I believe that we have to resist the temptation to benchmark the economic outlook against “normal,” where normal means what would have happened had the virus never appeared. Normal is not an option, either in the short run or the long run. You cannot use GDP to measure of well-being when there is a discontinuous shift in what people value.
In the short run, if you let everyone go about their business, you would not get normal. Even if the government were to say it’s ok to do whatever you want, how many people would book cruise ships or foreign trips? And if the government were to de-emphasize social distancing and instead do everything to try encourage or even “stimulate” normal economic activity, the likely result would be an overwhelmed health care system, triage, and so much fear and distrust that the economic disruption might exceed what we would see with a long-term lockdown.
In the long run, I don’t expect normal either. Pre-crisis, our patterns of specialization and trade were optimized for efficiency at the expense of fragility. Expect supply chains in the future to have a lot more redundancy and to be less driven by cost minimization. The Chief Risk Officer’s approval will now be needed before the CEO will approve a major new supply contract.
We will develop a lot of what you might call social-distancing capital, including the ability to make use of remote meetings and distance learning. Last night, some folks attempted a virtual session of dancing. Most of the time was spent getting a bunch of old people up to speed on using Zoom. Next time, we might be able to dance. People will get accustomed to new forms of entertaintment.
Many sectors were way too levered–households with too little savings and too much debt, businesses with too little cash reserves and too much debt, and governments with too much debt and unfunded liabilities. Behavior is likely to change going forward. I expect to see a major reduction in financial intermediation. Financial intermediaries, such as banks, are in the business of issuing riskless, short-term liabilities backed by risky, long-term assets. This allows the nonfinancial sector to do the opposite. I don’t think that we will be able to sustain as much financial intermediation as we did before, and the result will have to be individuals and firms undertaking fewer risky, long-term projects.
The challenges for other countries will be much more difficult. De-globalization is taking place, and that will produce losers and bigger losers (it won’t produce many winners). Become familiar with Peter Zeihan’s way of viewing the world. Don’t take the international order for granted. Zeihan emphasizes that the U.S. is one of the few countries that produces enough food and energy for itself. China, on the other hand, needs to import both. That would lead one to predict that China will be in the “bigger loser” category.
Would your longer term prognostication have been equally true following the 2008 financial crisis?
I’m not sure I agree with you that financial intermediation will decline following the COVID-19 crisis. Surely people will save more, insure more, and invest more in long-term projects (e.g. redundant physical infrastructure and pharmaceutical research) as a result of the COVID-19 experience. That requires financial intermediaries. Plus, large intermediaries are better able to handle risk than individuals and small firms acting on their own. Yes, the cost of intermediation may well rise to reflect the incorporation of previously unaccounted-for risks, but people may well be willing to pay for more intermediation for the same reason.
This paragraph re: intermediation confused me also because I see the resulting landscape similar to Diego.
Arnold, can you expand on this? You seem to be saying that non-financials will want fewer riskless, short-term assets. But I imagine liquid demand accounts will balloon for awhile, which you allude to in the beginning of the paragraph. I can also see firms in some industries pulling back on riskier longer-term investments, but without other industries seeing investment opportunities?
Banks somehow manufacture short-term, low-risk assets out of the long-term, risky liabilities issued by the nonfinancial sector. Going forward, the ability to work that magic will be much less. So the nonfinancial sector will have to be less levered. Think of having to make bigger down payments when you buy a car. Think of tech businesses like Uber, which are promising to *eventually* be profitable, not getting funding.
I think your argument is presented in reverse order. There are (private and social) rewards when individuals and firms undertake risky and long-term projects, say developing vaccines and treatments for viruses. However, it’s quite unlikely that the individuals with skills to carry out these projects will also happen to have the cash and or risk tolerance to fund them. Hence, there is a need for financial instruments to allow contributors of human capital, financial capital, and willingness to bear risk to not necessarily be the same people. Financial firms issue and facilitate trade of these instruments. For these reasons, once the dust settles, we are unlikely to see a reduction in financial sector activity, absent regulations to inhibit it. There’s just too much gain from these projects to stop people from finding ways to facilitate them.
The initial claim, “Many sectors were way too levered,” is essentially a claim that we should have less separation of human capital, financial capital, and risk bearing. Then, the conclusion is that we will be unable to take on as many risky and long term projects, which does indeed follow. But, what justifies the initial claim that human capital, financial capital, and risk bearing need to be merged more rather than separated?
“Banks somehow manufacture short-term, low-risk assets out of the long-term, risky liabilities issued by the nonfinancial sector.”
It’s not magic. Worthwhile projects in the nonfinancial sector produce cash flows with positive net present value (NPV) even if those cash flows are risky and long-term. If they are positive NPV, then they can be traded for short-term, risk-free cash flows of equal NPV. The financial sector merely facilitates trades of all cash flows of equal NPV but different timing and risk. What is the argument that such trading should or will be reduced in the future?
I don’t foresee redundant supply chains lasting very long. Even if we agree that they are desirable, firms will be engaged in a Prisoner’s dilemma with the lean companies winning markets… at least until the next crisis. Still, in the meantime, how many “prudent” companies can remain profitable?
As for the short run, you are certainly correct; public mandates are mostly codifying what precautions private actors are already adopting. The question is how others respond. For example, faced with closed bars and clubs, do some young people instead gather informally and surreptitiously, actually creating more risk of contagion? The analogy would be to banning drugs leading to poorly cut varieties and many more deaths or banning abortions leading to dangerous back-alley operations. As usual, we do well to remember that enforcement is always imperfect and bans do not equate with zero activity levels.
I think redundant supply chains could fill a niche sort of like a farmer’s market. Most people don’t go to a farmer’s market because it’s a good deal, they go because they think it’s important to buy goods grown and made in the local community. If people believe the same thing about redundant supply chains, they may not compete directly with the really price sensitive supply chains.
I agree. I wouldn’t say this will lead to any “permanent” changes. So the “long run” mentioned in the original post probably just means something like the next 5-50 years, depending on how bad this situation gets.
Those who lived through the Great Depression became very financially conservative afterward. That lasted until the Boomer generation came of age and threw it out the window. Things are forgotten over generations, and people think it won’t happen to them.
We can also use history as a guide. How much did the Great Depression, Spanish flu, flu of 1957-1959, or financial crisis of 2008 change things? That probably gives a bounded range for how much behavior changes and for how long after big shocks.
I second the motion. Globalization and supply chain engineering goes on. We can easily sanitize the intermediate components, much better isolation then keeping it in house. Shipping goods is not spreading the virus.
Then I think of the vaccine, we are pretty goods a making them, though there is reliability issues because we do not make many and at this pace. A vaccine in a year includes only about 6,000 dead in the usa, not worse than a sever flu pandemic (which do cause long term changes). *I guestmated a doubling every three months.)
The real problem is moving people around, a rather big problem.
Maybe we’ll end up with a kind of Minsky financial cycle (3 stage well-capitalized, risky, ponzi) but to do with more general risk leverage: supply chain vulnerability, pandemic vulnerability, etc.
How long can a non-China (or other global part of the chain) supply chain manufacturing firm stay competitive as the “buy local” legacy of Covid19 starts to fade?
Competitive forces and human nature combined seem to always force things from the stable to the risky.
“De-globalization is taking place…”
“When goods don’t cross borders, armies will.” —Frederic Bastiat
Not only more war but more pollution. Developed economies will no longer be able to use trade as leverage to pressure developing economies to go green.
Are you consciously aware that you are relying upon heuristics?
As one example, China needs oil and can get it from Iran in exchange for military protection. The only thing stopping them was the threat to trade with the US. Without trade, that threat disappears and China will become more militarily bold as they have less to lose.
As for the environment, this from an article titled “US trade war undermining Chinese efforts on climate, says official”:
“External elements, such as the Sino-US trade war, have brought negative impacts and increasing uncertainties to the global economy, which has also made it more difficult for China to tackle climate change,” said Li Gao, head of the climate change office at the ministry of ecology and environment.
The world’s biggest producer of climate-warming greenhouse gases has pledged to bring emissions to a peak by around 2030 as part of the global effort to curb rising temperatures.
“With the economy under downward pressure, the country has to take more measures to guarantee employment and the people’s livelihood,” he said. “Some of those measures may not fit our effort to tackle climate change.”
>>> “When goods don’t cross borders, armies will.” —Frederic Bastiat
>> Are you consciously aware that you are relying upon heuristics?
> As one example….
Sure, it is not impossible to come up with a plausible hypothetical scenario whereby your prediction would come true. But please bear with me for a second here: if you review our conversation, you may notice that you answered a question other than the one I asked.
Are you able to see this? (Serious question)
My comment is based on reading a lot of analysis by people who have spent their entire lives in studying these things. I then try to convey that in a simple saying and you assume that I’m using heuristics.
Here’s another saying for you:
“Most of economics can be summarized in four words: “People respond to incentives.” The rest is commentary.” — Steven Landsburg
Remove China’s incentives by reducing trade and its behavior will change.
Are you able to see this? (Serious question)
The world’s biggest producer of climate-warming greenhouse gases has pledged to bring emissions to a peak by around 2030 as part of the global effort to curb rising temperatures.
That, and $2.75, will get you on the subway.
From an article titled: “How China Became the World’s Leader in Green Energy”:
China has never been the most enthusiastic party to international climate accords, but Beijing might end up saving the planet anyway. In little more than a decade, China has made itself a world leader in electric vehicles, renewable energy, and energy storage. In response to its own poisoned environment, shrinking workforce, and security fears about foreign dependence, the country has incubated a green industrial policy that is both generous and ruthless.
China has been referred to as green energy superpower. So no, not just words.
China has been referred to as green energy superpower.
Donald Trump has been referred to as a genius. Consider me skeptical.
@Jay,
China has been referred to as green energy superpower (by the World Economic Forum).
The World Economic Forum was established in 1971 as a not-for-profit foundation and is headquartered in Geneva, Switzerland. It is independent, impartial and not tied to any special interests. The Forum strives in all its efforts to demonstrate entrepreneurship in the global public interest while upholding the highest standards of governance. Moral and intellectual integrity is at the heart of everything it does.
You wrote:
Donald Trump has been referred to as a genius.
“Stable genius” that is. Referred to as by himself of course, not somebody who might be a liar.
@Ahmed: Check out the energy flow diagram for China in 2017. It’s a few years old, but (as with the U.S.) China’s green energy is insignificant compared to its fossil fuel use.
On the bright side, this is a fantastic opportunity to eliminate many wasteful and antiquated customs and practices that have irrationally persisted for too long. Some things to get rid of now:
(1.) College campuses. As is being demonstrated, all coursework can be moved online easily and with no sacrifice. Massive savings from reducing state and federal subsidies and the 50% plus of research grants that is wasted on institutional overhead.
(2.) Davis Bacon Act. Self explanatory. Simply can’t continue to exempt wages from competitive pressures at the taxpayers expense.
(3.) Federal retirement annuities. The overly generous Thrift Savings Plan is more than sufficient.
(4.) The federal government’s general schedule pay plan. Let federal agencies manage their payrolls and allow the appropriators to put downward pressure on payrolls. No more shameful across-the-board pay raises like the obscene one Trump just signed.
(5.) Polling places. All voting done by mail with audit before results announced. A good way to introduce a modicum of integrity to a system greatly lacking it.
(6.) Redundant federal health insurance programs. Medicare for all the federal beneficiaries: Medicaid, Medicare, TRICARE, Veterans Health Administration, CHIP, FEHB, ad infinitum all rolled up into one program and at least 300,000 federal jobs eliminated. Replace all other welfare programs with an universal basic income. See Dr. Kling’s prior post.
(7.) Fire the peace-time regulators: see Dr. Kling’s prior post.
(8.) Eliminate section 501 tax exemptions and charitable contributions deductions. If the pandemic has demonstrated anything it is that the tax-exempt chattering class is completely worthless. And the vast majority of charities are personal enrichment schemes.
(9.) Increase the percentage of the USA land mass privately owned from 60% to 95%. Transfer all Forest Service and Bureau of Reclamation property to the states with the stipulation that the land ownership must be transferred to private hands within 10 years. Transfer the parks and refuges to the states to do with as they will. Transfer military land to be states with rent-back stipulation.
(10.) Now that we are experiencing the economic equivalent of the green new deal, protect energy supply by vesting states with independent authority not subject to federal regulation to manage energy production. Eliminate all subsidies for wind, solar, etc.
That is just for starters.
Interesting that you think that a pandemic that is leading to a massive increase in government spending & reach will result in the implementation of your libertarian wish list above. How do you square the circle of paid sick leave, checks to everyone & massive government credit facilities with the streamlining of government you call for above? I’m not agreeing or disagreeing with your proposals, just cannot see any plausible path to there from here.
It is the orgy of debt-fueled spending that will inevitably trigger another, much worse financial crisis and that crisis will force a decision: either continue on the road to Zimbabwe or cut non-essential government spending and promote substantive economic growth.
The list is not intended to be libertarian, but reflects a populist sensibility. Libertarians are generally opposed to pro-democratic reforms, expanding the tax base, and challenges to the aristocratic castes.
(1.) College campuses. As is being demonstrated, all coursework can be moved online easily and with no sacrifice. Massive savings from reducing state and federal subsidies and the 50% plus of research grants that is wasted on institutional overhead.
How is this “being demonstrated”? I have heard this being asserted a lot, that this episode is going to be a huge driver to online education, and it makes no sense at all to me. I am in the middle of making a crash conversion of a class to online, and despite my best efforts it’s going to be a fiasco (why wouldn’t it be?) I am extremely confused why anyone thinks this is going to be some great boon to online education; if anything, I expect the opposite. The experience is going to be so mediocre, and even if it weren’t, students are going to remember it with misery. How many college age people are excited to be at home with their parents in quarantine in a time of great national stress?
Qualitative assessments of instructional quality are a luxury we can no longer afford. On-line degree programs are fully accredited. Continuing traditions that have reached their expiration date for the sake of tradition is pure rent-seeking waste. Sure, people with learning-disabilities who require classroom learning should be afforded that option but to continue with the over-priced business as usual model would be ridiculous. No more public subsidies and tax exemptions to university administrators and their excessive overhead costs.
I’d like to have about half my university fired, so don’t mistake me for a defender of the status quo. I am simply skeptical that what is going to inevitably be a cobbled together mess of “distance education” in a time of national distress is going to make people excited about its future, whether or not its a “luxury we can no longer afford”. Online education is not even remotely new, and yet, people still line up to come to campus, and this experience seems to me likely to keep that going for longer, not shorter.
Which suggests that a major value of college to the students is the ability to be near lots of people of their own age, with whom they are free to discuss, argue, eat, drink, smoke, fornicate–and which is nevertheless safe and welcoming, like an indulgent parent.
I agree. But how will the pandemic change that? After a miserable experience where people are NOT going to be free “to discuss, argue, eat, drink, smoke, fornicate”, wouldn’t you expect demand for that to increase, not decline?
I’m not willing to hazard a guess, but I would not be surprised if demand went up, at least for a while.
When “policy makers” or “commentators” or politicians talk about college, they act as if it’s all about education (and maybe a little about signalling). But that is not how college students experience it. For some, education is not even the major part of the experience.
I think the biggest winners will also be local companies and local cultures. Won’t they grow and develop differently by having less competition and influence from conglomerates?
There are going to be serious limits to the local economy. Bake sales? Probably. Unusually expensive garden/small farm produce? Sure? iPads? Not even a small chance.
I remember when everyone said 9/11 would change everything. It didn’t and this won’t either.
Yeah I’d say that’s about right. There will be an increased interest in infectious disease research and people will be more germaphobic for awhile, but I don’t think this will upend our way of life. As with 9/11 some things will stay with us (TSA and Dept. of homeland security; maybe we’ll get a new agency) but not much more of a lasting legacy than that.
I disagree about China being a big loser here. Here’s my opinion though I’ll write it so that it comes-off as more matter of fact. China will be able to import because of one simple reason: they own a lot of U.S. dollars and they own them in a steady stream of maturing USD denominated debt instruments.
So, rather than doing what the Chinese had been doing (rolling maturing debts into newly issued debts coupled with goring claims on our currency), they’ll simply redeem those debt instruments and ask for the cash payment. From there, they start buying our stuff. Because we will be making that stuff. We WILL have a very large amount of unemployed people waiting to earn an income and they’ll be desperate.
Before you know it, we’ll be accused of running sweatshops and producing inexpensive stuff to keep-up with the new Chinese appetite for consumption. The irony will be that MAGA hat wearing folks, at least initially, will applaud even though their kids & grand kids will suffer a significantly worse standard of living. We will have done our kids and grand kids so terribly wrong. So many of them are ill prepared for what they will face; they are not used to hard work save for a small percentage of driven students who devoted gobs of time to their studies. Those over-achieving academic-focused kids are few and far between and many of them were learning the wrong sorts of world views, anyhow. They’ll have to re-learn some things, learn an entirely new way of thinking, and also repay the debts we left for them.
Which leads me to this: in order to keep-up with Chinese debt instrument redemptions, we’ll also have to print & inflate. This will just increase the purchasing power of the Chinese. And in addition to all that ****y stuff, we will break entitlement promises — promises that our ‘leadership’ set the expectation would not change. Small governmnet types will finally see entitlement spending shrink. Unfortunately the State’s budget will not be shrinking one bit. I cannot see what that rest looks like. But up to this point, I’m crystal clear.