Policy makers often describe their approach to the COVID-19 crisis as placing the economy in hibernation or an induced coma. In that sense, the restoration of normal functioning after the patient is revived will be the true measure of success.
Post-pandemic recovery will experience effects that persist after the initial cause — the coronavirus — cease to have an impact. There are several operative elements to consider:
1. The crisis will continue to destroy wealth: During the Great Recession, the U.S. lost around $10 trillion from drawdowns in savings, falling values of houses and investments. After the COVID-19 crisis, depleted savings will affect consumption levels. Longer-term, rising stock- and house prices may restore wealth, but only for those not forced to sell. The effects will be most damaging among people in lower socio-economic groups who are forced to spend more than they can save.
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2. The crisis will leave a legacy of debt: Household, business and government, many already highly indebted, will experience sharp rises in borrowing to cover cash-flow shortfalls. With around half- to two-thirds of the government support packages structured as loans, indebtedness will grow substantially.
For households and businesses, the need to meet debt obligations will restrict future spending and investment as they are forced to deleverage. Slower rebounds in real estate and financial asset prices will exacerbate the damage. A decade after the 2008 crisis, millions of homeowners still had mortgages greater than the value of their homes. For those who default, the effect on credit scores will restrict future ability to borrow, restricting their participation in the economy.
Low rates and central bank funding via quantitative easing (QE) will enable governments to increase debt. However, with debt likely to reach 150% of GDP for many countries, it will retard growth, reduce spending flexibility and crowd out other borrowers from capital markets. Low future growth rates and high debt levels are incompatible and will ultimately create destabilizing currency pressures.
3. Business will be slow to recover: Most smaller businesses lack reserves to meet expenses for more than a month or, at most, a quarter. Invested capital will be lost. Customers may shift to other providers. Failures destroy intellectual property embedded in networks of customers, staff, and processes. Reversing this loss takes time.
Many tourism and hospitality businesses, including airlines, also have crisis liabilities. In order to conserve cash, many of these companies have not refunded cancelled bookings but instead have provided vouchers for future use. When activity resumes, they will incur the costs of meeting these obligations without receiving additional revenue.
Changes in consumer demand from the crisis may affect the level of activity and certain businesses. Business travel may be substantially replaced by teleconferencing. Growth in working remotely, online shopping and entertainment may change demand for real estate. People may eschew cruising. They may be reluctant to travel overseas fearing future lockdowns.
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4. There will be persistent negative effects in the labor market: Lacking any realistic prospects of getting work, many will leave the workforce. A core of long-term unemployed with depreciating job skills are unlikely to be ever reemployed. This will increase the demand for welfare and incur large social costs. Employers will recalibrate their workforce for greater flexibility to shed costs quickly in future shocks. Freelance work and sub-contracting will become more prevalent, decreasing job security and overall incomes. The effects will fall strongly on the low-paid, minority groups and immigrants.
5. Increased state involvement and higher government debt will be difficult to reverse: Benefits provided in the COVID-19 crisis may be difficult wind back. Essential or strategically important services may shift back into some form of government control. Bailouts may reduce competition and create industrial zombies as governments seek to preserve firms and employment. Widespread income support may reduce incentives to save or even work.
6. Expect behavioral changes in people: Scarring from the crisis will affect family formation and fertility, which will alter demographics and accelerate the impact on societies with aging populations. Attitudes towards spending and saving may shift. After the Great Depression, people became thriftier and more cautious, fearing a new dislocation which would threaten their survival.
Governments can minimize some of these effects by facilitating investment and offering retraining facilities. However, many of these consequences are outside of their control. This points toward a slow recovery and lower economic growth.
Satyajit Das is a former banker. His latest book is A Banquet of Consequences (published in North America as The Age of Stagnation). He is also the author of Extreme Money and Traders, Guns & Money.
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