Why Economic Pain Could Persist Even After the Pandemic Is Contained

The one great reason for economic optimism during this pandemic is that once public health concerns are addressed, the economy could quickly return to something like pre-crisis levels.

After all, if there were a safe way to return to normal behavior, restaurants could fill up, planes could begin flying, and millions of workers could return to their posts. But even if that happens in the coming months, the United States will still be facing waves of second- and third-order economic effects that could last years.

Although every recession is different and much depends on the details of how the federal government responds, there are some warnings from the last recession.

In the 2008 downturn, bank failures didn’t peak until 2010, causing a shortage of credit to businesses even once the economy was comfortably expanding. State and local governments, after experiencing a collapse of revenue, didn’t stop slashing jobs until early 2013.

In this downturn, there is the looming collapse of many small businesses; potential losses in the commercial real estate sectors; a crisis in the funding of state and local governments that will most likely take years to play out; and a collapse of energy prices that could slow capital investment.

These factors could hold back the economy even if there’s a sharp rebound in employment as business life and public health return to normal.

In any given quarter, that may net out to G.D.P. growth or contraction. But the end result may be less a sharp V-shaped recovery or gradual U-shaped cycle and more a very gradual return to health, like the Nike “swoosh” logo or something more like a tilde (~), the wavy punctuation mark.

The potential for thousands, or even millions, of smaller businesses to close permanently stands out as a potential multiyear headwind to the economy. In a survey by the Society for Human Resource Management, half of small business owners expected to be out of business within six months. If anything close to that failure rate were to materialize, it could take months or years for their workers to find new jobs.

When businesses go under in normal times, or even in a typical recession, it can be part of a restorative process that keeps the economy dynamic — shifting workers and other resources toward the highest-productivity purposes.

But a widespread shuttering of companies that had perfectly viable businesses as of February of this year is something else.

A business is also a set of relationships: between skilled labor and suppliers; physical assets like equipment and intellectual assets like a brand name; and employees and their base of regular customers. If a company fails because of the pandemic, another company may ultimately emerge to fulfill its economic role, but it could take years to rebuild that complex web.

“I love the pizza place two blocks away,” said Erik Hurst, an economist at the University of Chicago Booth School of Business and co-author of a new paper that calculates that about 40 percent of lost employment at smaller firms in the pandemic results from companies that have reduced their payroll to zero. “If they go away, a new place might be started, but it will take time to hire workers, train everybody, figure out the menu, and it might not be the same. That means there’s a sluggish recovery.”

With revenue plunging precipitously at so many businesses — whether they ultimately close up entirely or not — the economic pain ripples throughout the economy.

For example, commercial real estate owners will incur huge losses and may be unable to make debt payments to their banks or other lenders. Banks absorbing those kinds of losses will soon find themselves undercapitalized, potentially causing some to fail and those that survive to be in poor position to lend enough to support an expansion — in an echo of the post- 2008 experience.

Banks in the United States had $3 trillion worth of commercial and industrial loans on their balance sheets as of late April, and $2.4 trillion more in commercial real estate loans. Together that amounts to 36 percent of the banking system’s assets, typically higher at the smaller regional and community banks that lend heavily to small and midsize businesses.

After years of expansion, the banking system has been well capitalized heading into this crisis. But what’s ahead will be a severe test.

“If it’s a temporary loss of rent and the banks have liquidity, they will be able to carry that loan for a while,” said Thomas Hoenig, a former top bank regulator at the Federal Reserve and the F.D.I.C. who is now a distinguished senior fellow at the Mercatus Center. “Concessions on loans are common. Forbearance is common. Hopefully the pandemic passes and spaces start filling up and incomes return. If that doesn’t happen or it goes too long, those losses flow through and at some point affects the liquidity of the bank, and then you have a problem.”

State and local governments are already starting to face cash shortfalls. They slashed more than one million jobs in March and April, many of them in schools, but if the 2008 experience were to repeat, they could be in cutting mode for years to come.

Their budgets were set in better times for the fiscal year now underway, and income tax collections this year are for their citizens’ earnings last year. But many revenue streams are under pressure, notably from sales taxes. And lower
incomes in 2020 will depress income tax revenue in 2021.

Moreover, states often have tools they can use to delay the full impact of revenue shortfalls, like selling assets, using rainy-day funds, and shifting money around. Think of it as the equivalent of an unemployed family selling some furniture or tapping savings that had been meant for a vacation.

But eventually those options run out. In the last economic cycle, that contributed to a weak recovery.

“The first year is not the worst in any crisis,” said Tracy Gordon, senior fellow at the Urban-Brookings Tax Policy Center. “It’s the second year where you have to do the harder stuff, and spending is usually easier to cut than taxes are to increase.”

A different economic episode from the recent past shows another risk for the medium-term future of the economy. In recent years, capital spending trends have been closely connected to commodity prices, especially for energy. In 2015 and 2016, a collapse in the price of oil contributed to a steep pullback in investment in energy, big enough to cause major economic distress in large sections of the country (though little trouble in the service sector).

The pandemic has fueled a steep drop in commodity prices as well, as demand for gasoline and other energy has collapsed. West Texas Intermediate Crude oil has fallen from above $60 at the start of the year to below $25 a barrel.

That will be enough to drive many American energy producers toward bankruptcy and cause a sharp drop in demand for the heavy equipment they use for oil drilling. Prices for major agricultural commodities like corn and soybeans are down as well, which will most likely depress demand for farm equipment.

In other words, even in sectors far away from the restaurants and airlines that are temporarily shuttered, there could be lasting pain. In the earlier episode, overall business spending on equipment and structures started falling in the second quarter of 2015. But even though energy prices started rebounding only a year later, business investment didn’t return to previous levels until the first quarter of 2017.

There is much that is unsettled about the economy of 2020, and much that will depend on the evolution of public health and the government’s response. But as much as we might hope for an economy that surges out of this crisis and quickly returns to prosperity, there are some powerful forces that may stand in the way.

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