The real killer is coronavirus unemployment

Phase 2: Hysteresis effect and solvency issues

A large chunks of layoffs are considered as temporary (up to 70% in the United States according to the April nonfarm payrolls report). When the lockdown measures will be lifted, the economy will restart as normal and companies will hire back those who were laid off during the crisis. I disagree with this assumption. If China leads the rest of the world in the ongoing process, then there is no V-shape recovery in perspective. In China, it took one month to one month and half for productive capacities to get back to 100%, but consumption remains sluggish. Retail sales fell 15.8% year-on-year in March and restaurant spending plunged nearly 50% over the same period. Many shops are still desperately empty, even in Beijing. This phenomenon is called the hysteresis effect. Although the pandemic has disappeared, it continues to have a noticeable effect on consumption and savings behavior. Due to the uncertain economic outlook and fears of rising unemployment, consumers are strongly inclined to save, which is a huge negative for aggregate demand, and will amplify the economic downturn. As a result, companies are facing increasing solvency issues topping sometimes preexisting decrease in industrial profit (as it is the case in China where industrial profit was down minus 37% in Q1 2020) and will have no other choice but to focus on restoring cash flows and to cut costs, including jobs. The vicious circle of sluggish aggregate demand and solvency issues is just about to start and will lead to a strong and lasting jump in unemployment which will be more important in countries with insufficient automatic stabilizers.

Winners and losers in the post-COVID world

Coronavirus scars will weaken the economy for years to come. Policymakers, with a massive inflow of liquidity into the economy, have delayed and postponed a lot of pain but they have not eliminated it. The second economic wave is coming and will be characterized by weak demand, an unprecedented number of bankruptcies and much higher unemployment. Before the outbreak, the global economy was already in a very weak position, with a high level of public and private debt, elevated market valuation and low growth momentum. Historical precedent tend to indicate that, contrary to wars, there is no strong recovery after pandemics and depressive effects, such as depressed investment opportunities and increase in precautionary saving, can persist up to 40 years (see for further details this excellent paper published on the website of the NBER).

Another characteristic of pandemics is that they leave the poor even farther behind. One of the latest IMF blogposts (see here) using the net Gini coefficient concludes that pandemics progressively widen gap between rich and poor and hurt employment prospects of those with only a basic education while scarcely affecting employment of people with advanced degrees. The most striking finding is certainly that inequality tends to increase in the long run (the net Gini increased by nearly 1.5% after five years), confirming that pandemics scars have a very long-term impact on the broad economy.

The risk is that the gap between rich and poor, symbolized in the below chart by the evolution of the S&P 500 since its low point of March 23 and the aggregate increase in U.S. jobless claims over the same period, will widen further. There have been plenty of research from the IMF and the Bank of England over the past years demonstrating that quantitative easing induces a lasting jump in wealth inequalities due to the increase in the price of financial assets (see here, here and here). Given the amount of liquidity injected by central banks all around the world and the initial effect on the stock market, the winners of the ongoing crisis might likely be the 1%. On the contrary, the losers will be the rest of the population, especially the less educated, that will need to cope with higher unemployment and lower purchasing power. Coronavirus unemployment is putting at risk the social contract made between citizens and the state and may pave the way to populism. Governments will certainly try to address the issues of unemployment and inequality by implementing more redistributive policy and letting the fiscal deficit widen. Will it be enough? I don’t have the answer yet, but I know that policymakers cannot let down the 99% one more time.