komal sri-kumar is an economist who heads Sri-Kumar Global Strategies, a California-based consultancy specializing in risk analysis.
Published September 30, 2020
Almost nothing about this recession is familiar territory. The big question now is whether conventional economic tools can dig us out — and if not, what will be needed to get back to prosperity.
As is a surprise to nobody at this point, the U.S. economy took a nosedive in the spring, with the unemployment rate surging from a 50-year low in February to the highest level in over 70 years in April. Initial jobless claims that had been in the neighborhood of 200,000 a week for the better part of five years shot up to almost 7 million at the end of March, in reaction to widespread closure of nearly everything that animates our lives.
Governments across the globe poured massive resources to counter the downturn. McKinsey calculated that fiscal stimulus worldwide totaled $10 trillion in just two months — triple the entire stimulus applied after the 2008 crash.
In the United States, the $2.2 trillion aid package passed by Congress toward the end of March was the largest in history. The bulk of the money went to one-time $1,200 payments to most adults, $600-a-week supplements to state unemployment compensation, $350 billion in loans to small businesses that automatically converted to grants if the businesses sustained employment, $500 billion in loans for large businesses (including $25 billion for airlines) and $150 billion for beleaguered state and local governments.
The Federal Reserve supplemented the assistance from the Treasury with equally dramatic action. The short-term interest rate target was lowered to practically zero, and more important, the Fed went on a spree of buying Treasuries and mortgage-backed securities in an effort to keep money markets sloshing with liquidity.
Deciding that reductions in interest rates and bond purchases (known as quantitative easing), a staple of the post-2008 recovery, would not be sufficient this time around, the Fed announced in early April that it would also purchase “fallen angels.” These are corporate bonds, such as those of Ford Motor, that had dropped from investment- to noninvestment-grade status in early April in response to credit jitters. Then a month later, concluding that even this was insufficient, it extended its bond buying to include shares of exchange-traded funds that invested in corporate bonds.
Fed Chairman Jerome Powell was not quite done. In case markets still did not fully comprehend the Fed’s resolve to keep the monetary tap open, he signaled that the Fed would tolerate inflation exceeding the official target of 2 percent before any tightening occurred — a message that investors took to mean that interest rates would stay near zero for several years and that the Fed would intervene liberally down the road to make it happen.
So far, so good. But, unlike the monetary measures, the fiscal stimulus was date-stamped. A mix of ideology and partisanship kicked in. Since the $600 supplementary weekly benefit payments for the unemployed ended on July 31, the Trump administration and a majority of Congressional Republicans have opposed renewing those relatively generous terms. The $600-a-week addition to unemployment benefits is seen as a disincentive to work at wages currently offered — and a budget buster to boot. Democrats and Republicans are also far apart on aid to state and local governments, where tax revenues have plunged due to business failures and loss of household income.
Which Way Is Up?
There are some green shoots in the economy’s wilted garden. Housing is one of them. Sales of existing homes rose by 24.7 percent in July to the fastest pace since 2006, driven by a combination of low mortgage rates and an apparent “flight to the suburbs” driven by a mix of Covid-19 fears and a belief that telecommuting will remain an option after the pandemic is a bad memory. On the job front, unemployment did fall to 8.4 percent in August, down from 10.2 percent in July. And the labor force participation rate even ticked up slightly, presumably reflecting a ray of optimism that it was now worth looking for work.
Neither of these developments should provide comfort that a sustainable economic recovery is under way, though. Low mortgage rates and a government-mandated suspension of foreclosures (combined with some voluntary bank forbearance) have helped housing, but the clock is ticking on the latter. And many businesses have announced plans to prune employment once some of the federal assistance runs out on September 30. And lest one forget, green shoots do not a vibrant garden make: total nonfarm employment is 11.5 million less than it was before the pandemic hit.
After the last spikes in Covid-19 cases, fewer businesses will be able to bounce back, and job losses labeled as temporary will morph into permanent.
Furthermore, a factor that was a major influence on the recent improvement in the employment stats could itself be a precursor of bad news. The July-August rehiring of furloughed workers stemmed in good measure from the lifting of pandemic-induced social distancing restrictions. But that reopening generated spikes in Covid-19 cases, which has led to a secondary wave of mandatory and voluntary shutdowns. One less recognized consequence: this time around, fewer businesses will be able to bounce back, and job losses labeled as temporary will morph into permanent.
The deadlock in Congress on renewing assistance, and the expiry of the $600 unemployment assistance with no replacement in sight, suggest that the economy’s path is more likely to resemble a “W” than a “V” — after a rise in GDP in the third quarter, expect another downturn in the fourth.
Two statistics on the job front bear this out. Those considered “permanently” unemployed by the Labor Department rose from 2.9 million in July to 3.4 million in August. The last time this figure was so high was in 2013. By the same token, long-term unemployment (27 weeks and up) has been on a relentless rise since the pandemic hit, and currently stands at 1.6 million. Judging from the past, these workers face grim prospects for finding work even after the economy fully recovers.
Good News to Watch For
Lower Savings Rates. When the pandemic hit, consumers decided to cut back on spending, even on essentials. Consumer confidence, which cratered immediately after the pandemic hit, has defied predictions and continued to fall even through August. And since consumer spending accounts for about two-thirds of GDP, the decline in consumer confidence is playing an important role in holding back economic recovery. Personal savings, the flip side of consumption, surged from 8.3 percent in February to an unprecedented 33.7 percent by April as households prepared for bleak times ahead.
A fall in the savings rate back to single digits would suggest that spenders are feeling more secure about their jobs and salary levels. It would also be a signal that lower income workers have started to participate in an incipient economic recovery.
Rapidly Rising Labor Force Participation. If the unemployment rate declines with an economic recovery, will that not cause inflationary pressures to increase? This concern is based on a concept called the Phillips Curve, which posits that there is a stable inverse relationship between inflation and unemployment: push unemployment below the “natural” rate, and inflation rears its head. On the other side of the debate, some have argued that the Phillips Curve is no longer operational because the Federal Reserve has not managed to raise inflation consistently to its 2 percent target level since the global financial crisis over a decade ago, even as unemployment dropped to a 50-year low in the months before Covid-19.
Did low unemployment not signal an unduly tight labor market? Should that not have caused inflation to surge? Don’t write off the Phillips Curve quite yet.
Despite very low measured unemployment before the pandemic struck (3.5 percent in February 2020), the labor force participation rate did not come close to the 66 percent level achieved just before the Great Recession began. In other words, for one reason or another (or many) millions of workers who lost jobs in the Great Recession were not returning to work. In that sense, the labor market wasn’t tight and the Phillips Curve hypothesis was not tested.
Look to Germany and Japan for the Way Out
I think that while macroeconomic stimulus is necessary for recovery, it’s not sufficient to put the United States on a path toward stable, high-employment growth. We have two experiences from recent decades showing that structural changes in the nuts-and-bolts economy are also necessary. Simply put, a quintupling of the Fed’s assets (and a parallel monetary expansion) between the end of 2008 and 2014 could not transform store clerks into STEM workers. Training is the key.
One relevant experience here is positive: Germany, which successfully shed its status as the “sick man of Europe” at the beginning of this century. The other is not: Japan failed to spur growth despite a host of measures (dubbed Abenomics) that were introduced by Prime Minister Shinzo Abe after he assumed office for the second time in late-2012.
Two decades ago, Germany was experiencing double-digit unemployment. Fiscal deficits were allowed to exceed the EU-mandated 3 percent of GDP ceiling in 2002 through 2005 as a means of generating growth, though to no avail. But Chancellor Gerhard Schröder’s government had another initiative, introducing labor market changes that came to be known as the Hartz reforms. In a nutshell, the reforms subsidized employers willing to invest heavily in training.
This helped to lower unemployment from almost 12 percent in 2005 to less than 7 percent by 2012. (It fell even further, to 5 percent in the months before the pandemic struck.) Even more striking, worker training under the Hartz measures was key to eliminating the scourge of youth unemployment (for those aged 15-24 years) that afflicted Germany (and still dogs most European economies). German youth unemployment fell from 15.5 percent in 2005 to 6.2 percent by 2018.
Japan had an altogether different experience in attempting to leverage the economy out of its persistent funk. Abenomics had three policy “arrows”: monetary and fiscal expansion and a third arrow consisting of a grab-bag of possible structural changes. That third arrow acknowledged the consequences of a shrinking and rapidly aging population and proposed targeted immigration to mitigate the related labor shortages. One often-cited example was the arrival of Philippine domestic workers to increase Japanese housewives’ traditionally low rate of participation in the labor force. Another consisted of a slew of measures to foster competition in heavily protected industries.
Japan certainly didn’t stint on macro stimulus, running budget deficits that raised the debt-GDP ratio to the highest among advanced economies even as the central bank pushed interest rates below zero. (Yes, that’s a real thing, but a story for another time.) But very little of the third arrow was translated into policy. And by no coincidence, GDP growth averaged just 1 percent annually in the years leading up to Covid-19.
Washington needs to reshape fiscal recovery incentives to encourage companies to hire and train.
Getting from Here to There I: Retraining Is Key
Structural unemployment in the United States continues despite over a decade of aggressive monetary and fiscal stimulus. This, and the experiences of Germany and Japan with their own stabilization programs, suggest how important it is to dig down to the level of individual workers in spurring growth rather than depending on blunter macro instruments. I believe a durable recovery has to be built on the availability of a steady stream of skilled labor to suit the requirements of the post–Covid-19 economy.
Retraining costs money, some of which could directly or indirectly come from workers themselves if they had the financial breathing room to take lower paying jobs that included training. To this end (and others) I favor the introduction of a Universal Basic Income that would put money in the pockets of all households, rich or poor or in between. It would be paid for by broadening the tax base (i.e., eliminating most deductions) and by shedding many existing means-tested transfers.
For its part, Washington needs to reshape fiscal recovery incentives to encourage companies to hire and train. Again, components of Germany’s Hartz reforms could apply to the U.S. context. Employers would get a subsidy for each worker they agree to train, and the workers themselves would accept a lower wage than otherwise to pay part of the cost. One hopes (and expects) that the training would pay off for workers in terms of higher wages in a competitive labor market.
Getting from Here to There II: Socializing Success
In the frenzied trading in securities that preceded the crash of 2008, financial institutions made large bets with borrowed money — some of it from banks whose liabilities consisted of federally insured deposits. With leverage that could be as high as 30 to 1, the firms (and the traders) made out like bandits if they bet correctly. When bets went south, the firms got bailed out as part of the broader initiative to protect the payment system from a meltdown. Yet when massive backstopping by the government saved the financial markets and the firms came roaring back, the taxpayers did not get checks for the capital gain.
In a recent opinion piece in The New York Times, Mariana Mazzucato of University College London wonders why we “socialize” corporate losses in a systemic crisis but we don’t socialize the fruits of a successful recovery. A citizen’s dividend, perhaps like the one Alaska provides from royalties on oil leases, would provide some upside to taxpayers — and reduce resistance to using taxpayer funds again in this context.
Getting from Here to There III: Immigration, Immigration, Immigration
The median age of Americans has risen from 30 in 1980 to close to 38 today. More troubling, the portion of the population over 65 is rising rapidly (as in virtually every middle- and high-income economy). Fewer American-born workers must support an ever-growing cohort of retirees.
Japan and much of Europe offer subsidies of various sorts to encourage women to have more children, and thereby push back the decade of reckoning for aging societies. The remedy for labor shortages that the United States has used over its history is to close the gap with immigrants.
The politics of immigration has changed. And even if Donald Trump loses his bid for a second term, an immigration policy that both gets the job done in terms of labor market needs and passes muster with Congress will take some nuance to create. One would expect that the policy would need to tilt toward encouraging immigrants at the high end of the skills spectrum. And perhaps the low end, too; somebody has to harvest perishable crops and to take care of the elderly (a task that has hardly become more attractive in the Covid-19 era). One interesting suggestion from Michael Bloomberg: automatically give green cards to foreign STEM graduates along with their advanced degrees.
A Little Perspective
This recession, you’ve already heard a million times, is like no other. And in light of its utterly novel aspects, policymakers deserve credit for not stinting in initially trying to spare the economy (and American households) the consequences of the supply collapse. It is terribly important that they not falter now — running up deficits would be an acceptable price to pay to keep the recovery going.
But it is also important that policymakers think beyond the conventional to medium-term programs that help to rebuild an economy blighted by tens of thousands of failed businesses, service-starved states and localities, and millions of households that are likely to be worse off when the crisis is over than when it began.