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What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
The virus outbreak and the government response in the United States have severely disrupted the pattern of personal income and expenditures in the last few months, and the disruption continued in May, according to the latest data. First, some context: In March, as the crisis started to unfold, many employers dismissed workers and real (inflation-adjusted) disposable income fell 1.8% from the previous month. Real consumer spending fell 6.4% as consumers began to face economic restrictions and, due to fear of the virus, the necessity of maintaining social distancing. In April, a very large number of people lost jobs. But the impact on income was more than offset by the government providing massive stimulus in the form of cash disbursements as well as enhanced unemployment insurance. The result was that real disposable income increased by a record 13.6% from the previous month. Yet due to lockdowns and social distancing considerations, Americans saved rather than spent. Real spending fell 12.2%. The personal savings rate increased from 12.6% in March to 32.3% in April.
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Now, the US government has provided data about May and the pattern has slightly reversed. Specifically, real disposable income fell 5.0% from April to May as government stimulus checks declined. This was only partially offset by a rise in wage income as employment rebounded. Meanwhile, real spending increased 8.1% from April to May, largely due to a massive 28.4% increase in real spending on durable goods, such as automobiles, electronics, and furniture. Spending on services, however, grew only 5.2% after having fallen 12.0% in the previous month. The savings rate fell to 23.2%, still a historically high level.
What can we infer from the government’s May report? First, although income grew at a historically high rate, it remained well below the pre-crisis level given the continued high level of unemployment. In fact, nominal income in May was the lowest since 2017. Second, although spending rebounded, it too remained well below pre-crisis levels. This reflected continued high unemployment as well as consumer caution in the presence of a continuing threat from the virus. Still, there are evident pockets of strength in the economy. Spending on durables was robust as consumers responded to pent-up demand and low borrowing costs. Demand for housing was strong as evidenced by a surge in applications for new mortgages. This likely reflected low mortgage interest rates as well as demand for bigger homes that have home offices in an age of telecommuting. That being said, the number of existing homeowners who are late with mortgage payments has soared.
Going forward, the current revival of the virus could lead to a new wave of job dismissals and, consequently, a decline in income. Without a second round of stimulus money from the government, the impact on spending could be substantially negative. The enhanced unemployment insurance is set to expire at the end of July. There is debate in Congress about what to do next and the outcome of that debate could have a big impact on the path of consumer spending in the Autumn.
The United States is experiencing what might be called a second wave of the virus. The only hesitation in labelling it as such is that the first wave never truly ended. The number of cases from the first wave never fell significantly except in the New York area. Indeed, another way to look at it is that the United States has been through two separate outbreaks: one in the New York area, the other in the rest of the country. The pattern of infections in New York was similar to what transpired in much of Europe. There was a major outbreak, a draconian lockdown, and then a sharp decline in the number of new cases. Meanwhile, there is currently a surge in new infections in much of the rest of the country, with 26 states reporting a sharp acceleration in infections. These largely reflect the decline of social distancing that accompanied the easing of economic restrictions in the last several weeks. They might also reflect the impact of political protests in multiple cities.
The latest flareup of the virus in the United States is spooking financial markets as well as political leaders. Concerned about the potential impact of the flareup in other states, the governors of New York, New Jersey, and Connecticut ordered that people arriving from problematic states must undergo a 14-day quarantine. Specifically, these three states are targeting people arriving from states with a “significant community spread” problem. There are nine such states that meet the criteria. The three governors are keen to avoid a repeat of the outbreak they experienced in April. As Connecticut Governor Lamont said, “The northeast region has taken this seriously, and that has allowed us to power through. But we’re not an island.”
Meanwhile, infection rates are rising rapidly in several key US states including Florida, Texas, Alabama, Arkansas, North Carolina, South Carolina, Washington, Utah, and especially Arizona. The number of new reported infections in the country last week was the highest ever. The lead infectious disease specialist for the US government, Dr. Anthony Fauci, said, “The next couple of weeks are going to be critical in our ability to address the surges we’re seeing in Florida, Texas, Arizona and other states.” He described the current surge as “disturbing” and said that the failure of people to wear masks and engage in social distancing is creating a significant risk. Some people claim that the surge in cases merely reflects an increase in testing. Theoretically, increased testing should be accompanied by a decline in the rate of new infections. In fact, that is what is happening in Europe and Asia as well as in New York. Moreover, if increased testing was the only explanation for the surge in reported infections, there would be no surge in the number of hospitalizations. Yet there has been such a surge.
Financial markets reacted with US and European equity prices dropping sharply last week. Investors were likely worried that the revival of the outbreak will threaten the economic recovery. Moreover, they have good reason to worry. There is already evidence that, even without new economic restrictions, people are avoiding situations that involve social interaction. For example, in Houston and Dallas, where major outbreaks are under way, high frequency data show that there has been a sharp decline in restaurant reservations in the last week. Meanwhile, Texas Governor Abbott urged people to stay at home. In addition, he ordered the closure of bars (pubs), banned elective surgery in order to assure an adequate supply of hospital beds, and restricted dining in restaurants. In Florida, the governor banned the sale of alcohol in bars. In North Carolina, the governor ordered that people wear face masks. The President of the Federal Reserve Bank of Chicago, Charles Evans, said, “My forecast assumes growth is held back by the response to intermittent localized outbreaks, which might be made worse by the faster-than-expected re-openings." Indeed, our own Deloitte forecast for the US economy assumes that the early reopening will lead to a bigger outbreak that, in turn, will suppress economic activity in the fourth quarter of this year.
IHS Markit reported preliminary Purchasing Managers’ Indices (PMIs) for June. PMIs are forward-looking indicators meant to signal the direction of activity in the economy. They are based on surveys of purchasing managers who are asked questions about output, new orders, export orders, employment, pricing, inventories, and sentiment. A reading below 50 means a decline in activity; the further the number below 50, the sharper the decline—and vice versa. The latest PMIs for the United States suggest that economic activity continued to decline in June, but at a slower pace than in May. This was mostly due to a continued decline in activity in the broad services industry.
Markit publishes PMIs for manufacturing and services, as well as a composite index. The PMI for manufacturing increased from 39.8 in May to 49.6 in June, indicating that activity in manufacturing was stable in May, after having fallen very sharply in the previous three months. The PMI for services, however, improved from 37.5 in May to 46.7 in June. This meant that services activity continued to fall, but more slowly than in May. Services encompasses such industries as finance, professional services, telecoms, transportation, retailing, wholesaling, hospitality, entertainment, utilities, health care, and education.
Also, the composite index increased from 37.0 in May to 46.8 in June. Markit commented that the deceleration in the decline in economic activity reflected the easing of economic restrictions. Still, overall demand remained weak, especially for services. Markit commented that “any return to growth will be prone to losing momentum due to persistent weak demand for many goods and services, linked in turn to ongoing social distancing, high unemployment and uncertainty about the outlook, curbing spending by businesses and households. The recovery could also be derailed by new waves of virus infections.”
The PMIs for the Eurozone, like those of the United States, indicate that economic activity continued to decline in June, albeit at a more modest pace than in May. Specifically, the manufacturing PMI increased from 35.6 in May to 48.2 in June. The services PMI increased from 30.5 in May to 47.3 in June. Finally, the composite PMI increased from 31.9 in May to 47. 5 in June.
Many companies in both manufacturing and services continue to report a decline in output and new orders. As Markit noted, “For those companies continuing to report falling output and order books, the pandemic was again by far the most commonly cited cause. The persistent closure of non-essential business, notably in hotels, restaurants, travel and tourism and other consumer-facing sectors, continued to be widely reported as many social distancing measures remained in place. Many other companies reported weakened demand as business and consumer customers remained cautious with respect to spending.” Markit also reported that, within the Eurozone, France experienced a return to growth in activity while Germany and the rest of the Eurozone did not. However, Markit noted that France had experienced a sharper decline than Germany in prior months.
In Britain, the pattern was similar, but manufacturing activity increased slightly. Specifically, the PMI for manufacturing increased from 40.7 in May to 50.1 in June, indicating a very slight increase in activity after having fallen sharply in prior months. The services PMI increased dramatically from 29.0 in May to 47.0 in June, indicating a continued modest decline in activity. Markit commented that, although the British economy is likely to see positive growth return in the third quarter, “the longer-term recovery prospects remain highly uncertain. Some of the recent gains in the PMI reflect short-term bounces as businesses returned to work, but demand clearly remains weak, as indicated by a further steep decline in backlogs of orders and an ongoing fall in new orders.”
Finally, a word about interpreting the PMIs. If you examine a chart showing the latest PMIs for the United States and Europe, you will see a line that dropped precipitously in April and May and rebounded sharply in June. I’ve seen some commentators suggest that this is the much-heralded V-shaped recovery. It is not. The line looks like a V, but the line shows the change in activity, not the level of activity. Thus, when the PMI falls sharply and then reverts to near 50, it means that activity fell sharply in April and May and then stabilized in June. It means that the level of activity in June remained far below the pre-crisis level. A V-shaped recovery would involve the PMI moving far above 50, indicating rapid growth of activity. For now, that is not even close to reality. As such, the US appears to be experiencing a U-shaped recovery with a risk of a W in that another downturn is possible.
This pandemic is a hugely disruptive event. It has already led to one of the four largest declines in global GDP of the last century (the others were centered around the two world wars and the Great Depression). In the past, events that caused a large number of deaths, such as wars and pandemics, have had significant long-lasting economic consequences. This time will be no different. What, then, are the long-term consequences of pandemics? Several economists at the International Monetary Fund (IMF) have attempted to answer this question by examining data going back nearly a millennium.
Based on a statistical analysis of very long-term data, the IMF economists determined that pandemics have significant long-term impact that differs from the impact of wars. They found at least 15 episodes in the last 700 years in which more than 100,000 people died from pandemics. They also looked at a number of deathly wars. They found that wars tend to lead to a sustained increase in borrowing costs, largely due to the destruction of physical capital and the need to rebuild. This was not the case with pandemics. Rather, pandemics lead to a sustained period of lower real borrowing costs, but higher wages. That is because pandemics often cause a shortage of labor relative to capital. Moreover, pandemics are often followed by an increase in private saving that leads to slower growth of demand.
The good news is that, if pandemics cause a decline in borrowing costs and a rise in private saving, the recent and massive increase in government debt will be more easily serviced. The bad news is that, all other things being equal, it appears that pandemics are followed by slower economic growth, at least initially.
The authors did, however, offer some caveats to their analysis. First, past pandemics created a labor shortage because of the death of working age people. But the current pandemic will most likely not lead to a shortage of labor. Indeed, because of modern medical care, the death rate in this pandemic is likely to be far lower than in the past. Second, governments have taken aggressive measures to offset the negative consequences, thereby potentially boding well for a more rapid return to normal growth. Finally, despite those caveats, the authors conclude that “we still expect a sustained period of low real interest rates (though attenuated by the factors we discussed). Low real rates should then provide welcome fiscal space for governments to aggressively mitigate the consequences of the pandemic.”
The point is that we are likely to live with the economic consequences of this pandemic for a long time, although it is too early and too difficult to discern what those consequences will be. Examining the past is one of the useful ways to understand how pandemics influence economic events. Of course, this pandemic will be different from the others, not least because of the existence of medical technology and more sophisticated government policies. Still, we don’t know what we don’t know. For businesses, this is an especially difficult map to navigate.
Michael Wolf, a global economist with Deloitte, looks at the rise in debt in emerging markets during the COVID-19 crisis.
As global investors began to realize the magnitude of the pandemic in March, they pulled funds from emerging markets and put their money in safe-haven investments. Portfolio outflows from emerging markets during this crisis dwarfed what was seen during the global financial crisis. Fortunately, portfolio outflows from emerging markets were short-lived this time around. The world’s largest central banks, such as the US Federal Reserve, injected huge sums of liquidity into financial markets, which spilled into emerging markets. April and May saw portfolio inflows, though only about one quarter of the outflows from March were recovered. Some emerging markets were even able to raise funds in international capital markets, with more than US$83 billion of bond issuance since April.
Given the return of portfolio flows and the ability of some countries to access financial markets, it is tempting to believe emerging markets are out of the woods. However, these countries are still facing steep increases in financing needs, which are unlikely to be met through domestic resources. Some of that increase will come from existing liabilities needing to be rolled over as recessions take hold and earnings miss prior expectations. But new financing will also be necessary. Government expenditures are rapidly rising to fight the health crisis and cushion the fall in demand. Meanwhile, tax revenues will plummet as incomes and spending remain depressed. The consultancy firm Oxford Economics expects gross government debt as a share of GDP to rise more than 20 percentage points in Egypt and South Africa between 2019 and 2021. In Brazil, Romania, Saudi Arabia, and Russia, it is expected to rise more than 10 percentage points. The private sector will also face sizable shortfalls that will require external financing.
Not every emerging market country will be pushed to the brink, though. Those that have ample foreign reserves, such as Saudi Arabia and Thailand, will have the option to draw them down to cover financing costs. Their vast reserves also help them attract foreign private financing. Saudi Arabia raised about US$7 billion in April at reasonably low interest rates despite oil prices plummeting. In March, the Fed set up swap lines with the central banks of Mexico and Brazil, reducing—though not eliminating—risks of dollar liquidity drying up in those countries. In May, the G20 suspended sovereign debt payments for the 76 poorest countries in the world and Angola, which will free up about US$11 billion. Unfortunately, private creditors have yet to agree to suspend payments, and the initiative covers only the poorest countries and misses the more indebted middle-income countries.
Other countries will not be as fortunate. Coming into the crisis, Argentina, Pakistan, South Africa, Turkey, and Ukraine lacked sufficient reserves to cover external (current account) deficits and short-term external debt servicing for the next year. Of these five, only Turkey has managed to avoid going to the IMF. Even countries like Bangladesh, Chile, Colombia, Egypt, and Nigeria that came into the crisis with more reasonable foreign reserve levels have either tapped the IMF for emergency funds or gained access to its flexible credit line.
Perhaps one of the largest issues is that the IMF may not have the capacity to deal with the financing needs that are coming. By the IMF’s own estimation, emerging market financing needs will be at least US$2.5 trillion. But the IMF only has about US$1 trillion in lending capacity. The United States, which has the largest voting share at the IMF, blocked expanding that capacity at this year’s spring meetings. The private sector can meet some of those funding needs. For now, global investors seem relatively optimistic about the economic outlook and have been happy to provide financing to borrowers in emerging market countries with ample reserves and government guarantees. However, a second wave of infections like what the University of Washington is projecting for the United States could easily cause investors to head for the exits from emerging markets. Untamed infection rates in much of Latin America, Africa, and parts of Asia may also force investors to reevaluate the risk profile of their investment in countries grappling with the worst outbreaks. The financial risks these countries are facing seem to be far greater than the relative stability in emerging markets over the last few weeks would otherwise suggest.
The issues emerging market countries are facing could have sizable implications on the rest of the world. The Latin American debt crisis in the 1980s and the Asian Financial Crisis in the 1990s are two good examples of how problems in emerging market countries can quickly spread to much larger ones. Foreign banks own roughly half of all emerging market external debt, exposing them to the rising risk of default in emerging market countries. Those banks are heavily concentrated in the United States, United Kingdom, Japan, and Spain. Plus, the risk of default could linger after the pandemic is over should commodity prices and exports remain subdued. Emerging markets also account for a greater share of global output, amounting to nearly US$20 trillion annually in 2018 after excluding China, which is almost the size of the US economy. That means weakness in emerging markets can now have serious negative effects on global demand and output.
Last week, China’s government released several economic indicators for May, and they offer a mixed picture. On the one hand, industrial production was up as was investment in property and infrastructure. On the other hand, retail sales were down and weaker than anticipated, and overall investment continued to decline. China’s economy is reviving faster than Europe’ and the United States’, but activity mostly remains below pre-crisis levels. Here are the details.
Industrial production was up 4.4% in May from a year earlier, implying that overall activity is close to the pre-crisis path. Manufacturing output was up 5.2%, including a 12.2% increase in output for the automotive sector. There was also strong growth in the production of construction equipment. This was related to increased government spending on infrastructure. However, the US space agency NASA reports that, based on satellite imaging, nitrogen dioxide emissions in China were down 12.3% in early June compared to a year earlier. This is seen as a proxy for overall production as it reflects the burning of fossil fuels.
The Chinese government reported that retail sales fell 2.8% in May versus a year earlier. Keep in mind that, prior to the crisis, retail sales’ annual rise was between 7% and 8%. Thus, the report signals that retail sales remain 10-11% lower than they would have been had pre-crisis growth continued. However, some categories experienced significant increases from a year earlier. These included telecoms equipment (up 11.4%), automobiles (up 3.5%), furniture (up 3%), home appliances (up 4.3%), cosmetics (up 12.9%), and personal care products (up 17.3%). Sales of oil and related products were down sharply while sales of apparel were down modestly. Separately, it was reported that the number of restaurants that have resumed operation remains 3.8% below January levels. The overall business resumption rate now stands at 88% of the pre-crisis level.
In the first five months of this year, fixed asset investment was down 6.3% from a year earlier. Considering that investment had been growing at a rate of about 5.5% before the crisis, this means that investment spending is about 12% below the level that might have taken place without the coronavirus crisis. The public sector helped to offset the overall weakness of investment, with public sector investment falling only 1.9% versus a year earlier. Private sector investment, however, was down 9.6%. Investment in manufacturing fell sharply, but investment in public infrastructure increased strongly, up 10.8% in May versus a year earlier. The latter was largely funded by a massive issuance of bonds by local governments. In fact, such issuance was about US$183 billion in May, with most of that money flowing into infrastructure projects. Public spending on infrastructure led to a surge in the demand for construction-related vehicles and cement. China’s government is once again turning to fiscal stimulus to boost the economy.
Although foreign direct investment (FDI) into China has declined, foreign-funded merger and acquisition (M&A) activity has increased. Specifically, in the first five months of 2020, inbound FDI was 6.2% below the level from a year earlier. However, inbound FDI was up in both April and May from a year earlier. In April, inbound FDI was up 8.6% and, in May, it was up 4.2%. Thus, foreign investors appear to have lately had a change of heart regarding opportunities in China. In addition, outbound FDI in the first five months of the year was down 1.6% from a year earlier. Direct investment involves direct purchases of businesses and assets, controlling stakes in existing businesses, or purchases of property. It often involves deciding to start a business in China, such as rolling out factories or fast food restaurants. It does not include financial investments, such as purchases of bonds, non-controlling interest in stocks, and other financial assets. Interestingly, however, inbound investment into M&A transactions increased in the first five months of the year, hitting a level not seen for a decade. It looks like global investors are confident in the recovery of Chinese domestic demand. In addition, US and European companies are taking advantage of looser restrictions on foreign ownership. M&A transactions differ from the preponderance of inbound FDI in that they involve acquiring existing businesses rather than building new businesses from scratch. The rise in M&A while other forms of FDI decline indicate that foreign investors have growing confidence in the quality of businesses that originated in China.
In May, retail sales in the United States bounced back after having fallen dramatically in both March and April. This reflected the reopening of retail businesses in most US states. Specifically, retail sales were up 17.7% from April to May, following a decline of 14.7% in April and of 8.3% in March. However, in May, sales were down 6.1% from a year earlier. Considering that retail spending had been growing at an annual rate between 3% and 5% prior to the crisis, it can be argued that retail sales in May were between 9% and 11% below the level that might have been achieved had the crisis not happened.
The 17.7% monthly increase was distributed unevenly by category. The best performing category was clothing stores where sales were up 188% from April, although sales remained 63.4% lower than a year earlier. Other strong categories were furniture stores (up 89.7% from April), electronics stores (up 50.5%), and automotive dealers (up 46.2%). Restaurants and bars (pubs) were up 29.1% while spending at grocery stores was up only 1.3%. Non-store retail sales were up only 9.0%.
High-frequency credit card data indicates that, as lockdowns in the United States have eased, spending has risen, but remains below normal levels. Moreover, the rebound in spending differs substantially depending on income. That is, high-income households continue to engage in very suppressed spending while low-income households have almost returned to normal levels. Specifically, as of early June, high-income household spending was 17% below pre-crisis levels while low-income household spending was only 4% below pre-crisis levels. Why this difference? One explanation is that it is largely low-income individuals who lost jobs during this crisis and who have received substantial government benefits. As such, their ability to spend, which was damaged by lockdowns, is now revived. Meanwhile, high-income households are better able to maintain a suppressed level of spending as a precaution due to uncertainty about their economic futures and about the path of the virus. A larger share of their spending is discretionary. Thus, they might choose to avoid restaurants and movie theatres. Importantly, highincome households account for a disproportionate share of total spending. Consequently, their failure to fully revive spending has negative consequences for the larger economy.
One of the reasons that New York was such a major hotspot for the virus earlier this year is its high population density, which makes it difficult to engage in social distancing. Now there is evidence that New Yorkers are taking that to heart and departing. It is reported that demand for suburban homes outside of New York has soared recently as professionals are trading their small Manhattan apartments for larger homes that come with home office space. This move is likely driven, in part, by the need to work from home given that it is highly difficult to enforce social distancing when traveling to and from office buildings, and especially when attempting to populate tall office buildings by riding in elevators. This suggests that there could be a sharp decline in the demand for office space as companies reevaluate their needs in the age of teleconferencing.
Could this become a trend that goes beyond New York? Probably. Recall that, in the first 40 years after the Second World War, there was a big population shift from urban to suburban areas in the United States, partly driven by construction of highways as well as favorable mortgages for single family homes. Then, starting in the 1990s, there was a reversal in which young people especially opted for urban living, leading to a revival and strengthening of many US cities. We could be on the cusp of yet another reversal. And the result could be a weakening of urban economies which, again, creates fiscal stress for urban governments. Interestingly, a survey recently found that 66% of people now telecommuting would consider moving if their jobs allowed them to continue working from home once the crisis abates.
For some time, there has been a disconnect between what was said by analysts and economists in the private sector and what was said by public health experts in the United States. The latter kept warning that if economic restrictions are lifted too early, there could be a rebound in the virus outbreak, also known as a second wave. Many in the private sector downplayed the warning and celebrated the lifting of restrictions, anticipating a sharp rebound in economic activity. Moreover, many said that, even if the virus returns, as long as governments don’t order lockdowns again, the economy would rebound quickly. Their view suggested that there is a choice between suppressing the virus and boosting the economy. Yet it is likely a false choice as research on the pandemic of 1918 has shown. In fact, research undertaken by the Federal Reserve found that, in 1918, those US cities that removed restrictions early had a larger outbreak and a slower economic recovery than otherwise. Even in the absence of lockdowns, an outbreak of the virus has negative economic consequences because it forces consumers and businesses to avoid social interaction, thereby suppressing economic activity. Thus, the most important goal of public policy should be to suppress the virus and, only then, to focus on economic revival.
Last week, equity prices in the United States and Europe fell very sharply, reportedly due to fears that a second wave is now under way in the United States. The number of new infections and hospitalizations is soaring in many US states that reopened despite not meeting the Federal government’s guidelines. The recent protests in multiple cities are likely to exacerbate this trend. Evidently, many investors now view this as potentially negative for the economy, either because it will lead to a renewal of lockdowns or because people and businesses will engage in more social distancing. It is important to note that the reopening of US states was done under very different circumstances than the reopening of European countries. In Europe, the rate of infection fell sharply (except for the United Kingdom), thus allowing for a gradual reopening. Such a decline in infections was not evident in most of the United States, with the exception of the New York area.
What is the risk of a second wave in the United States? There are several factors that will determine the answer to this question.
First, there is the issue of temperature sensitivity. Some analysts have suggested that, if the virus is sensitive to temperature (as was the case with the 1918 influenza), then the virus might abate in the summer and return in the autumn. However, the southern hemisphere, including countries close to the equator, has experienced an outbreak when temperatures were high. Thus, temperature might not play the role it played a century ago.
Second, there is the question of whether being infected renders immunity, which influences the degree to which herd immunity is possible. If a large number of people become infected and immune, then the virus has fewer opportunities to be transmitted to new hosts. Such immunity reduces the likelihood of a second wave. Yet the evidence so far is not conclusive as to whether infected people always become immune and, if so, whether the immunity is enduring.
Third, the degree of social distancing that can be maintained is critically important. Mathematical modeling shows that a small increase in the average number of new people infected by someone already infected can lead to a very big surge in infections. Thus, small changes in social distancing behavior can make a big difference. The worry is that, as economic restrictions are lifted, there could be more opportunities for the virus to be transmitted to new hosts. If, however, people and institutions remain cautious and diligent about social distancing, transmission can be stymied. Recent lifting of restrictions in the United States and Europe, combined with a wave of political protests in the United States, raises the risk of a second wave. Moreover, research shows that events in which large numbers of people are in contact with many other people (such as concerts or protests) can lead to very rapid transmission of the virus. In such a case, the second wave could be considerably worse than the first. This was true of the pandemic in 1918.
One thing that might halt or stymie a second wave even after economic restrictions are lifted is widespread testing and tracing. This can be used to isolate the infected, trace their connections, and limit the spread. Experts suggest that a strong regime of testing and tracing can enable a society to suppress a revival of the virus without having to lock down the economy again. Some countries now have such capabilities (such as Singapore, South Korea, and Germany) while some do not (such as the United States). It has been suggested that the recent increase in equity prices reflects investor confidence that, even if a second wave emerges, there will not be another lockdown. Yet if a second wave comes without adequate testing and tracing capabilities, it is likely that economic activity will plunge even without lockdowns. That is because people will likely respond to higher risk by avoiding social interaction, thereby reducing economic activity.
Finally, viruses often tend to mutate, thereby either increasing or decreasing the outbreak. Some scientists believe that this happened with the so-called Spanish Influenza in 1918 when, after a modest outbreak in the spring of 1918, the virus receded in the summer only to return with a vengeance in the autumn, possibly due to a mutation that caused it to strengthen. This cannot be predicted, but remains a risk.
Why is it so important to think about this? The answer is that the economic outlook is almost entirely dependent on what happens with the virus. If we can accurately predict the virus, we can potentially predict the economy. The uncertainty, however, has negative economic implications. Businesses cannot make meaningful plans and, therefore, put investments on hold. Consumers worry about the future and, consequently, delay discretionary purchases. These decisions reduce economic activity. Governments have attempted to offset this behavior, but with limited success. Consider the fact that, in the US, government spending significantly boosted consumer income. Yet consumer spending fell sharply. The result was weakened economic activity.
Michael Wolf, an economist with Deloitte Touché Tohmatsu Limited, looks at the latest high-frequency data from the United States and Europe.
Each region is different when it comes to the pandemic and the economic implications of deterring its spread. However, the United States continues to look like an anomaly. The most obvious way it defies the experience in other rich countries is its inability to lower the rate of infection. The peak infection rate in the United States was not terribly different from Italy or the United Kingdom after controlling for population. More recently, European countries like Germany, France, Italy, and Spain have managed to push the number of new daily cases below six per million, while the rate of infection in the United States is more than 10 times that. Even the United Kingdom, which struggled to bend the curve quickly, has pushed the rate to 25, well under half the rate of infection in the United States.
Measures taken to prevent the spread of the virus were less restrictive in the United States than in most of Europe, which allowed the infection rates to climb relatively high. Some parts of the United States then eased those already-lax restrictions prematurely, preventing infection rates from coming down further. This dynamic is visible in the mobility data. In general, mobility in the United States has been stronger than the largest European countries since mid-March, with only Germany catching up by the end of May. Relatively strong US mobility suggests economic activity should also be stronger.
Unfortunately, the consumer spending data suggests the US outlook is not nearly as optimistic as the mobility data would otherwise indicate. For example, mobility near retail and recreation establishments in April was just 41% below its baseline in the Unites States, whereas in Europe it was anywhere from 52% lower (Germany) to 89% lower (Spain). That did not translate to a softer decline in retail sales in the United States. Indeed, US retail sales fell 16% in April, far worse than the 5% decline in Germany and even the 10% drop in Italy.
Since then, mobility near retail and recreation establishments improved, with US mobility just 24% lower in the last week of May. German mobility was slightly better at 22% below its baseline, while UK mobility was 64% lower, the worst among the large European countries. Judging by the Johnson Redbook weekly retail sales, which posted its worst ever year-over-year decline for the week of June 6, US consumer spending remained weak through the first week of June despite the ongoing improvement in mobility. An unrelated measure of retail activity shows that US foot traffic at retail stores remained depressed while foot traffic in Italy has climbed notably higher.
Activity at restaurants has a similar theme. In the first week of June, restaurant bookings in the US were 79% lower than a year ago. That is considerably worse than the bookings in Germany, which were just 24% lower than a year ago. Recall that mobility in Germany and the United States were strikingly similar at the end of May. Still, US spending on restaurants looks likely to outpace spending in the United Kingdom where restaurant bookings were still 99% lower than a year earlier, though the difference in mobility between these two countries better explains the restaurant booking differential.
Now that most European governments have eased economic restrictions, activity in Europe is starting to recover, albeit slowly. Still, it is useful to see how far things fell. We learned about that last week when the European Union (EU) released data on industrial production in April, which was the height of the crisis. For the EU, industrial production was down 27.2% in April versus a year earlier. This was the largest annual decline on record. Output of capital goods was down 40.8% and output of durable consumer goods fell 45.4%. In contrast, production of non-durable consumer goods was down only 12.5% and production of energy was down 12.4%.
By country, there were interesting variations. For example, the countries with the largest monthly declines in output in April were Hungary, Romania, and Slovakia, all of which experienced a relatively modest outbreak of the virus. Evidently, their industrial sectors were hurt by precautionary lockdowns as well as the spillover effect of weak demand in Western Europe. Of Europe’s big economies, the biggest decline took place in Italy (down 42.5%, not surprisingly) and the smallest was in Germany (down 30.2%). What happened in the Nordic region is also interesting, given Sweden’s decision to avoid a lockdown altogether. Swedish industrial production fell 14.2% from a year earlier. Yet output fell much more modestly in Sweden’s neighborhood, falling 5.5% in Norway, 9.6% in Denmark, and 3.1% in Finland.
Meanwhile, industrial production in the United Kingdom (which is no longer part of the EU) fell 24.4% in April versus a year earlier, the biggest decline ever recorded. The manufacturing component was down 28.5%. Also, the United Kingdom is one of the rare economies to report monthly GDP numbers. It reported that GDP in April was down 20.4% from the previous month.
There is concern in China that the United States intends to create trouble for China’s currency. The renminbi has fallen relatively sharply in recent weeks, likely because of weakening exports to the United States and Europe, as well as fears that the US-China disputes over trade and capital flows are likely to worsen. The decline in the renminbi is not a surprise, but it does provide ammunition for US officials who complain about China engaging in unfair competition. A lower-valued Chinese currency means greater competitiveness for Chinese exports and lower competitiveness for US exports to China. Yet, under the terms of the US-China trade agreement signed in January, China is obligated to significantly boost imports from the United States. A lower-valued renminbi works against this goal.
What happens next? There are several things the United States could do to punish China. Most likely would be a withdrawal from the January trade agreement, thereby setting the stage for the United States to boost tariffs on Chinese imports. Other options include once again labeling China a currency manipulator (which would allow new tariffs), and possibly defaulting on bonds held by China, although this option is not seen as realistic. The worst-case scenario from China’s perspective would be a US decision to impose sanctions on businesses that use US dollars to interact with Chinese businesses—similar to sanctions imposed on Iran. Such an action would likely hurt both sides and is considered highly unlikely but not completely implausible. It would likely compel China to take steps to internationalize the renminbi, thereby encouraging more global transactions in its own currency. This would actually go a long way toward undermining the dominant role of the US dollar in global commerce, something that would hurt US capital markets and possibly lead to higher US bond yields. Meanwhile, US Treasury Secretary Mnuchin said that the United States is considering restrictions on US capital flows to Hong Kong as retaliation for China’s imposition of a new national security law in the territory.
Things keep happening that surprise everyone. That was the case lately with respect to the employment numbers. Against almost everyone’s expectations, the government’s employment reports for May indicated a strong increase in employment and a drop in the unemployment rate. The number of people out of work remained historically high, but the reversal from the steep drop in employment in April led some analysts to believe that the economy has bottomed and that the recovery has begun. Global equity prices, oil prices, and bond yields surged on this news. Let’s look at the numbers. The government releases two reports: one based on a survey of establishments and the other based on a survey of households.
The establishment survey indicated that, after declining by 20.7 million in April, the number of people employed increased in May by 2.5 million. Incidentally, both numbers are records. About half of the increase took place in the leisure and hospitality sector. That would include restaurants, bars, hotels, and entertainment venues. Given the rapid reopening of businesses in many states in May, this increase is not entirely surprising. There were also sizable increases in retail, construction, manufacturing, and health care. These were partially offset by a very large decline in employment in government, mainly state and local governments dismissing workers due to a steep decline in government revenue as well as the shutdown of many services, such as schools and libraries. Interestingly, average hourly earnings fell sharply from April to May, largely because of the rehiring of low-wage workers. Average earnings remained much higher than a year earlier as employment among low-wage earners remained relatively low.
Why were so many workers rehired so quickly? There are several possible factors. First, businesses were permitted to reopen in many states. Indeed, when the government reported the loss of 20 million jobs in April, it also reported that about 18 million of those people were on temporary furlough. Thus, as businesses reopened, some of those people were quickly rehired. Second, the response rate to this month’s survey was unusually low, which could have distorted the results and certainly makes them less reliable. Third, it is possible that many small businesses chose to rehire after having received money from the Payroll Protection Program (PPP). This program involves low-interest loans to small businesses that can be forgiven if the money is spent on payroll. Thus, these businesses had a strong incentive to rehire, even if it meant that people were not necessarily working but simply on the payroll. Finally, a note about unemployment insurance. The program has been supplemented during this crisis with an extra US$600 per week going to the unemployed. For many people, this has meant more income than when they were working. Some critics complained that people would be reluctant to return to work as doing so would entail a cut in earnings. Today’s numbers suggest that this was not necessarily the case.
The separate household survey indicated that 1.7 million people returned to the labor force after 6.4 million departed in the previous month. The participation rate increased moderately, although remained well below previous levels. And the employment-population ratio bounced back from 51.3% in April to 52.8% in May—still way below the 60.6% clocked a year earlier. The result was that the unemployment rate fell from 14.7% in April to 13.3% in May. However, the government noted a technical glitch in which some people were misclassified. Specifically, it said that:
“If the workers who were recorded as employed but absent from work due to “other reasons” … had been classified as unemployed on temporary layoff, the overall unemployment rate would have been about 3 percentage points higher than reported (on a not seasonally adjusted basis). However, according to usual practice, the data from the household survey are accepted as recorded.”
This means that the unemployment rate ought to have been significantly higher. Still, the overall report should be seen as positive. The main reason is not simply the return of some service workers to reopened businesses. Rather, it is good that we have not yet seen a second round of job losses. In fact, we actually saw modest increases in professional services and financial services in May when we might have expected a sharp decline. Still, if consumers and businesses continue to save and hoard cash despite massive government cash injections, it remains possible that another round of job cuts could take place in the months ahead. Moreover, if a second wave of the virus wreaks havoc with the economy, the job market would likely be negatively affected. Thus, we can celebrate some good news with caution, knowing that we are not yet out of the woods.
During this pandemic, many large corporations in the United States have been borrowing heavily, largely through bond issuance, mainly in order to accumulate cash and be prepared for what might come. Meanwhile, small businesses have been able to borrow through the PPP, which provides that loans can be forgiven if the money is used for payroll and other specific purposes. That leaves many medium-sized businesses without adequate access to emergency credit. Consequently, the Federal Reserve has created the so-called Main Street Lending Program (MSLP), which is meant to provide credit to businesses with less than 15,000 employees and less than US$5 billion in revenue, but too large to qualify for the PPP. Borrowers will be able to obtain loans for up to US$200 million, far more than the US$10 million limit under the PPP. The program provides that commercial banks will lend the money and that the Fed will purchase part of the loans. Only companies that were in good shape prior to the crisis will qualify. However, the Fed says that banks will have to retain some part of each loan as an incentive to originate good quality loans. Yet this requirement might lead banks to only lend to high quality borrowers, those that likely can already obtain credit without difficulty. In fact, if such companies don’t participate in the MSLP, then only low-quality borrowers will seek loans through the program, and banks might recoil from lending to them on a large scale. Thus, some critics worry that the program, which began operating last week, might not generate the US$600 billion in lending that is intended. That said, with some areas of the economy starting to recover slowly, it is not clear whether this new program will truly be needed. Certainly, if there is a second wave of the virus outbreak later this year, which would have negative economic ramifications, the program will likely be badly needed.
Another program set up by the Fed is starting to be used. It is the Municipal Liquidity Facility (MLF) whereby US$500 billion is available for direct loans to state and local governments facing a cash shortfall during this crisis. The program is meant, in part, to prevent a seizing up of the large market for municipal bonds. The first state to receive a loan under the MLF will be Illinois. The loans under the MLF are only meant to be a temporary backstop and must be repaid. Given the massive decline in revenue that many states are now facing, there is currently debate in Congress about providing more direct aid to states in order to prevent a catastrophic reduction in essential government services.
As expected, the European Central Bank (ECB) has expanded its program of asset purchases (quantitative easing) by an additional EUR600 billion. This will be on top of the original plan to purchase EUR750 billion in government bonds, bringing the total to EUR1.35 trillion. The purchasing program, known as the Pandemic Emergency Purchasing Program (PEPP), is being expanded because the ECB is concerned about the depth of the downturn and the risk of a weak recovery. ECB President Christine Lagarde said that a high degree of uncertainty has taken a toll on consumer and business spending. Consequently, she predicts that Eurozone real GDP will decline 8.7% in 2020 versus the previous year. That is roughly in line with the forecast of Deloitte’s European economists. Lagarde also predicted almost no inflation for the year. Indeed, producer prices fell in April at the fastest pace since 2009. She said that, so far, the recovery has been “tepid.” While the PEPP is not a stimulus plan, it is meant to boost inflation and unclog financial markets, thereby allowing credit to flow to those that need it. In response to the latest announcement, the yield on Italian government bonds fell to a two-month low as did the spread between Italian and German bond yields. The recent rise in Italian yields was the result of investor concerns that Italy and Greece might have difficulty in raising funds and in servicing debts. That concern, left unaddressed, could have led to a seizing up of credit conditions for the private sector. Thus, the ECB action was likely helpful. The question now is whether it will be sufficient. The scale of the PEPP remains well below that of the US Federal Reserve’s purchasing program. Still, some analysts expect that the ECB will expand the program yet again before the end of the year. Meanwhile, Lagarde said that she was not concerned about the recent ruling of a German court that raised questions about the program. She noted that the European Court of Justice (ECJ) had approved ECB bond purchases in 2018 and that the ECB is accountable to the ECJ, not a German court.
Meanwhile, Germany is moving in the direction of more fiscal stimulus. It has long been a bastion of fiscal orthodoxy and conservatism, and Chancellor Merkel has been a strong proponent of such orthodoxy. Before this crisis, she resisted ECB and IMF entreaties to boost spending to stimulate the Eurozone economy. Yet during this crisis, orthodoxy has been thrown out of the window. Already, German has significantly boosted spending and credit availability. Last week, the government announced that it will increase spending and reduce the value-added tax (VAT) by 3 percentage points, measures that will cost about EUR130 billion. This is a sea change for Germany and is being undertaken because of concern about a potentially weak recovery after the worst downturn in post-war history. Peter Altmaier, Germany’s economy minister, called this the “biggest stimulus program of all time.” He added, “We want to trigger a recovery that makes our country better, more sustainable, more climate-friendly and more humane.” Germany is in a good position to do this—the debt-to-GDP ratio has declined sharply in recent years and bond yields remain negative. Thus, the government can borrow essentially for free. Within German politics, there has been broad support for doing this, but there has been debate about how the money ought to be spent.
Recently, when the European Union (EU) Commission President Ursula von der Leyen revealed plans for a EUR750 billion jointly funded stimulus, there was considerable excitement, especially on the part of long-standing supporters of more fiscal integration in the EU. However, some critics have begun to question whether the plan will be impactful and whether it truly represents a move toward “Hamiltonian” integration. Moreover, implementation of the plan is hardly assured as it requires unanimous agreement of the 27 members of the EU. While something is likely to happen, obtaining unanimity will likely require that the size of the plan be reduced.
In any event, there are several issues that critics have pointed out. First, the EUR750 billion will only involve EUR500 billion of direct grants to member states, with the remaining EUR250 billion offered as loans. Thus, the size of the direct stimulus would be quite modest compared to the massive size of the EU economy. Second, the funds will be raised through bond issuance. Yet the issuance will not come with the usual “joint and several” guarantee. Consequently, it would not be a “true mutualization” of member state debt. Instead, each state would be responsible for a share of the increased debt. This hardly represents fiscal integration. Third, a German court has already raised questions about the ability of the ECB to purchase member state bonds indiscriminately. Surely there is a risk that the German court will question whether the EU can impose a liability on member states where the money is transferred to other member states. Keep in mind that the plan is meant to be a transfer to those countries most ravaged by the crisis, such as Spain and Italy. Finally, von der Leyen suggested that the bond issuance could be funded by an EU tax on large businesses. Yet it is not clear whether such a proposal could generate significant support, especially at a time when businesses are stressed by the virus outbreak. Without any agreement on taxes, how the stimulus might be funded is not clear. Still, the fact that the EU is even discussing such a proposal does represent a sea change from the recent past. If the plan on offer does happen, it could spur further moves down the road. Or, if it is rejected, then the likelihood of disintegration of the EU probably increases.
When governments the world over implemented lockdowns meant to keep people apart, a disproportionate share of the damage to the economy accrued to the services sector rather than manufacturing. That is because many services businesses were forced to shut down. Moreover, for those that remained open, consumers were wary of interacting for fear of the virus. Thus, people were reluctant to get on airplanes, trains, or in taxis. They were often unable to visit stores, restaurants, or movie theaters. The end result was that activity in the broad services sector dropped sharply around the world. However, by May, many governments had either ended lockdowns or started the process of easing such restrictions. How did the services industry fare under these circumstances? The answer is that, in most countries, services activity continued to contract, but at a slower pace than in the previous month. The one major exception was China, where services activity actually increased in May for the first time in four months. We know this from examining the Purchasing Managers’ Indices (PMIs) for services in multiple countries, published by IHS Markit. The final PMIs for May were released last week. Each PMI is a forward-looking indicator meant to signal the direction of activity in the services sector. A reading below 50 indicates declining activity; the lower the number, the faster the decline. A reading above 50 indicates growing activity. Services encompasses finance, professional services, telecoms, transportation, distribution, retailing, wholesaling, entertainment, tourism, education, and health care.
The global services PMI increased from a record low of 23.7 in April to 35.2 in May. This is a number indicating a very sharp decline in activity, but it is still better than in the previous month. IHS Markit commented that the steepest drop in activity took place in consumer-facing services while the smallest decline was in financial services.
The services PMI for the United States increased from 26.7 in April to 37.5 in May. This remained the second-fastest decline on record. While Markit noted that many businesses believe that the worst behind them, “a substantial part of the service sector nevertheless continued to be devastated by social distancing measures and looks set to remain so for some months to come, limiting scope for a v-shaped recovery.” It appears that the sector is being hurt by limited supply as well as weakened demand. This could remain a problem as long as the virus is not seen being suppressed.
In Europe, the PMI for UK services increased from 13.4 in April to 29.0 in May. In the Eurozone, the services PMI increased from 12.0 in April to 30.5 in May. The PMIs for the major European economies were each close to this level. Markit commented, “Consumer-facing services are likely to continue to take the hardest hit from those COVID-19 containment measures that may need to stay in place the longest, acting as a particular drag on the overall recovery.” Thus, it appears that Europe’s economy faces the same obstacles to recovery as that of the United States. Meanwhile, the EU reports that the unemployment rate remains muted, helped by the policies of multiple governments to provide subsidies to companies that retain workers on their payrolls. As in the United States, European consumers have boosted their saving, thereby diminishing spending.
The Indian services sector nearly shut down in April, with a PMI of 5.4, a number I’ve never seen before. However, the PMI increased to 12.6 in May—still a remarkably low number—indicating a continued massive contraction in activity. Markit said that the extended shutdown of business hurt output as well as demand. Also, Markit reported that “new business from overseas collapsed,” with 95% of businesses reporting a decline in orders. Air transportation and tourist revenue collapsed.
In contrast, the services PMI for China rebounded considerably, rising from 44.4 in April to 55.0 in May, a number indicating the strongest increase in activity since 2010. This was also the first time in four months that activity increased. Markit commented that both supply and demand recovered strongly as the virus was brought under control. However, export orders were weak and employment in the sector continued to decline. Despite the good news on the PMI, overall activity remained well below pre-crisis levels and it will take some time to return to normalcy.
Finally, Japan’s services PMI improved, but remained low. It increased from 21.5 in April to 26.5 in May, indicating that activity in the industry continued to decline sharply. In May, the government extended the state of emergency, so it is not surprising that the PMI was low. Markit commented, “Services activity fell to a broadly similar extent to that seen in April as store closures continued and events were cancelled. Social distancing and reduced tourism are clearly having a severely negative impact on the service sector, and these factors are likely going to limit the speed and strength of any recovery.”
In its latest Financial Stability Review, the European Central Bank (ECB) expressed concern about the state of member-country finances. It noted that, in aggregate, the member countries of the Eurozone will see sovereign debt rise from 86% of GDP in 2019 to over 100% in 2020, with debt reaching especially high levels in Italy and Greece. This stems from running very large budget deficits this year, mostly in the range of 6–8% of GDP. It also stems from a very sharp decline in real GDP as economies struggle in response to lockdowns. Moreover, the ECB noted that several member states face large debt refinancing requirements in the coming year. Naturally, the debt-to-GDP ratio will decline once economies start to grow. Still, early indications suggest a slow return to normal. This comes, in part, from the propensity of European consumers to save an unusually large share of their income. In fact, the European Commission estimates that the household savings rate will rise from 12.8% in 2019 to 19% this year. That, in turn, reduces the scope for consumer spending growth even as governments ease restrictions on consumer-facing businesses. Saving has risen due to reduced opportunities to spend, declining asset values, fear about social interaction, and fear about the future. Something similar has happened in the United States as well (more on this in the next story), limiting the scope for recovery.
Meanwhile, the ECB worries that the sharp rise in sovereign debt might be unsustainable. It said that the “increase in public debt levels could also trigger a reassessment of sovereign risk by market participants and reignite pressures on more vulnerable sovereigns.” It acknowledged that the fiscal impulses under way will be helpful in mitigating the negative consequences of lockdowns. Yet it warned that “a more prolonged and severe economic downturn could give rise to debt sustainability risks in the medium term.” It said that “such a development could reactivate the negative feedback loops of the sovereign-bank nexus, especially for Italy and Portugal, as well as for Spain, where bank ratings are closest to non-investment grade.” The ECB warning comes even though the bank itself is engaged in massive purchases of memberstate sovereign debt. It also comes despite the possibility that the EU will soon borrow money to provide grants to member states. Evidently, the ECB worries that, even with large central bank purchases of debt, governments will struggle to service these debts, possibly leading to a seizing up of financial markets. One could say that this argues for greater financial and fiscal integration of the Eurozone. Conversely, one could say that this argues for member states to gain control of their own currencies, thereby enabling them to inflate their way out of a debt problem. In any event, it suggests that the Eurozone is balancing on a knife’s edge in which it must move in one direction or the other, but not retain the status quo.
Meanwhile, amidst concern about the sovereign debt of European Union (EU) members, the EU itself is moving toward fiscal integration. Two weeks ago, Germany and France agreed on a plan for the EU to borrow EUR500 billion in capital markets and distribute the money as grants to member countries. The aim was to support troubled countries in their fight against COVID-19, by servicing the incremental debt through the membership fees paid by member countries. The plan was welcomed by southern European countries, but was viewed with suspicion by countries in the north that preferred to distribute the money as loans.
Then last week, European Commission President Ursula von der Leyen proposed to go even further than the Franco-German plan. She wants the EU to borrow EUR750 billion to assist member countries in dealing with the crisis. In addition, she vetted the idea of having the EU impose its own taxes in order to service the debts. Specifically, the EU anticipates generating funds from tapping into the carbon trading system and possibly taxing other areas of environmental degradation. In addition, there is talk about taxing large companies and tech companies. Either way, the good news is that the EU will likely be able to borrow at negative interest rates, thus assuring that it will pay back less than it receives. While the ultimate impact of this extra expenditure is difficult to measure, it is clear that if it goes forward—although that remains uncertain—this scheme will represent a significant shift in the architecture of the EU. It will be a kind of fiscal integration, making the EU more like a United States of Europe. It will surely be a source of controversy. Europhile voters will likely be pleased to see this happen, but there could be a populist backlash, especially if voters feel that they are being taxed without adequate democratic processes. Moreover, northern European voters might be averse to transferring fiscal resources to the south. The sense of nationhood that allows this to happen in the United States on a large scale will not necessarily be present in Europe.
Something very unusual and interesting happened in April in the United States. Personal income grew at the fastest pace on record, while consumer spending fell at the fastest pace on record. Evidently, the massive outlays by the Federal government led to a surge in personal income, but that money was mostly saved rather than spent. Thus, government borrowing was used to fund an increase in consumer wealth. As such, the government programs did not stimulate economic activity. Rather, they provided households with a financial cushion—which was precisely what was meant to happen. Here are some details.
Although wage income fell 8.0% from March to April, total personal income increased 10.5%. The difference was due to a massive transfer of funds from the government to households in the form of one-off transfers as well as enhanced unemployment insurance. Specifically, while wages fell at an annual rate of US$740 billion, government assistance to households increased at an annual rate of US$3 trillion. After taking account of declining tax revenue, disposable personal income was up at a rate of roughly US$2 trillion. However, consumer spending fell 13.6% from March to April, or at an annual rate of about US$2 trillion. Thus, personal savings increased at a rate of about US$4 trillion. In fact, the personal savings rate (the share of disposable income not spent) rose from 8.2% in February, to 13.7% in March, to 33.0% in April. Americans saved a third of their income in April.
Why did people save so much? There are several explanations. First, with much of the economy in lockdown, there were few spending opportunities. Second, people were averse to engaging in activities that required interaction with other people, such as visiting restaurants or flying on airplanes. Third, many people lost jobs and were uncertain as to when jobs would return. Hence, they hoarded cash. Finally, even people with jobs likely reduced spending in anticipation of possible trouble. While the decision to save was sensible for each household, the net effect was to severely dampen economic activity. Consumer spending is, by far, the largest component of GDP, and a dramatic weakening of spending augurs for a sharp drop in GDP. Indeed, our own Deloitte forecast is for a substantial decline in GDP in the second quarter. The latest report on consumer spending confirms that view.
How did people spend their money? The data shows that, after adjusting for inflation, real consumer spending fell 13.2% despite a 13.4% increase in real disposable income. The decline in spending included a 16.7% drop in durable goods, a 15.5% drop in non-durable goods, and a 12.0% drop in services. Thus, spending declined across the board. Early high-frequency data suggests that spending began to recover in May, albeit modestly. However, there are reports that spending on automobiles increased substantially in May. Still, such spending remained 25% below the pre-crisis level.
Michael Wolf, global economist at Deloitte, provides an update on Japan’s economy.
Japan’s recession may be deeper than analysts had anticipated. Both retail sales and industrial production fell more than expected in April. Industrial production dropped 9.1%, with some of the largest losses in autos and steel. Meanwhile, retail sales were down 9.6% over the month as consumers held back spending on general merchandise, apparel, and motor vehicles. Weakness likely persisted in May as well. The government placed the country in a state of emergency and the last of the prefectures, which includes Tokyo, were only given the green light to reopen on May 25. Manufacturers expect their output to fall another 4.1% in May. In addition, weekly retail sales data show that spending on discretionary items remained weak during the first three weeks of May. Economic contraction during a state of emergency was to be expected, even if the losses are a bit larger than previously expected.
Given the unprecedented amount of fiscal stimulus and the 2.6% unemployment rate in April, it is tempting to assume the economy will bounce back quickly this summer. Unfortunately, that is unlikely to be the case. The relatively low unemployment rate does not include the 4.2 million people on furlough. If all those workers were counted as unemployed instead, the unemployment rate would easily jump into double digits, which better highlights the extent of the pain workers are experiencing. In addition, the new stimulus package, which amounts to US$1.1 trillion, comes mostly in the form of loans that are meant as a lifeline to prevent bankruptcies from surging while the virus continues to limit economic output from reaching its potential. Those loans are necessary to prevent more economic damage, but they will do little to bolster demand. Plus, mobility data suggest Japan’s consumers are still cautious despite the easing of lockdown restrictions and very low rates of COVID-19 infection. We still expect Japan’s economy to begin recovering this summer, but the pace of recovery will likely be modest.
Craig Alexander, Chief Economist of Deloitte Canada, offers some thoughts on what the COVID-19 crisis could mean for productivity trends.
One of my key concerns about the post-lockdown economic recovery is the potential slowdown (or outright decline) in labor productivity. There is some evidence that, on average, workers tend to be less productive when working remotely than when physically in the office. And, since remote work is likely to remain a significant part of doing business until a vaccine is fully deployed, aggregate productivity is likely to suffer. This could be further exacerbated by physical distancing rules in retail, finance, transport, and other service-producing sectors. The new restrictions will likely increase costs and require investment in potentially non-productive capital (barriers, scanners, etc.) when maintaining an office, operating a store, or producing in a factory. In the absence of productivity gains, the rising operating cost are expected to put downward pressure on wages or upward pressure on prices and make a slow recovery scenario much more likely.
However, this somber short-to-medium term view masks the possibility of some very large long-term productivity gains, if the opportunities are realized. To illustrate this, let us consider the main macroeconomic and geopolitical trends from three distinct perspectives.
First, the global economy prior to COVID-19 was undergoing structural changes that are still affecting businesses. This includes issues such as the aging of the labor force, the rising importance of immigration to economic growth, and policies aimed at addressing climate change.
Second, some of the existing trends have been accelerated by COVID-19. The pandemic has greatly accelerated the shift toward digital adoption and consumption, and is likely to rapidly speed up the deployment of artificial intelligence (AI) and use of Big Data. The future of work is also being transformed by accelerated automation and the shift to remote work, which is likely to linger even after the economy is reopened.
Third, the pandemic has also created new trends that did not exist before, including changes in consumer behavior around health and trust.
These transformative forces are likely to lead to many business failures during the current recession and its aftermath. Closures related solely to the new disruption from the pandemic are a particular economic loss. However, many firms that fail will be those that were already being disrupted by the first two factors. For example, we are seeing firms that invested in digital prior to COVID-19 thriving, and businesses that underinvested in the shift to digital falter. With this perspective, one could argue that the process we are seeing is an acceleration of the creative destruction that is an inherent part of economic evolution—a cornerstone of economic theory since the 1950s.
We can lament the loss of businesses, but we should also be mindful that the closures will enable the opportunity to create new firms during the recovery and subsequent expansion. Indeed, I believe policymakers should establish incentives and create an environment to encourage startups, something that would greatly help the job recovery. And these new firms will be positioned to thrive in the new post-COVID environment that will be more digital, more automated, more informed by AI, and employ more flexible workers. This would make the economy more flexible, productive, and competitive.
There is also the possibility that many of the small businesses that are lost are lifestyle businesses. These are businesses where the owner’s ambition is to provide a good quality of life for their family instead of looking to grow and scale significantly. In the post-COVID world, we could have stronger, more competitive businesses if new startups are more oriented to growth and scaling.