The economic crisis caused by the coronavirus pandemic could last much longer than the health crisis, and its effects could extend beyond 2060. This is because the pandemic will carve deep scars in our thinking. If things go wrong, the US could lose as much as 188% in 40 years. your GDP. Therefore, bankruptcies must be avoided, economists suggest.
A post-pandemic crisis could last 40 years or more
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Just as the coronavirus infection leaves deep scars and changes in the lungs for life, the economic crisis triggered by the pandemic will leave “scars” in our thinking. Such conclusions emerged from a study conducted by three US scientists Julian Kozlowski, Laura Veldkamp and Venky Venkateswaran at the recent remote conference of central bankers in Jackson Hole.
Their presentation made a powerful impression. Julian Kozłowski works at the US Fed’s central bank in St. Louis, Laura Veldkamp is a professor of finance at Columbia University in New York, and Venky Venkateswaran is a professor of economics at the Stern School of Business in New York.
“Our goal … is to quantify the long-term effects of the COVID crisis from the belief scarring effect, which stems from the discovery that pandemics are more likely than we thought,” the researchers wrote in a recent study published by the Fed.
– The greatest economic cost of a pandemic … is likely to arise if behavior changes long after the immediate health crisis has subsided. The reason for such a long-lasting effect is the scarring of beliefs, economists added.
Now we are even cheering up – the pandemic will finally pass, a vaccine will be invented, the population will be immune, and people will go back to work. It will be “as it used to be” and the economy will start to boom again, because companies will start to invest and consumers – to buy. Nothing could be more wrong, scientists say. Looking to the future like this does not take the “scar effect” into account. And these – engraved by the pandemic in our beliefs – can be very deep.
In order to get a good understanding of the whole “scar effect” thing, a little bit has to be said about the method. When economists try to guess the future, they are guided by the probability of events that may occur. The normal probability distribution is similar to a drawing of a snake that swallowed an elephant. Of course, the most likely events are those where the elephant in the snake’s belly has a head and a body. The ones with a head and a tail are least likely. The least likely ones are even called “tail events”. But it is their occurrence that causes the deepest scars.
Let us add that it is the “tail events” that the media focuses on. The fact that a dog has bitten a person is not remarkable to them, as it happens that dogs bite people. The real news would be an extremely rare case if a human bites the dog. As a result of media attention, “tail events” may reach our consciousness more often than those which are most likely to occur.
For example, to the crisis that broke out in 2007-2009. Previously, no one expected it, it was considered unlikely, and the tangle of such events shook the world economy for several years.
“The pandemic taught us that the risk was greater than we thought. It is this newfound knowledge that has a long-lasting impact on economic choices, wrote Julian Kozlowski, Laura Veldkamp and Venky Venkateswaran.
Whatever your view of what will happen next year, the cost of this pandemic will be much greater than the short-term calculations suggest, they added.
In the short term, no one knows what will happen in the economy and how severe the shock of the pandemic will be. It is impossible to estimate how much US GDP will decline in 2020. But it turns out that no matter how deep the decline is this year, the long-term effects can be very strong. However, the biggest problem is not the depth of the current recession, but the permanent changes. And they depend on how our beliefs will evolve.
According to the researchers, the shock caused by a pandemic attack alone will not have these long-term effects. Generally, after crises – for example after wars – investments come back more than enough to compensate for the loss of lost capital. This time, however, may be different. The decline in economic activity can be long-term and its effects can be felt until 2060 or longer.
Scientists prepared three scenarios for the recovery period. The first assumes a short, though deep, recession and a V-shaped economic recovery. According to this scenario, the US will lose 65 percent in the long term. GDP at discounted net present value. If the shape of the recession is less favorable – it may be 114 percent. GDP, and with a long recession – 188 percent. GDP. It’s as if the US economy has produced literally nothing for almost two of the next 40 years.
Because the popandemic crisis means a drop in productivity. This is best seen in services. Since people stay home, hairdressers and beauticians don’t have customers. This is not the worst yet, because the much deeper “scar” is caused by the expectations that lower productivity will also be in the future. And what are the consequences of such beliefs?
Expectations for a higher risk premium on your invested capital. And if capital wants a higher risk premium, it becomes more expensive, which deters firms from investing. Even when nominal interest rates remain as low as they are today.
The second effect that causes “scarring” is the aging of capital. Empty premises after restaurants that have gone bankrupt, empty rooms in hotels, cinemas, concert halls, empty offices because employees sit in home offices – this is capital that is not used productively and which is “aging”. The more capital “ages” and the longer it is, the smaller its working resources and the more expensive its depreciation.
Finally, finally – widespread bankruptcies. They deepen the erosion of the economic value of capital resulting from the initial shock. For example, if shops in a shopping center go bankrupt, the space rented there will be worth less. If the company’s supplier goes bankrupt – it will have to undertake the costly search for another supplier or introduce capital-intensive changes in production.
Less valuable capital turns out to be more costly to investors than a temporary decline in productivity. Reducing the value of working or “aging” capital means that it is necessary to reach for its new – and more expensive – resources. But since there is less capital, it needs less work. Demand for labor is falling, unemployment is rising and consumption is falling.
According to scientists, the most important thing is to prevent bankruptcies of enterprises, because they increase the loss of capital value the most. Bankruptcies also mean a “permanent separation” of labor and capital, not just a temporary lockdown. Preventing them is a task for economic policy, they believe.
“The achievement is greater than anyone could have imagined,” they wrote.
Only that the US economic policy has lost room for maneuver. The Congressional Budget Office has just calculated that the US government’s debt will almost double in the next 30 years to 195%. GDP in 2050.
Jacek Ramotowski
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