What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
One could take the perspective that the decline in economic activity in recent months was principally the result of government-imposed lockdowns. The view is that once businesses reopen, consumers will quickly return to stores, restaurants, bars, movie theatres, bowling alleys, and airplanes. But the data suggests otherwise. A new study by economists at the University of Chicago found that only 7% of the change in consumer mobility in the United States in recent months can be explained by lockdowns. The rest is due to consumer aversion to social interaction because of the virus. In other words, most people would avoid restaurants and theatres even if they were open. Using high-frequency mobility data, the researchers compared the experiences of consumers in locations with severe lockdowns to those in locations with no or limited lockdowns. They found there wasn’t a big difference between the two.
Learn how to combat COVID-19 with resilience
Listen to the 2020 economic outlook podcast
Go straight to smart. Get the Deloitte Insights app
View previous weekly updates
Visit the Deloitte Insights economics collection
Indeed, one can examine the recent history of consumer spending by state at www.tracktherecovery.org and note how similar the trend is among states that have followed very different policies. This suggests two things: first, the lockdowns alone are not the primary reason for the sharp decline in economic activity in April and May. Second, easing economic restrictions alone will not be enough to significantly boost economic activity. In fact, the only way to bring activity back to pre-crisis levels is to convince consumers that the virus is no longer a risk. This, in turn, will require a vaccine or a treatment.
For some time now, Deloitte’s baseline forecast has been that there will be moderate positive growth of the US economy in the third quarter, largely due to the reopening of economic activity that took place in May and June. We did see a moderate but significant rise in consumer spending and mobility since the economy bottomed in March, although growth appeared to subside by late May. Last week marked the first day of the third quarter and there are already indications that in some sectors of the economy, activity is starting to decline. This is likely because there has been a severe outbreak of the virus in about half of the US states. The number of new cases is increasing rapidly. In many major cities, hospitals are becoming overloaded. Dr. Anthony Fauci, the lead infectious disease specialist of the US government, said, “I am very concerned because it could get very bad.” He noted, “What has happened, I guess understandably, but nonetheless regrettably, is that people took the attitude in some places of either all or none. Either you’re locked down, or you just let it fly and you just ignore many of the guidelines.” And US Health Secretary Alex Azar said, “The window is closing, we have to act, and people as individuals have to act responsibly. We need to social distance. We need to wear our face coverings if we’re in settings where we can’t social distance, particularly in these hot zones.”
In some US states, reopening orders are being reversed. In others, the process of reopening is being halted. In Florida, the Mayor of Miami-Dade County said that Miami’s beaches would be closed for the July 4 holiday weekend. In Texas and Florida, access to bars is being restricted. In California, indoor restaurant dining is being restricted. In fact, the states that are renewing restrictions account for about 40 percent of the US population. Even in New York, where the virus was brought under control as early as May, the state is postponing the easing of restrictions on indoor dining. It will also restrict visits from 14 US states where the outbreak is worsening. On the Memorial Day weekend in late May, large numbers of people visited beaches, bars, and parties without masks and social distancing.
Some authorities believe that the current wave is, in part, related to these events. Consequently, the goal of policy now is to avoid a repetition of the outbreak. The latest actions by state governments, meant to contain the spread of the virus, are likely to curtail economic activities that involve human-to-human contact. Moreover, there is evidence that people are choosing to engage in social distancing even in the absence of government orders. High-frequency data on restaurant visits indicate that in states currently experiencing severe outbreaks, the number of visits has declined in the last two weeks after having increased substantially in previous weeks. Mobility data that tracks the amount of time spent at retail and recreation venues indicate there has been a decline lately in Florida and Texas.
If, in the coming weeks, the outbreak worsens further (as expected by public health officials), lockdowns are renewed, and more people choose to stay home, then it’s possible that economic activity in the third quarter will either grow more slowly than we expected or not grow at all. One unknown factor is whether the Congress will extend the enhanced unemployment insurance payments that are set to expire at the end of this month. If this program is not sustained beyond July, there will be a sharp decline in consumer income in August, which will likely have a negative impact on consumer spending. It could also lead to an increase in consumer defaults and bankruptcies, thereby potentially creating financial market stress.
During the crisis, things have changed so quickly that economic data published by governments is often a mere snapshot of recent history rather than an indicator of where we are or where we are headed. That is certainly the case with the jobs report published last week by the US government. It shows in June, there was strong job growth and a decline in the unemployment rate. But the survey on which this data is based was completed in the first half of June. Meanwhile, events changed quickly in the second half of June—the viral outbreak worsened significantly, leading state governments to reverse the easing of economic restrictions and consumers to become more cautious about social interaction. Notably, a significantly large share of the jobs gained in June were in leisure and hospitality apart from retailing. These are the kinds of jobs that are likely to be negatively affected by recent decisions taken by state governments. As such, the latest jobs report must be taken with a grain of salt.
The US government publishes two reports: one based on a survey of establishments and the other based on a survey of households. Let’s consider both.
The establishment survey found that 4.8 million jobs were added in June. This follows an increase of 2.7 million jobs in May and a decrease of 20.8 million in April. Meanwhile, employment remains nearly 13 million jobs lower than a year earlier. Much of the June increase in employment was related to industries that reopened as state governments attempted to revive economic activity. Employment increased by 2.1 million in the leisure and hospitality sector and 740,000 in retailing. In addition, manufacturing jobs increased by 356,000 and health care jobs increased by 475,000. The manufacturing gain was largely due to a 196,000 increase in automotive employment, driven by pent-up demand for cars. The health care gain was driven by reopening of offices belonging to doctors and dentists. Average hourly earnings were up 5% from a year earlier. This was a smaller gain than in May, reflective of the fact that many low-wage earners returned to work in June.
The survey of households found that 1.7 million people re-entered the labor force, either by working or by seeking work. The participation rate increased by 0.7 percentage points—a very big rise. Moreover, because employment increased so much more than the growth of the labor force, the unemployment rate fell sharply—from 13.3% in May to 11.1% in June; keep in mind, however, that the figure was 3.7% a year ago. Also, because so many of the jobs created were in restaurants or retail stores, it is not surprising that the unemployment rate among teenagers (16 to 19 years old) fell from 29.9 percent in May to 23.2 percent in June—a decline of 6.7 percentage points.
The problem with drawing conclusions from this report is that the circumstances changed quickly after the survey was conducted. The viral outbreak worsened considerably in the last half of June and early July and many state governments have recently taken steps to reimpose restrictions on economic activity—especially by placing limits on restaurants and bars. In addition, high-frequency mobility data indicates that consumers are already spending less time at stores and restaurants. Assuming that the locking down of the economy continues for the next few weeks and that consumers further avoid locations that involve social interaction, it seems likely that many of the jobs gained in June will be lost in July.
One way to judge the recent situation is to examine weekly initial claims for unemployment insurance. In the most recent week, there were 1.427 million initial claims for unemployment insurance, a small decline from the previous week’s 1.482 million. Since March 21, 48.7 million people have filed claims for unemployment insurance. In addition, the number of people continuing to collect unemployment insurance increased slightly from the previous week. This suggests the jobs market started to face headwinds as the end of June neared. Financial markets were pleased that job growth in June exceeded market expectations. However, many investors are likely wary of another revival of the outbreak. As such, equity prices rose only modestly on news of the jobs report. Going forward, if enhanced unemployment insurance payments—which are set to expire at the end of this month—are not extended, there could be a sharp drop in personal income in August. This could have negative effects on consumer spending and, consequently, on employment.
The Federal Reserve has taken extraordinary measures meant to assure that credit markets stay open and available amid the viral outbreak. At the beginning of the crisis, indicators of financial stress started to rise, leading the Fed to act quickly. It cut interest rates, bought assets on a massive scale, and loaned money to inject liquidity into the economy. These actions were successful in that measures of financial market stress quickly improved. A potential seizing up of credit markets was averted.
However, one Fed leader is worried that the financial system is not yet out of the woods. James Bullard, the president of the Federal Reserve Bank of St. Louis, said, “Even though we got past the initial wave of the March-April timeframe, the disease is still quite capable of surprising us. Without more granular risk management on the part of the health policy, we could get a wave of substantial bankruptcies and that could feed into a financial crisis.” He added, “I think it’s probably prudent to keep our lending facilities in place for now even though it’s true that liquidity has improved dramatically in financial markets.” Some critics have complained that the Fed has gone too far and that by intervening in so many asset markets, it is removing price discovery from markets, potentially leading to misallocation of assets. But Bullard defended the Fed, saying, “With all these programs, the idea is to make sure the markets don’t freeze up entirely, because that’s what gets you into a financial crisis, when traders won’t trade the asset at any price. It’s not my base case but it’s possible we could take a turn for the worse at some point in the future.”
In Europe, the unemployment rate has remained quite low compared to that of the United States, even amid a historic decline in economic activity. This is because many European governments have implemented employment protection programs, which offer subsidies to employers for keeping workers on the payroll even when businesses are closed. In the five largest economies in Europe—Germany, France, the United Kingdom, Italy, Spain—these programs have helped 45 million workers, or about one third of the labor force. The result is that in May, the unemployment rate in eurozone was only 7.4%, up one percentage point since April, but lower than the 7.6% reported in May 2019.
The subsidies were only meant to be temporary, although many governments have extended the programs by a few more months. However, the cost is enormous and most governments expect to ultimately end these programs, with the hope that employment will quickly rise as economies recover. It is likely that there will be a spike in unemployment as these programs end later this year. Moreover, so long as the virus remains a threat, it is likely that industries in which human interaction is high won’t return to normal levels of activity. This could mean the permanent loss of many jobs. In fact, a study by insurer Allianz estimated that nine million jobs in Europe could be permanently lost due to decrease in the size of industries such as restaurants, hotels, airlines, and retail stores.
When the Trump administration came into office in 2017, it chose to renegotiate the North American Free Trade Agreement (NAFTA), claiming that the 1990s-era agreement was responsible for significant job losses in the United States. The replacement deal is the United States Mexico Canada Agreement (USMCA). In many respects, this agreement is very similar to NAFTA. However, the most important difference concerns automotive trade. The USMCA mandates that in order to be eligible for tariff-free trade within North America, at least 40% of the value of an automobile must be produced by workers earning more than US$16 per hour. When the deal was signed, only 13.5% of the value of automobiles exported from Mexico to the United States met this requirement, mainly because of components being imported from the United States and Canada. The US administration expected that the 40% provision would lead auto companies to shift final assembly to the United States, thus boosting automotive employment in key Midwestern states. The provision says that if companies fail to meet the 40% requirement, their vehicles will be subject to a 2.5% tariff when crossing the border from Mexico to the United States.
However, it has been reported that major Japanese carmakers that have invested heavily in Mexico-based supply chains have no intention of shifting production to the United States. Rather, they will either triple wages in Mexico and/or will accept tariffs. Their calculation is that this will still be cheaper than investing in a massive transfer of capacity across the border. In any event, the cost of production will go up and the carmakers expect to pass on the increased cost to US consumers in the form of higher prices.
The Center for Automotive Research estimates that because of increased tariffs, the average price of cars sold in the United States will rise between US$470 and US$2,200 per vehicle. They said the provisions of the USMCA, along with trade tensions with China, will lead to a decline in the number of units sold and a decline in US automotive employment. Meanwhile, the USMCA came into effect last week. The timing of the implementation couldn’t have been worse, given the massive disruption caused by the viral outbreak in the past few months. Automotive production and sales fell sharply since the crisis began and are only now starting to recover.