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The Longer-Term Implications of COVID-19

April 28, 2020
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The economic impact of COVID-19 becomes increasingly significant as the lockdown extends. In the past five weeks, 26.5 million people filed initial claims for unemployment. To put this into perspective, that is almost as many people as those filing for unemployment in all of 2018, 2019 and the first 11 weeks of 2020 combined – a total of 115 weeks.

The unemployment claims come from a wide variety of industries, but the category of leisure and hospitality workers are most severely impacted – those who work in restaurants, hotels and hospitality. However, the economic crisis is spreading to other sectors of the workforce. Based on the number of jobless claims, unemployment may be as high as 13 to 14 percent today; the rate depends on how many people who lost their jobs found part-time employment and how many left the labor force entirely.

The impact of COVID-19 has also impacted small businesses, which typically do not have the level of reserves or access to credit that larger businesses typically have. The Payroll Protection Plan (PPP) loan program, which was created as a part of the Coronavirus Aid, Relief and Economic Security (CARES) Act, went through its $349 billion allotment quickly. About 5,000 financial institutions participated in the initial offering, issuing 1.6 million loans at an average loan amount of $216,000. Congress recently approved an additional $310 billion for the program.

We have seen other signs of economic turmoil at an unprecedented pace. New car sales fell to 11.7 million units in March from 17.2 million units in February. Expect new vehicle sales in April to likely fall below the lowest levels previously recorded in December 1981 – 9.1 million units – but May data may improve due to some loosening of restrictions coupled with very enticing offers from vehicle manufacturers.

The housing industry is also taking a hit. As shown in the chart below, the immediate impact on home sales was not as severe as for vehicle sales. However, anticipate significant slowdowns over the coming months, as home buying is a much lengthier process than vehicle purchasing. The inability to show homes today, coupled with job losses, will likely be felt in the housing market in the summer months.

The Path of Recovery

It is unknown how quickly our economy will recover when COVID-19 finally abates. Economists and pundits have a wide variety of views on the likely trajectory economic recovery will take.

A few economists feel this will be a lengthy recession or even depression, as depicted in the chart below, which shows gross domestic product (GDP) dropping very rapidly followed by flat or slightly negative growth.

In this view, COVID-19 is likely to persist for an extended period as we work our way toward herd immunity. A vaccine will take at least 18 months to develop; until that point, the economy will be closed to all but essential businesses.

Additionally, in this scenario small businesses will likely fail despite efforts by the government such as the PPP program. Small businesses are the engine of our economy and are responsible for a large percentage of our jobs, so joblessness will climb to extremely high levels and stay there until we finally have herd immunity and/or an effective vaccine.

Finally, recovery will be difficult, as well; massive compression in the financial services space would likely result, and access to capital could become a significantly more severe issue.

Other economists feel that the more likely economic result of the abatement of COVID-19 would be an L-shaped recovery, as depicted in this chart, which shows a sharp drop in GDP followed by modest growth.

In this scenario, recovery begins when COVID-19 measures end, but the recovery is slow and takes several years to get back to where we were economically at the end of 2019.

The recovery is slow in this scenario because of the damage that has been inflicted on the economic infrastructure. Small business failures and related layoffs result in lower consumer spending, which then has a further debilitating impact on economic production. This downward spiral continues for a period of time before finally recovering.

This pattern is similar to what followed the financial crisis of 2008-2009. However, there are fundamental differences between 2008-2009 and this economy prior to the onset of COVID-19. Prior to COVID-19, we were fundamentally more economically healthy, with lower levels of debt relative to income levels, and a housing market that was not in a bubble. Because underlying economic fundamentals are stronger, this recovery could be quicker.

The third shape the recovery could take is a V, as depicted in this chart, which illustrates a sharp decline in GDP followed by rapid growth.

In this scenario, the economy recovers quickly once COVID-19 abates. Production ramps up again, and consumer confidence returns, which then restarts consumer spending. Economic growth returns rapidly, and we soon see a return to levels of economic output like before COVID-19.

How likely is this outcome? The longer we remain economically shut down, the less likely this recovery scenario is to happen. The longer we remain closed, the greater the number of small businesses that likely fail, and employment suffers accordingly.

However, there are factors which favor this type of recovery. First, we were much more economically healthy going into this event than prior to other recessions. Second, small business owners tend to be serial entrepreneurs. In Raddon small business research, we consistently find that even with the hard work and long hours that most small business owners put in, they would not do it any differently. Even those small business owners who lose their business because of COVID-19 are likely to start again.

How likely is each scenario? In our view, the least likely is a prolonged recession or depression. Whether the recovery is L-shaped or V-shaped depends on the length of the lockdown and the continuing government response. At this point, it may be a toss-up between L and V, and a lot will depend on the state of the consumer.