After the Virus: Economic Consequences

There are a number of forecasts of what the world will be like after the virus. Let’s take a look at some of them.

Many long-term trends have been accelerated by the virus. Probably the most cited example has been the accelerated move to digital-based transactions and behavior. This has occurred among both consumers and businesses.

I think we have hit an inflection point. Before, there was a great deal of discussion about how one industry or market was becoming more dependent on digital platforms and automation based on artificial intelligence. The Internet of Things, online shopping and ordering, business conferencing, telemedicine. Or how a particular company was transforming an industry (Amazon, Uber). But now we see that the entire economy – all industries and markets – rely on digital. The technology and rapid adaptation are accelerating the shifts.

Income inequality is bad and probably getting worse. The usual reasons given are outsourcing in the global economy and the effects of automation. The two reasons are related. Advances in telecommunications, including global digital networks, and management software have made the management of multinational companies possible. 

There now appears to be another reason. We talk about the growth of the service economy. What this means specifically is that most of the new jobs created over the last few decades have been relatively low-paying service jobs. About 15% of the entire labor force (about 25 million people) works in restaurants and bars. Much of the service industry consists of services that relatively low-paid workers provide to relatively high-paid and wealthy customers. A recent study indicated that unemployment among service workers in the affluent parts of New York City was higher than in the rest of the city. On the other end of the income scale, the upper-middle class, dominated by the technological and professional elite, have seen their average incomes rise much faster than low-paid service workers. As digital replaces service workers, including office workers, income inequality and its political consequences will probably get worse.

The move to the digital economy will also threaten many owner-managed small businesses. Because of economies of scale and scope, large digital-based corporations will lead the trend towards more concentrated industries and markets. 

Another consequence of the accelerating use of digital platforms is the demand for technological workers will probably also accelerate. Salaries will go higher. Automation and AI software will “deskilled” (lower salaries) professions based on specific knowledge and eliminate many manufacturing and office positions. Online business collaboration will become more common. Video conferences may not be as effective as face-to-face conferences and interaction but they are a lot cheaper than leasing office space in Manhattan.

We don’t have to worry about the huge increase in government debt. Well, maybe. Almost all of the government “stimulus” programs are income maintenance programs. They are paid for through government borrowing, a large part of which is directly or indirectly selling debt to the Fed. The Fed pays for the debt by creating money. All this does is transfer federal debt from one part of the government balance sheet to another part. 

As long as the Fed keeps interest rates extremely low, the cost of debt service (federal interest expense) as a percent of nominal income will be low.

A few comments. Large yearly deficits and the total national debt will continue to increase for years after the virus comes under control. None of this debt will disappear. Total debt service costs will rise, even at extremely low interest rates. If for some reason, such as inflation, interest rates rise, the cost of interest expense could rise dramatically. By fiscal 2022, a one percent increase in federal borrowing costs could add at least $250 billion to the yearly deficit. The federal government could avoid most of any potential future interest expense increases by financing the national debt at the current rate of 0.6% for 10 year bonds.

The Fed might want to sell off some of the government debt they have accumulated. They basically have to sell it to someone else who wants to hold U.S. government debt. This increases the supply of U. S. government debt offered to be sold. It might raise interest rates on all of the national debt. 

Even if tax revenue increases, which will happen if there is an increase in taxable nominal income without tax cuts, the continuing large deficits will put pressure to reduce outlays on “discretionary” spending. That is, all spending after Social Security, Medicare, defense, federal pensions and interest on the national debt. Unless taxes are raised substantially, it is likely that in a few years all “discretionary” spending will be funded by new debt.

There will be little, if any, distinction between monetary and fiscal policy. The pretense that the Fed makes monetary policy independent of the rest of the government will not be credible.

The amount of lost income should go down as the economy expands and employees go back to work. The fiscal stimulus programs basically replace the lost income of workers and small business owners. Lost income may be about $400 billion per month, including PPP subsidies of salaries. $3 trillion in income maintenance programs won’t last long. The programs are expected to end or be reduced between August and October. 

To avoid a worse recession, income maintenance programs will probably be renewed. With the number of virus cases rising rapidly, the recovery of the service economy may be slower than forecasted. If the number of virus cases do not go down soon, service businesses either cannot open, are restricted, or customers will be afraid to patronize service establishments or entertainment venues. Many small businesses will go bankrupt. Income maintenance programs may have to be greater than assumed and continue for a longer time. Or both. We could see high unemployment levels, a surge in bankruptcies, and even higher future government debt levels.

State and local finances are even worse. State and local governments cannot create money to cover deficits. Inadequately funded public pensions were already killing some state and local budgets before the virus hit as more public employees were retiring. These governments, which provide most of the public goods and services, will have to cut services. Already large numbers of employees, including health care workers, have been laid off. Public office workers will be laid off as more interaction with citizens will be done online. Possibly more public education will also be done online, especially at the college level. Many of these employees qualify for pensions. The federal government would have to borrow trillions of additional dollars to support state and local governments.

Longer term. Health care is now the largest industry in the United States and growing faster than the rest of the economy. It is also a major and growing part of the federal budget. But there is no way health care benefits paid by Medicare programs are going to be cut. The number of senior citizens is expected to double in the next 20 years. Senior citizens make up a large percent of voters. Over 30% of the Florida voters in this year’s presidential election will be senior citizens. In a close election, the winner must take Florida. I doubt if a candidate campaigning on a platform of cutting health care services to slow down the growth in Medicare costs would do well in Florida and elsewhere.

All of this indicates that government money to tackle societal problems – large increases in investment in infrastructure, funding the huge costs of climate change, programs to increase the low rates of economic growth and productivity, new income maintenance programs, and many others – will not be available in adequate amounts. What this means is that the costs of mitigating the damage from climate change will be higher than expected. 

One partial answer to these problems is accelerated innovation in new technology, especially in health care. This is likely to happen. Senior citizens, technology companies, and their employees and stockholders will benefit. But unlike the past, the new technology may be highly disruptive by increasing long-term unemployment and income inequality. Whether or not new public programs and policies will be created is uncertain in the current political climate and the future reality of government budgets. If not, the types of social, economic and political conflicts we are currently experiencing could get worse.

For background on understanding government finance, budget deficits, trade deficits, and how they are related, see my Government Finance 101. This post also discusses the fiscal effects of Covid-19.

You might also be interested in my extended explanation of The Stock Market Crash of 1929 and the Beginning of the Great Depression. Some of the analysis and conclusions may surprise you.