Learning from the Covid economy

Learning from the Covid economy

By Matthew Yglesias

SlowBoring.com

March 2, 2021

COVID-19 hammered the world economy in general, and the American economy suffered as part of that. Lots of stuff was shut down for public health reasons. And even when people were allowed to do things, they often didn’t. Indoor dining has been allowed in D.C. for the majority of the past year, but I haven’t dined indoors, and I’m not the only abstainer — people I’ve spoken to in the industry say even since reopening, it’s been a hellish time for their businesses since the customers just aren’t there.

The same is true for travel. You’re allowed to fly on airplanes. People do it. I went to Austin for Joe Rogan. But there are just way fewer flights than there used to be — not a lot of people traveling. 

Yet in a fascinating way, when you dig into the details, things are better than you might think. Household net worth is up thanks to a booming stock market and a rise in home prices. Disposable income is up. Savings are up. Poverty is down.

Not because “the economy” isn’t damaged, but because it turns out that an assertive welfare state can work miracles. There’s a powerful lesson in that which we should learn for ordinary times.

The big picture

Let’s start with the most basic — gross domestic product. GDP measures the value of all the goods and services produced in the economy. It’s a very imperfect measure of well-being, but we do know that over the long-term, countries that enjoy GDP growth also see other good stuff happen, while those that don’t, don’t.

The GDP story is that the economy slipped in the first quarter of 2020 thanks to the pandemic’s impact on world trade, then collapsed in Q2 thanks to widespread shutdowns, then bounced back in Q3 thanks to widespread reopenings, but then the V-shaped recovery stopped in Q4 because we hadn’t actually contained the pandemic.

A more organized policy response could probably have avoided that Q2/Q3 swing, since whatever you make of the Q2 closures, we didn’t adhere to them long enough to try to suppress the virus — in which case there was really no point.

The jobs picture looks similar, but bleaker, with a less robust recovery in Q2 and Q3.

I normally don’t like to do charts with two y-axes, but in this case, I think it clarifies the point — GDP and employment exhibited a similar pattern, but GDP has come closer to full recovery.

Another way of looking at this is that median earnings soared during the pandemic, not because the typical worker got a huge raise, but because the job losses were concentrated in low-paid sectors. With a ton of foodservice and hospitality workers left jobless, the median pay of the still-employed surged.

None of this is surprising to anyone, but I think laying it out in detail is important because it illustrates that the GDP and wage effects are two sides of the same coin. If you talk about GDP you sound kind of heartless, while if you talk about low-wage work you seem like a caring and concerned person. But the nature of the thing is that low-wage workers’ contributions don’t matter all that much for “the economy.” Total income is equal to total production, so shutting down a low-income sector of the economy had a modest impact on production. What really hammered the economy was the brief period in which dentists’ and doctors’ offices were shut down. The bars and restaurants have much less economic significance.

But of course it matters a lot to people who lost their jobs.

The picture at the bottom

Absent government financial assistance, this would have been a total disaster for lower-wage families.

But in fact, the government did step in with financial assistance. Unfortunately, the way the official poverty numbers are released doesn’t give us visibility into what happened in 2020 yet. Fortunately, Jeehon Han, Bruce Meyer, and James X. Sullivan got funding from the National Science Foundation to calculate something close to a real-time look at poverty.

What they find is kind of shocking, namely that in Q2 of 2020, the poverty rate was lower than it had been before the pandemic, because the CARES Act more than compensated for the decline in employment. When CARES expired, poverty rose once more, and by Q4 of 2020 poverty rates were again higher than they had been pre-pandemic. But even by December 2020, poverty was still lower than its November 2019 level. The very strong labor market that we were finally starting to enjoy in the winter of 2019-20 was better for poverty than the December 2020 situation, but all earlier points were worse.

The good news is that by January 2021, the $600 stimulus checks that Trump signed during the lame-duck period start flowing, and poverty drops again. When the American Rescue Plan is signed, larger checks will go out along with an increase in the generosity of Unemployment Insurance, on top of a huge increase to the Child Tax Credit, plus a more modest increase to the Earned Income Tax Credit (EITC).

In other words, those poverty numbers are going to fall again, but this time in the context of a growing economy.

Ready for a breakout?

Historically, the economy used to bounce back fast from recessions. Really deep recessions like the one that hit us in 1982 and sent unemployment soaring to 10% caused a lot of pain, but they didn’t last a long time — they led to very rapid recoveries. But the not-so-bad recession that hit in 2001 took several years to recover from, despite being shallow. And in retrospect, policymakers should have taken that experience more seriously when thinking about the deep recession of 2008-09. Some economists were confident in a rapid bounce-back, but what we instead got was a 2001-paced recovery from a 1982-sized hole, so it took 10 years (or maybe more) to get back to a healthy labor market.

That means we now have a lot of people who cut their teeth on the Not So Great Recovery from the Great Recession and are primed to assume that the comeback from our current deep hole will also be slow.

But I think that’s probably wrong. The thing about the Great Recession is that unemployment immiserated the unemployed, and even middle-class people who kept their jobs saw their net worths plummet in the form of tumbling housing prices and damaged 401(k) accounts.

This recession isn’t like that. Incomes took a hit from joblessness, but federal relief spending has filled more than 100% of the gap.

Meanwhile household spending fell despite the rise in incomes, since — as you have probably noticed — there’s less going on than usual thanks to the pandemic. And that’s not just a function of formal business closures. When people don’t commute to the office, they’re more likely to make coffee and lunch at home than to stop on the way for a cup and then grab a sad desk salad from someplace nearby. The shift to more home cooking, more nights in watching Netflix, more nature walks as a leisure activity, etc. is a fundamental shift to a more frugal lifestyle.

The upshot is people have something like $1.6 trillion in accumulated savings (with more to come in the form of $1,400 checks), over and above what we would have expected from a normal year.

A big question is: What happens with that money? It’s sometimes described as “pent-up savings,” as if it automatically flows off household balance sheets when public health conditions allow. That’s not correct. The conventional wisdom pre-pandemic was that most people weren’t saving enough for retirement, and they might just hang onto the money.

But there is a phenomenon called “pent-up demand” that’s well-attested in empirical history. If for some reason the nature of the pandemic was that it became impossible to manufacture sofas, we would expect the post-pandemic year to feature unusually high demand for sofas, because over and above whatever the usual life-cycle for sofas is, there’d be all the people who would have bought a sofa in 2020 but had to wait until 2021 instead. Back when there was more domestic manufacturing and more strikes, this kind of thing used to come up fairly frequently. But what we’re really looking at today is a lost year for the purchase of services. Jason Furman has thought a lot about the economy, and he thinks pent-up demand for services might not be real.

Twitter avatar for @jasonfurman

I kind of see this the other way from him. Unless you’re willing to commit to the ongoing expense of a bigger house, there are only so many durable goods you can accumulate. But given a temporary cash windfall, the sky’s the limit on consumption of services. Of course there are logistical limits to how often any given person is going to go eat out. But even people pretty far up the income chain have places they’d like to eat that they can’t afford, or pricier bottles of wine they can’t spring for. Parents of young kids are constrained by babysitter costs. Parents of teens will want to indulge them after a difficult year.

To me, the big thing here is going to be capacity constraints. The good news for bars and restaurants is that “normal” restaurant conditions are to be operating well-below capacity a fair amount of the time, so you can accommodate flukey demand by being full on a random Tuesday night.

The bad news for “the economy” is that obviously, a lot of restaurants have gone out of business over the past year. We’re going to have a ton of dining demand chasing a diminished supply of tables, and while I am the opposite of an overheating-worrier, I do think we’ll see some inflation here.

In the travel sector, things are worse. Leisure destination hotels are available at the times people want to travel. And in a lot of cases, off-season travel is not a good substitute for visiting at the right time of year. It also seems to me that the airline industry can’t just flip a switch and “turn on” a full-capacity national web of routes. The logistical issues around getting the planes up and running and the crews changed are exacerbated because nobody is quite sure what’s going to happen with business travel, so you probably won’t even want to exactly replicate your pre-pandemic network.

The biggest risk to the recovery, in my view, is that the Fed will face pressure to raise interest rates in the face of transient inflation focused in the dining and travel sectors and slow the recovery down. But the people running the show seem pretty determined not to do that. The best GDP growth year of my lifetime was 7.2% in 1982, and I think if anything, we’re slightly more likely to go above than below that in 2021.

But instead of just marveling at things having held up better than you might think, we should really try to learn some lessons.

Better things are possible

The key thing, to me, is that we made incomes go up even as production was going down. That “shouldn’t be possible.” Shelter the most vulnerable from the worst effects of the downturn? Sure. But actually have disposable income rise and poverty fall in the middle of a huge catastrophe for GDP? That’s kind of wild.

Of course this was made possible thanks to super-low interest rates, which made it viable to transfer trillions of dollars off the government’s balance sheet and onto those of households.

But that’s not automatic. European governments, despite myths widely circulating on leftist twitter, have been much stingier than the United States so far, and we’re poised to do another $1.9 trillion in relief while they are doing nothing.

And while we did pretty amazing stuff, we also did much worse than we could have. Bonus UI money, in particular, phased out and in and down and up in a crazy, unprincipled way which would have induced extra anxiety over and above the administrative problems. We didn’t give state and local governments money last spring when it would have been most helpful, so now they’re poised to get a huge infusion just as the crisis is passing. And most of all, we never really did enough to keep small businesses solvent — driving lots of bars and restaurants into bankruptcy over the past year, while also generating tons of political pressure to allow an unwise amount of masked indoor activity.

But it’s also worth taking a moment to dunk on what the politicians got right.

There was a common line of critique last spring that united leftists and private equity fund managers alike that the government should have let all kinds of big businesses — cruise lines, airlines, hotels, etc. — go bankrupt, and that the Fed’s low interest rates constituted a kind of mass bailout of big business that would leave the economy strangled by zombie businesses. That was completely, risibly wrong. Our biggest economic problem going forward is that we won’t have enough capacity to meet all the coming demand for services. We didn’t do enough to bail out independently owned bars and restaurants. But if we’d let huge swathes of the travel and leisure sector be liquidated, we’d be in a much worse jam.

All tomorrow’s welfare states

This has been a lot of charts.

But beyond bailouts being good, the main thing I think people should take away from this is that detaching incomes from labor market outputs works fine. The government sent people checks and it worked fine. Some low-wage workers got more money in unemployment benefits than they’d made while working. Even that worked fine! You probably wouldn’t want to make that the situation all the time. But at a minimum, it’s a clear sign that the baseline of Unemployment Insurance benefits could be much higher. If a generous child allowance leads to some reduction in hours worked as people spend more time with their kids, that’ll be fine.

It’s true that over the longer term, this stuff will need to be offset with higher taxes and not just borrowing.

But that’s fine too. The point is — people’s market incomes were hit by a shock that was so big and so obviously not their fault that the government stepped in and mobilized to ensure that some other distribution of income would be obtained than the one the pandemic wanted.

The pandemic was unique in its scale, but it’s not unusual to see people suffering through no fault of their own. It happens all the time that years of accumulated job skills are rendered obsolete by some new technology or shifting trade patterns. Certain kinds of natural aptitudes are valuable at some periods and less valuable in others. I’m good at a style of writing that traditionally appeared in magazines rather than newspapers, but I’m also good at writing very fast, which was traditionally valued by newspapers and not magazines. Thanks to the internet, that’s a valuable combination of skills. If I’d come along 10 years earlier, I wouldn’t have been able to break in. If I’d come along 10 years later, I’d have been battling in a much more competitive field with fewer first-mover advantages. That’s life — even bona fide skills and hard work are, in important respects, just another form of luck.

There’s lots of great free market stuff out there — consumer choice! innovation! — but we just don’t need to accept the labor market’s allocations of incomes to people. We rejected that choice during the pandemic, and it worked — we should learn from that.