the financial crisis.
Countries responded to the 2009 global financial crisis by progressively increasing protectionism both in terms of trade and investments as well as on people movement. This tendency has crept in mainly through marginal adjustments to import practices—such as non-tariff barriers—and FDI rules, rather than through direct adjustment to tariffs rates. On average, business leaders in G20 countries evaluate that the prevalence of non-tariff barriers increased by 7.9% over 12 years ago (Figure 3.5) and that restrictiveness of FDI rules and regulations has increased by about 11.6% over the same period (Figure 3.6).
A similar trend is visible in terms of the ease of hiring foreign labour. Since the 2009 financial crisis, most countries have progressively tightened migration policies, limiting companies’ access to the international pool of talent. As a result, business executives in advanced and emerging countries alike have reported that hiring foreign labour became significantly harder in 2009–2010 and has remained at lower levels since then (Figure 3.7). In about 30 countries out of the 141 covered by the GCR, hiring foreign labour has become significantly harder than it was in 2008–including in Austria, Switzerland, Denmark, Italy, Iceland, Singapore, the United Kingdom and Sweden (among advanced economies), and India, South Africa, Botswana, Colombia and Peru (among emerging and developing economies).
The health crisis has further exacerbated the decline in international openness trends. Countries have restricted access to people even more during the pandemic, and the “prevalence of non-tariff barriers” indicator is one of the aspects that declined the most in G20 economies between 2019 and 2020, together with other indicators of international openness (e.g. rules on FDI, collaboration with other companies). As an example of the change in policy-makers’ mindset, the shortage of personal protective equipment (PPE) triggered by the pandemic, has induced governments to issue temporary export bans and consider reshoring production deemed as strategic.34
Although most health-equipment export bans have already been partially removed and health-related restrictions in the movement of people are likely to be lifted as the health crisis is resolved, there is a risk that protectionist policies and mindsets will stick. For instance, policy-makers of different countries have announced support to re-shoring of industries within national borders, and over 30% of business leaders in several G20 economies expect value chains to be less globalized than today (Figure 3.8).
Taken together, recent and longer-run trends in trade and the movement of people point to a lower commitment to international collaboration. As signalled by episodes of disengagement from the international community (e.g. Brexit, withdrawal from international environmental agreements) the space for effective international agreement has shrunk. This will be particularly crucial at a time when political will is needed to find common solutions on a broad set of topics (e.g. environmental targets, international taxation, vaccinations).
As noted in previous editions of the report, globalization and openness will remain important factors for global prosperity, but governments need to ensure better support to those who have been losing out to rapidly advancing globalization and technological change. In the new context, governments will also need to support those small and medium-size businesses that have lost out to the current shock of new restrictions and de-globalization.
To respond to the long-standing challenges and as well as the new ones caused by the health crisis, the following priorities have been identified to revive the economy over the next 1-2 years, beyond immediate crisis management.
Ensure stable financial markets, a sound financial system and expand access and inclusion.
Significant actions have already been taken to respond to the financial risks generated by the COVID-19 crisis, including support via guarantees to banks on loans and relaxation of some regulations to allow for flexible use of capital and reserves. However, governments must also look beyond the current crisis to guarantee financial stability, preventing losses and fragilities in the corporate sector from weakening the financial system, and expanding its access.35
As COVID-19-related credit support may increase corporate and household indebtedness in the medium term, financing difficulties may arise when moratoria on debt repayments are lifted. Continuing loan guarantees and a gradual phase-out of direct support to firms, accompanied by continued monetary accommodation, should help to avoid mass insolvencies and private debt defaults. In addition, a strong framework for private debt restructuring to resolve nonviable firms should be established, including guidance on how banks should treat restructured loans and moratoria on loan repayments. Further, to prevent future credit crunches, banks should be allowed to continue using flexibility in regulatory frameworks and prudent accounting standards for loan classification and provisioning.36 Beyond the immediate emergency period, policy-makers should prioritize solvency support for strategic or systemic firms, gradually tightening eligibility criteria for direct support to companies, and find innovative solutions to offer grants to SMEs in countries where small companies represent a large share of employment.37
A second policy element to strengthen financial stability is to set up regulations and prudential supervision of the non-bank financial sector, as well as to balance consolidation of weak banks with the growing competition from emerging financial players (shadow banks, FinTech and the entry of BigTech into financial markets). Regulation will need to allow innovation while ensuring financial stability in these new domains of the financial industry to prevent the build-up of systemic fragilities. For developing economies, in addition to monetary and macroprudential policies, policy-makers may also need to manage foreign exchange and capital flows, and vastly expand access and inclusion for their populations.
Balance support for firms to prevent excessive industry consolidation and further concentration with sufficient flexibility to avoid keeping ‘zombie-firms’ in the system.
As a first response to the COVID-19 crisis, governments have provided swift and strong direct and indirect support to the private sector (e.g. tax deferrals, guarantee loans, recapitalizations, subsidies). These measures have not only been effective in avoiding massive foreclosures and in supporting livelihoods; they have also prevented excessive consolidation and further increase in market concentration in multiple sectors.
In the next phase of the recovery, however, it will be important to consider firms’ fragility jointly with excessive and unconditional support that may lead to resource misallocation, keeping ‘unviable firms’ alive and preventing market competition and limiting industrial renewal. To strike a balance between support on the one hand and competition and innovation on the other, public support to companies should be phased out gradually in line with the evolution of the pandemic, targeting primarily solvent yet illiquid firms, by industry. This is a difficult distinction to make. However, firms should be increasingly required to demonstrate the extent of the COVID-19 negative impact, their financing needs, as well as be assessed against historic financial performance (operating profits, previous borrowing history, etc.) in order to be eligible for different support instruments.38
Such approaches can help ensure that resources reach primarily firms and industries that required for the future and those that have suffered in the crisis but have long-term viability. Conversely, support should be less generous toward sectors or activities which create externalities, are declining, or not required for the future. In these sectors, policy-makers should instead provide planning and support for redeploying talent and assets elsewhere.
Create financial incentives for companies to engage in sustainable and inclusive practices and investments.
Emergency support to the private sector during COVID-19 has helped sustain some employment in the short term, but also offers an opportunity to nudge future business strategies towards more inclusive products and services, low-carbon investments or new emerging sectors or markets. Conditional lending and subsidies have been used in some countries during the COVID-19 crisis and can be extended to direct companies towards socially desirable behaviours (e.g. addressing tax avoidance, committing to future investments in energy-efficiency, providing personnel training). 36
As emergency public support to companies phases out, other instruments should be designed to incentivize investment in the low-carbon economy, new pioneering technologies or socially valuable markets (e.g. care economy), using a mix of subsidies or tax breaks on the one hand, while introducing new taxes (e.g. emissions) that can increase government revenues while correcting externalities.
Lay the foundations for better balancing the international movement of goods and people with local prosperity and strategic local resilience in supply chains.
With the outbreak of the pandemic, long-standing opposition to globalization and a stricter stance on migration has converted into nationalistic industrial policy announcements that aim to attract or re-shore production within national borders to create employment, and at the same time have a more direct control of supply chains. To some extent, partial re-organization of global value chains that proved to be too fragile during the crisis is desirable. It may not only improve resilience but also open up opportunities to countries currently not well integrated into global trade.
However, some caution is needed when it comes to the expected outcomes of re-shoring policies. First, companies tend to replace a supplier from a location with a new one in a different location rather than expanding their network. Hence, resilience may not necessarily improve. Second, sudden re-shoring may disrupt supply chains in the short run and may lead to less employment opportunities than expected when combined with a higher degree of automation. Third, these policies may not necessarily secure the supply of critical pharmaceutical or medical products as supply is better guaranteed by international networks than by a single country’s domestic production.
To lay the groundwork for fairer trade that achieves local prosperity, international collaboration is essential along with local support. In the near term, the international community should remove remaining trade restrictions on essential medical supplies, share more information globally on the pandemic, and channel funding for vaccine production and distribution at an affordable price for all countries. In parallel, more dialogue is needed on travel and migration, new trade policies and managing climate change to prepare for reforming international governance in the longer run.
As part of their efforts to shape goods, services and financial markets that not only achieve shared prosperity, respective of planetary boundaries, the following policies are recommended for countries to start their economic transformations post-pandemic.
Increase incentives to direct financial resources towards long-term investments, strengthen stability and expand inclusion.
While in the near future, the priority for financial markets will still be on contributing to minimize employment loss without excessive weakening of banks, in the longer run the financial sector will need to embark on a deeper restructuring. Banks will have to rebuild capital buffers, thinned during the COVID-19 crisis. In this phase, the regulatory flexibility allowed to give banks margins of manoeuvre will need to be removed and the implementation of the Basel III standards will have to resume, starting in 2023.39
A new regulatory framework will, however, need to encompass both banks and non‑bank financial institutions, including further prudential supervision to contain excessive risk-taking in this segment of the industry and to avoid that a new source of systemic risk is introduced in the financial system. Further, as BigTech firms become new players in financial markets, the regulatory framework will have to include provisions on customers’ data ownership and portability. Regulators will therefore have to balance prudential regulation and competition policy to avoid compliance becoming a barrier to entry for new players without allowing new entrants to be a source of instability.40
Moreover, to steer the financial system to channel funds towards productive, long-run investments, policy-makers should remove incentives that divert funds from these types of investments and instead incentivize financial support to environmental, social, and corporate governance (ESG)-compliant companies. For instance, corporations could be more proactively discouraged to engage in short-term return operations as open-market repurchases, as some countries have done in the short term.41 When it comes to incentives towards investments in ESG, triple accounting and reporting, together with greater demand for green and inclusive investments by a new generation of consumers could lead banks to renew their product offerings. There is already some evidence that wealth managers are moving towards ESG-informed investing and that banks are creating sustainable exchange-traded funds (ETFs) as well as loans dedicated to home energy-efficiency improvement.42 37
Rethink competition and anti-trust frameworks needed in the Fourth Industrial Revolution, ensuring market access, both locally and internationally.
New and pre-COVID-19 competition issues need to be addressed for economies to deliver widespread prosperity in the long run. In terms of long-standing issues, policy-makers must take more action to resolve excessive market power, overall and in specific sectors. This includes reinforcing existing anti-trust authorities and implementing regulation that allows new players to enter the market. It also includes addressing ‘winner-take-all’ dynamics in some specific markets, such as those where digital platforms offer a position of dominance. New policies in this domain could include developing new metrics to: measure the impact of market concentration in the platform economy, move away from monitoring only market price increases to detect market dominance, scrutinize the practice of the acquisition of start-ups before they become serious competitors to incumbent leaders, and use technology to reduce barriers to entry, such as finding smart solutions to assign property rights to data.43
A potential new issue, triggered by the COVID-19 crisis, is the risk, not yet materialized, that stimulus packages—after having been a useful tool to prevent consolidation in the short term—can actually become a tool of market distortion in the long run. If countries convert emergency packages into permanent state aid that promotes ‘national champions’, competition and level playing fields will be compromised.44 Recovery strategies should therefore make sure to increase support to companies gradually as the crisis resolves, possibly re-directing resources towards broader incentives for developing inclusive and green products and services.
Facilitate the creation of "markets of tomorrow", especially in areas that require public-private collaboration.
A new market is created via the interaction of i) norms and standards, ii) technological possibilities, and iii) demand. The World Economic Forum has identified 20 innovative “markets of tomorrow” as new, emergent niches with the potential of transforming economies from the bottom up, by taking advantage of new technologies and new norms to generate economic value while meeting the needs of society and the environment. These markets include, for instance, the market for EdTech and reskilling services, the market for data, and the market for care services.
Six conditions need to be in place for these markets to materialize: invention, production, demand, standards, codification and infrastructure.45 Enabling these conditions can foster the creation of such new markets to meet societal needs in new ways. For instance, safety nets can be thought of as a market of tomorrow, where the need of employees will be to receive insurance in a context where cross-sector and cross-country mobility will be higher and unemployment episodes may be more frequent than today for a significant section of the workforce. New technologies, adequate norms and public-private collaborations can help offer new solutions to these new needs, creating a new market for safety net services.