I keep forgetting that most people believe textbook macroeconomics instead of my preferred paradigm of Patterns of Sustainable Specialization and Trade. To understand how I think about the recovery from the virus crisis, forget everything you learned about “aggregate demand” or “aggregate supply” or anything you read in the newspapers, especially about all the things that the Fed is doing to “save” the economy. Instead, try to approach this with a fresh outlook, bringing no baggage with you.
I am going to make some points here that have the potential to offend people of all political stripes.
1. “We” didn’t kill the economy, if by “we” one is referring to the government. Most, if not all, of the actions that reduced economic activity were undertaken voluntarily by households and firms.
2. The economy is not going to “re-open” or “get back to normal” in response to government action.
3. The CARES Act and the Fed’s extraordinary interventions are more likely to hurt than to help the recovery.
Read on.
Think of the economy as a complex mosaic of patterns of specialization and trade. Just about everything you enjoy as a consumer is the ultimate results of millions of different tasks performed by millions of people. In my book, I use the example of cereal that you eat in the morning. Getting you that cereal required having a truck driver to deliver it to the store, which meant that people had to build trucks, which meant that people had to make steel, which meant that people had to mine metals, and on and on, without even getting into the process that produced the actual cereal.
The virus crisis has broken many patterns of specialization and trade. Think of two scales.
Necessity: the importance of the activity for basic health and safety. Food and urgent medical care are high in necessity.
Risk: the potential for the activity to spread the virus. Large gatherings and travel to different cities and different countries are high in risk.
The higher an activity is on the risk scale and the lower it is on the necessity scale, the less likely it is that we are doing it right now. It either has to be low risk, high necessity, or both.
A truck driver may be contributing to risk by traveling from one location to another. But if the truck is delivering food, that activity is also high on the immediate necessity scale.
As people started to perceive the crisis, economic activities with low necessity and high risk were shut down. Sporting events, large conferences, tourism, etc. These were almost entirely private-sector decisions.
As worries about the crisis deepened, people curtailed activities that were lower on the risk scale and higher on the necessity scale. We increased teleworking. Colleges closed. Many of us sharply curtailed our social contacts. Again, most of these were private-sector decisions.
Eventually, authorities stepped in and put tight boundaries on the necessity/risk matrix. You cannot travel to work unless your job is deemed essential. In some jurisdictions, you cannot invite other people into your home.
What recovery means is a gradual loosening of the necessity/risk matrix. Do you have a toothache? Maybe at the height of the crisis you decide (or the government decides for you) that you should not go to the dentist. But as we make some progress in “flattening the curve,” dentist office visits are permitted and some of us decide that the benefits outweigh the risks. With more progress, some of us decide that going for a haircut has benefits that outweigh the risks. With still more progress, colleges decide that re-opening is worth the risk.
These decisions will not be made by the government (except in the case of state colleges, which we might treat as a government decision). Once government lifts restrictions on these activities, it can only offer advice (which people may or may not trust). Government cannot order me to get a haircut, eat in a restaurant, travel by airplane, or go on a cruise ship. So it cannot “re-open” the economy by fiat.
So far, I have made it sound as though recovery is just a step-by-step process of expanding inside the necessity/risk matrix until we get back to normal. But that is misleading.
The economy is always evolving. In normal times, each month 4 million jobs are created and approximately the same number are destroyed. The official employment statistics only report the net difference, which is usually on the order of 200,000 jobs a month.
With the virus crisis, the need for adaptation has soared. There are high-necessity activities where supply is constrained by a lack of workers. Amazon and Wal-Mart want to hire. Some pundits have suggested that the government should recruit an army of workers to implement “test, track, and trace.” I believe that Scott Gottlieb has suggested building manufacturing capacity for every vaccine that is currently considered promising, in case one of them turns out to work.
As long as schools are closed, teachers and parents need training in the use of online tools. I assume that a number of Internet companies need to hire more staff to deal with a new surge in demand.
We are never going to restore the pre-virus patterns of specialization and trade. Here are a few reasons.
1. Changes in technology and tastes that would have occurred anyway over the course of the next eighteen months would change these patterns. Remember those 4 million jobs that are created and destroyed each month in normal times.
2. People are acquiring new habits and skills. Learning to use Zoom. Discovering that they like InstaCart. Learning how to be productive working remotely and how to monitor the productivity of remote workers. More than one company is starting to look at its fancy headquarters building as a liability rather than as an asset.
We are getting better at distance learning and distance teaching. Even years from now, the demand for attending large entertainment events may be far below what it was before the crisis.
3. Some businesses will not be able to be saved. Maybe they were already failing. Maybe the political process either cannot or will not bail them out.
4. The international economy has been severely disrupted. Europeans have lost a lot of wealth, so that even when they feel comfortable traveling they will find it difficult to afford to come here as tourists. It is not clear when global supply chains will be renewed, if that ever happens.
5. We don’t know how the virus will affect less developed countries. A catastrophe in India would be felt in our economy.
This PSST framework leaves me very skeptical of phrases like “re-start” or “unfreeze” or “re-open” as applied to the whole economy. I would prefer a phrase like “regenerate” or “renew.”
The years immediately following World War II showed how powerful the forces of regeneration and renewal can be in a capitalist economy. America, Germany, and Japan did particularly well. I always recommend David Halberstam’s The Fifties for its stories of the important companies, like Holiday Inn and McDonalds, that were founded in that era.
Unfortunately, this time around, instead of letting the private sector take care of regeneration and renewal, we are putting our faith in central planning. Every business is looking for help from Congress or the Fed. When the government picks winners and losers, it is always the losers who have the advantage.
In theory, the goal is to put the pre-virus patterns of specialization and trade back in place, even though this is neither possible nor desirable. In practice, what we will see is a rolling wave of bailouts, as the attempt to keep one constituency afloat creates problems for another constituency.
For example, giving households the right to skip mortgage payments creates financial problems for everyone who depends on those payments. I don’t know how mortgage-backed securities are supposed to work now, and I imagine nobody does. Who is supposed to take the hits? Freddie and Fannie? Mutual funds, pension funds, and other investors?
As time goes on, the attempt to restore pre-virus patterns will run into the need for more and more patches and fixes. The easiest way to do this is to enact spending bills. Government will act as if it has unlimited resources.
In fact, these policies will be counterproductive, because they will inhibit the private sector from undertaking the necessary regeneration and renewal. As a society, we will be spending a lot more money without a corresponding increase in productive capacity. Too much money chasing too few goods is the very essence of inflation.
It is clear that as of last week, the financial markets were anticipating a rosier outcome. Wall Street people tend to believe Keynesian macroeconomics, and they absolutely worship the Fed. But if the PSST framework is correct, then the investors who bought last week will be in for a disappointment as this plays out. It is not that the PSST framework is inherently pessimistic. My pessimism is about a medium-term future that includes de-globalization and a lot of central planning.
I think the US will end up with something similar to the Treuhand that was tasked with liquidating the East German economy. The Fed will end up with a lot of the US pre-crisis economy on its balance sheet and then a bunch of bureaucrats will try to ‘privatise’ the bunch.
Good post, as usual. However, I find the following analysis as problematic.
“The economy is not going to ‘re-open’ or ‘get back to normal’ in response to government action.”
1) But, STEP #1 in returning to normalcy actually does require government action. E.g lifting the “shelter in place” orders throughout the country. Let the counties or states decide this on their own and let a thousand experiments bloom from there.
2) Perhaps I’m not as plugged in as you, but I don’t see anyone from the “re-open” crowd actually arguing that the economy will return to normal on Day 1. This part of your analysis strikes me as a straw man. It’s a multi step process, and when “safe” to do so, getting us from 40% to 70% of normal will yield huge gains. The sooner we can safely start this process the better off we will be. Small steps towards a better world as they might say.
3) and “safe” is a term that the elites in Belmont will get to define. Fishtown is out of luck
[gratuitous insults will not be tolerated–ed.]
I second Barry’s comment. What the government has done is the equivalent of applying a tourniquet to a leg with a severed artery. We have a very short window to repair the leg enough before it has to be released, and if we can’t repair it immediately, we have to remove it anyway, at least for a while and see what happens.
Great post!
The roughly 14 million jobs in bars, restaurants, sports stadiums, hotels, and conference centers are not coming back soon. That might be a recession right there.
But another 10-15 million jobs in retail could be restarted with just better protections, as Arnold has documented.
I believe your statement, “ Most, if not all, of the actions that reduced economic activity were undertaken voluntarily by households and firms.” is a bit shallow.
Absent government restrictions, many of the voluntary restrictions of economic activity by particular private entities would be countered by voluntary increases of economic activities by other private entities who find satisfactory methods to overcome the safety issues. The chain reaction of learning that would be acquired from these private counter measures continues to be suppressed by government action.
A nearly identical process will take place as soon as government restrictions subside. The process of returning to a “new normal” began as soon as the first private cancellation was met by an adjustment by a competitor to better their position. A vast array of adjustments are currently being contemplated. Benefits from these adjustments are quarantined along with the people that would put them into action.
“A nearly identical process will take place as soon as government restrictions subside. “The process of returning to a “new normal” began as soon as the first private cancellation was met by an adjustment by a competitor to better their position. A vast array of adjustments are currently being contemplated.”
+1
(we have to start from somewhere and lifting the government restrictions seems like the most logical starting point…it will hopefully CASCADE from there as you suggest).
In Québec, groceries, pharmacies, business supplies take-out restaurants and even hardware store are open provided staff is protected by full-length plastic screens, payment made by contactless cards, the number of customers is computed according to distancing rules and marks on the floor separates customers. Deliveries must be made in front of closed doors. It’s somewhat cumbersome but it works. So we have rather low community transmission and while one death in an old people home is still too much, it’s 15 times less than in New-York.
Full retail stores can return rather easily if the measures we are beginning to get used to are applied.
Movie house and sports are a minuscule part of employment.
As an industrial organization guy I always had confidence in Canadian industry but the speed and scale of redirection of production amaze me. In my 25k inhabitants harbour town an industrial plastics company designed a new protection system for intubation crews. Designed, prototyped, tested, produced, shipped, in use. Within one week.
The main problems will be the hospitality and travel sectors. Bizarrely, bookings for cruises next year seems to be very high. I personally wouldn’t go but the problem might not be how to restart but how to prevent people from travelling to dangerous areas.
Dr Kling,
How does the inflationary effect of releasing $3T in cash into the economy figure in to your analysis?
I imagine it drives up the price of every available asset. Equities and houses for example. Might that help attenuate the feeling of reduced wealth at least in the short term?
I am old enough to remember how the stock market performed in the 1970s. You might look into that.
One hypothesis for why things might be different from the 1970s is that nowadays the government is acting with a much stronger and more direct goal of propping up Wall Street (and the stock market in particular).
Therefore, rather than stock prices being driven up by a purely supply-and-demand inflationary effect, I think the recent interventions are also greatly strengthening the public confidence that the government will do whatever it takes to prop them up, to a far greater extent than it would have been politically conceivable decades ago. (Not just in terms of the sheer sums involved, but also in its willingness to intervene in novel and much more intrusive ways. There is already serious discussion about the possibility of the Fed buying stocks!)
In other words, we may be entering an era where the government will be increasingly treating the stock-owning incumbents as a protected group that must be protected from any excessive loss. Perhaps the current enthusiasm in the stock market is due to people trying to hop on to this gravy train, as the recent series of interventions has made such a prospect increasingly likely?
(I am not convinced of this strongly enough to join the enthusiasms myself, but I do consider it an interesting and plausible hypothesis.)
I’m quite a bit more sanguine about the future. I don’t see endless propping up of various industries that are hurt because it seems evident that there are a lot of profit opportunities to be had in industries that are going to be helped.
Stunningly good analysis. As usual ahead of the “curve”. How about calculating weekly deaths from all causes over time. Compare week “n” with same week in previous years. What does that tell us? Maybe nothing, but I always start from the top down. My spies tell me things like heart failure, pneumonia, etc. deaths are way down. True? Who knows. We see folks jobbing data in all kinds of fields. “If I just bend the data a bit, I’ll get my grant” can be powerful. “I have priors and will accept all data consistent and reject all that disagree as outliers”.
And please don’t just use multiple regression (all pdf’s are gaussian, right?, no) to TRY and snake out the various diseases’ fractions.
Happy Easter. Arnold is a treasure.
Maybe I am wrong about this, but isn’t the government trying to keep the financial system from blowing up again while also trying to keep people from being evicted, buying groceries, etc.? I guess I don’t see how to keep the financial system from blowing up again without massive government action, and it doesn’t seem to me like the financial system blowing up helps speed up the process of adjustments to our new reality.
Isn’t there a lot of balance between PSST and Keynesian?
1) The worst issue of PSST Economic Recovery is it does family and community. And if our society is already slow in family formation and declines in community the post-COVID 19 continues in this direction. Young people put off marriage even another couple years will negatively effect society.
2) Probably worst aspect of COVID-19 is more people will move towards large corporations that have survived the COVID-19. Just as more consumers moved to big banks after 2008 Financial Crisis.
3) I still on the fence on US return of manufacturing. I don’t think it will a large scal return as it cost companies money and nations like Vietnam exist. I suspect we will see the return of medical equipment (capital intensive here) but little else.
3)
I have always liked the PSST story, but as a complement to the Keynesian story, not an alternative. Why should we believe that the economy can adjust to shocks of any size? There is an implicit Walrasianism in the pure PSST story that I find completely implausible. All complex adaptive systems have limits to their homeostatic capabilities. As Leijonhufvud would say, we are way, way outside the corridor right now. We cannot “freeze” the economy, but we can keep it on life support, keep it from disintegrating, so that it can more easily and quickly renew and regenerate once this crisis ends.