Serving Up a Recession
Photo by Michael Raphael [Public domain]
In the current environment, it is hard to see how the United States can avoid a recession.
We may want to consider the experience with previous American recessions in thinking about how this one may go. However, this recession will be different in at least one way from previous recessions.
In most recessions, services are basically acyclical, falling little even during economic turndowns. The one exception is the Great Depression, as we can see in Figure 1 below. However, the decline in investment is much more severe, as is the upward swing in the recovery. Services just don’t fall that much, even in the Depression.
However, this decline in the Depression is related to the deflation of the early 1930s. This is a nominal series, in dollar terms. If we control for changes in inflation by dividing the nominal services consumption series by the PCE price deflator, we can see that the real series is even more acyclical, as shown in the figure below:
Real service purchases basically fall little or not at all during recessions. Why are services so acyclical? One reason is that services cannot be stored and so to consume services during a recession, services must be purchased during a recession. You can drive that old car a little longer, but your hair keeps growing. There are furloughs of auto manufacturing workers during every recession, but barbers have not been furloughed- until now.
Services make up a bit less than half of the economy now, as we can see in the above figure. In general, services go up as a share of the economy in recessions (given by the shaded bars) as other parts of the economy shrink faster. Services, by their very nature, largely involve human interaction. In a pandemic, unlike in other recessions, that will mean sales in the service sector will collapse due to social distancing. Unlike with goods, the output of the service sector cannot be stored. That means that layoffs will have to start very soon as businesses adjust their employment downward. While people’s hair will continue to grow, we may see many bankruptcies among barbershops and hairdressers as people cut their own hair to avoid infection. This is very different than what we have seen in basically any recession in modern experience.
Retail employment peaked just below 16 million employees and is down closer to 15.5 million now. The retail sector is already hurting, and the closure of malls is unfortunately likely to accelerate. The restaurant industry employs over 12 million workers. The layoffs in this industry will be painful as more people make meals at home. Total nonfarm employment is about 150 million. In February 2020, the retail and restaurant industries combined were over 18% of total US nonfarm employees. Almost one in 5 US nonfarm workers works in these two sectors alone. If we take the over 130 million workers in the overall service sector, they make up 86% of total nonfarm employment. Starting the shock in a sector with a much larger share of workers can only accelerate job losses relative to a recession that starts in goods-producing industries. One can imagine how devastating job losses could get given the large number of employees in the labor-intensive service sector.
As Americans see the prospect of unemployment looming over them, they will cut back further, beyond the spending which is just no longer occurring due to social distancing and people staying home more. This will then spread the downturn to the goods producing sector as people delay purchases of consumer durables and other consumer goods (basically the usual dynamics in a recession). Even people who might spend will be stuck at home. Firm investment cannot but fall as firms are much more capacity than they need to make sales. As demand for air travel (another service) collapses, it’s hard to see when new airplane purchases will next be made given that coronavirus appears to be here to stay in some form. Boeing has a lot of cash and has many side businesses, but their profitability will be impaired significantly in 2020 in the wake of a wave of order cancellations related to the 737 MAX.
The coronavirus epidemic has the prospect to be one of the biggest economic shocks ever experienced, eclipsing the shocks of 1929 and even 9/11. However, the response to a sectoral shock like this one initially should not be to stop GDP from contracting, as social distancing is necessary to control the virus. The focus should be on allowing business to continue operation without massive layoffs in a way that’s not a big giveaway to business, expansion of unemployment insurance and extension of the eligible duration of collecting unemployment. There will be few job openings and job search is not optimal. We want to ensure the unemployed do not cut back on necessities and can continue to pay their bills. There should be a payment to all Americans as well to ensure that spending doesn’t contract too much and so people can purchase necessities. Once the epidemic recedes then the standard stimulus measures can be applied. At the same time, monetary policy is constrained by being close to the effective lower bound to interest rates at or near zero. Federal debt levels are perceived to be high, limiting the fiscal response, which was already disappointing in the last recession. This one could be very long and painful.
SOURCES:
All Employees, Retail Trade https://fred.stlouisfed.org/series/USTRADE
All Employees, Total Nonfarm https://fred.stlouisfed.org/series/PAYEMS
All Employees, Food Services and Drinking Places https://fred.stlouisfed.org/series/CES7072200001
Personal Consumption Expenditures: Services https://fred.stlouisfed.org/series/PCESVA
Gross Private Domestic Investment (GPDIA) https://fred.stlouisfed.org/series/GPDIA
Personal consumption expenditures (implicit price deflator) https://fred.stlouisfed.org/series/DPCERD3Q086SBEA
Shares of gross domestic product: Personal consumption expenditures: Services https://fred.stlouisfed.org/series/DSERRE1A156NBEA
All Employees, Service-Providing https://fred.stlouisfed.org/series/SRVPRD
This is one possible scenario. But it’s also possible that this could be like a six-week snow storm, at least in the US. I’m not guessing either way.Report
A six week GLOBAL snowstorm, with a forecast for no end in sight for more snow, maybe. But in this case, I think a significant portion of the globe would be dead with only our boots sticking up out of the ice.
A global complex adaptive system like a market is great at bringing goods and services to a local area hit by a disaster. But in this scenario the entire network takes a hit globally all at once.Report
A lot of cities in North America were like mine over the last few decades: industrial production dried up quite a bit (not completely) and the cities tried to replace an industrial economy with a service economy by promoting restaurants, hotels, and tourist amenities. I’ve never thought the math of that quite worked, nor did I think it was going to work with the commodification of housing that’s driven up rents in cities across the globe. Finally, I’ve been pointing out for a while that restaurants, etc. aren’t exactly recession-proof. Inflating the rents has meant that many of the small businesses, boutiques, and gourmet food places in cities like mine are closing rapidly anyway. But, who knows- maybe there will be some sort of stimulus package for latte places. Or, conversely, running local economies like a confidence game might not work out after all.Report
I think it can be made to work but never will in a system designed for the world as it was 60 years ago. Paging Andrew Yang.Report
I’ve never thought the math of that quite worked, nor did I think it was going to work with the commodification of housing that’s driven up rents in cities across the globe.
That’s not how housing prices work. If housing prices are rising, it’s because demand is rising faster than supply. Which makes the rest of your story not really make sense. If the economy’s dying, how are people driving up housing prices? Has there been a reduction in the housing stock?Report
Was reading somewhere that part of the problem is that the construction cost difference between ‘affordable’ housing & ‘luxury’ housing was quite small, but the profit margin between the two was quite high. Add in that a lot of ‘luxury’ housing sits largely vacant (either it can’t find a buyer/renter*, or it’s just held as an investment, or a part time residence), you can get price inflation simply because the housing stock is not being built necessarily for the bulk of the market.
*Toss in corporate welfare programs that allow developers to write off unsold units, etc.Report
The detailed report on housing vacancy (the source of the data you linked) doesn’t really support this story:
A table detailing the “variety of other reasons” is linked in a footnote, but none of them really support the “luxury housing” conspiracy theories. It’s mostly stuff like repairs or temporary absence for personal reasons.
Note also the median prices of vacant units for sale or rent: $1,000 for rental units and $225,000 for sale units.
It’s true that when 80% of the cost of a unit is in the land, it doesn’t make sense to skimp on quality. when developers are only allowed to build a little bit, they’ll build “luxury apartments.” But when demand is high and supply is restricted, any market-rate housing is going to be expensive. This is a symptom, not a cause. If you want cheaper housing, you have to allow more building, period.
Also, vacant rental units aren’t actually a real problem. The owner’s still paying property taxes, but nobody’s living there and using infrastructure, which is basically free money for the city. There are very few places where physical space to build, rather than infrastructure to support the residents, is a major constraint on housing supply. If owners of apartments won’t rent or sell them, just allow more building to drive down prices further.
Toss in corporate welfare programs that allow developers to write off unsold units, etc.
I’m not sure what this refers to and couldn’t find anything with a web search. I’m not a big fan of using the term “write-off” to refer to tax deductions. It engenders sloppy thinking; a lot of people will talk about “write-offs” as if they made things free. A loss is a loss, and a tax deduction only offsets a fraction of that loss.Report
Vacant rentals are a problem if you have a large part of the population that can not afford them, especially if that population then simply becomes homeless within the city, costing money to the city in other ways.
Ideally, if the units sit vacant too long, they should come down in price until they are no longer vacant, but how long is too long? It’s one thing if a couple months vacant can get the price to drop, but it’s something else if the owner can, or is willing to, let it sit vacant for a year or more (this is where the ‘write-off’ comes in, and it doesn’t have to be a tax write-off, necessarily -my understanding is that companies like to restructure debt and loss in their financial reports). I don’t know if anyone has numbers on how long a unit sits vacant and what the asking rent is. Maybe that’s a city-by-city kind of stat.
I am right there with you regarding building more housing. Clearly certain cities need to build more housing than they want to, but at the same time, there needs to be some kind of incentive to build housing that simply is not going to grab a healthy profit margin because of luxury appointments and amenities. Either the cost of building has to come down, or cities have to be willing to offer low overhead grants* to developers. Because to be honest, short of some kind of crazy urban renewal eminent domain program, most cities simply don’t have enough available land to build up more housing fast enough to meet demand, and developers are going to keep building higher end housing for as long as it is profitable (and I don’t blame them).
*Grants with few strings attached, which don’t really exist. If the government gives you money, even if it is to incentivize something the government wants, people always got load it up with strings.Report
We would need to look at the percentage of income people are spending on rent these days. I know I certainly wouldn’t want to be renting in Chicago these days.Report
I don’t understand why you think this makes sense as a response to my comment.Report
“A lot of cities in North America were like mine over the last few decades: industrial production dried up quite a bit (not completely) and the cities tried to replace an industrial economy with a service economy by promoting restaurants, hotels, and tourist amenities.”
I think this anthropomorphizes economies way too much. The “cities” didn’t have to try to do anything, and it tended to happen whether the city “tried” or not. The economy shifted, as developed growing economies tend to do, from manufacturing to services over time. Full stop.Report
To the extent the microcosm represents the macrocosm – over the course of the weekend, Alberta has shut down
– gatherings of over 250 people (putting Fledermaus, a theatre designer, out of work)
– community rec centres (putting Mr T, a figure skating coach, out of work)
– schools (putting the kid out of “work”)
So yeah. Good thing I work for the provincial health authority – our current cut-everything austerity-fetishist conservative government would love to put me out of work too but healthcare is the one sector they don’t dare cut right at the moment.Report
This is a good argument for a National Industrial Policy to keep durable goods manufacturing in the country. It was already smart for national security supply chain reasons, but added resilience against pandemic-induced recession is another worthwhile benefit.Report
Why? This recession is primarily affecting service industries — bars, restaurants, entertainment venues, etc. It probably would be a good idea for the government to stockpile medical supplies relevant to such a situation, such as respirators, and figure out how to build more slack into our healthcare system in general, but durable goods in general? I’m not worried about where my next microwave oven is built.Report
That horse galloped out of the barn in the mid- 1990’s. And unless you convince a majority of companies to change their mind set to growing profits constantly at obscene rates you might get some of the ponies back into the stable so to speak.Report
The shift in developing nations from manufacturing to services is intrinsic in economic growth. See the writings of economist Dietrich Vollrath for an explanation. In a nutshell, the steadily increasing productivity of goods, drives consumers to services. The exporting of manufacturing overseas only hastened what is inevitable in a growing economy.Report
The US government can borrow money for 10 years at <1% interest rate. The thesis that there is too much US Govt debt is not recognized by fixed interest markets.Report
I’m thinking that the recession is only not going to be a depression because we know how to deal with that sort of thing now, but, yeah. It’s going to be bad.
When I look at a timeline of what I am likely to spend over the next few weeks, it’s not going to be a whole lot. Sure, we spent a *LOT* of money at the grocery store… but that was to get us to a place where if the gummint said “nope, you’re quarantined for three weeks”, we could weather that without much of a problem. (We might need more cheese, maybe.)
(Knock wood.)
But the restaurants in town went take-out/drive-through only. We’re not going to be going out to eat. The climbing gym shut down for a few weeks. We’re not going out there either. We’re not going to go to the big box stores or the Entertainmart to pick up used Blu-ray or videogames. All of the people that I used to buy services and/or products from aren’t going to see me for a good long while. And while that wouldn’t be a bad thing for me, it would very much be a bad thing if everybody I knew also did that.
And everybody I know is also going to do that.
Along with most everybody they know.
And so on and so on.
There’s going to need to be an edict that comes down that protects the service industry folks from eviction/foreclosure because if the landlords and banks start kicking people out of their homes due to inability to make the payment, there’s going to be blood in the streets.Report
“I’m thinking that the recession is only not going to be a depression because we know how to deal with that sort of thing now, but, yeah. It’s going to be bad.”
But do we know how to deal with a services recession in an economy where half of all workers are in services and half of these are no longer able to offer their services?
In one week, we went from a mild health concern, to a shut down. Most people I know are in the service industries and they either can’t go to work, or nobody wants their services any more. And a lot of the rest are in jobs where they manufacture things for those same people no longer working. And this phenomena is happening globally!
On top of this, the government employee pensions in places like Calif. and Illinois are as good as bankrupt. Their assets are gone, and now the taxes on workers and profit needed to prop up their pensions are gone too.
If this is not solved in a matter of weeks, then the global economy grinds to a halt. It collapses, with no quick way for anyone to restart it (you’d have to convince everyone that flying, eating out and going to NBA games is safe again, when it still isn’t).
I think people are vastly underestimating how serious the market collapse can be. We aren’t talking about a significantly lower DJIA, we are talking about no DJIA.
If I had to bet on the situation, I would predict we solve the pandemic with no significant rise in total flu deaths in developed nations by year end (more Coronavirus but less other flu as a result of social distancing). But as a negative side effect, or unintended consequence of our efforts, I predict the largest global depression of our lives.
I hope I am completely wrong.Report
We’re tumbling down Maslow’s staircase. I’m hoping that we’ll be able to keep up with the bottom two rungs for everybody during the crisis.
(And if banks even *THINK* about foreclosure and if landlords even *THINK* about eviction… well, I shudder to think.)Report
So now my 89 year old mother and 95 year old mother in law won’t be able to demand rent from their tenants either? That impoverishes both of them as well.
The whole system implodes until “social distancing” is overcome (via a vaccine or immunity or burn out)
Social distancing = laid off service workers = less demand for goods = less people in manufacturing = financial collapse = ?Report
I don’t know what the solution is but I recommend that your mother and m-i-l not evict tenants.Report
I just heard that my sister told her recently jobless tenant that he could just pay half his rent this month. But she also made it clear she and her husband are likely about to both lose their jobs now too. Now she has two mortgages and no income.
My mom may be forgiving, but I have never known my mother in law to give a tenant so much as an inch of leeway. I will suggest she reconsider for a few months (95 year olds don’t listen very well though LOL)Report
There has been talk in various legislatures of suspending mortgage payments for the duration of the crisis, since that let’s landlords suspend rent payments.
The basic idea is just to freeze all these required transfers so that everybody comes out the other side with essentially the same bank balance they went in with, as if time had been suspended.Report
Love it! This is a truly brilliant idea. Then the govt only has to assist the lienholders.
That along with a $1000 check per person and Extended unemployment insurance and we are talking about real relief.Report
The NYTimes has an opinion piece prominently placed this morning that calls for making the entire chain whole. That is, the federal government picking up all the slack everywhere with loans. The feds will loan your employer the money to keep on paying you so you can meet all of your own payments. The author admits that it will cost trillions with a “T”, perhaps as much as $10T. He also thinks it can all be paid back by the beneficiaries over five years.Report
Apparently Trump has decreed a policy to this effect:
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I am with you on the the effects of the virus, not much damage from health concers compared to economic concers. But I do think there are ways out, which if I am reading the tea leaves correctly, are already in play.
Amazon just put out word that it is looking for 100K workers. And as we ramp up on-line shopping, there will be an even greater need for people working in the logistics world. Couple that with a greater use of local and national manufacturing, and we could weather the storm fairly well.Report
Plans for economic mitigation from the coronavirus — by Tyler Cowen
1.Scale down economic activity in a rapid way to keep people at home, but without devastating the physical, cultural,
or organizational capital that will be needed to restore growth and normality.
2.Boost the confidence of markets — both retail and financial markets — by showing progress in limiting the spread
of the disease. (But note that merely slowing the spread of the disease may not help the economy, as uncertainty
would linger for longer periods of time.)
3.Keep business in a position to rebound.
4.Create incentives for production to bounce back once that is appropriate.
A good piece by him, here:
https://docs.google.com/document/d/1Sf2ZtjSwANDNP4yATuvwwMMPlTE5DhXccVpEK73av5U/editReport
Yeah, I like these, especially the $1000 guaranteed income. I am in no way a proponent of UBI in most circumstances, but then again this isn’t most circumstances.
Not sure those in charge will listen to this type of wisdom though.Report
The usual suspects are, as always, predicting a V-shaped recession. At least from the employment perspective, the last time the US had a V-shaped recession was 1981-2. Since then they’re all U-shaped, getting deeper each time, with a bigger federal package, and taking longer to recover. If we take the last three as a trend, this time we’re looking at roughly 10% of jobs disappearing, a $2T federal fiscal package, and about six years to recover from the bottom.Report
Same old shit recipe of socializing the loss and privatizing the gain with no structural action to sure up consumers. Exactly what we’re probably poised for this time.Report
If the government can force you to buy insurance, what’s to stop them from forcing you to buy snowblowers and boats, too?Report