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Friday, March 27, 2020

A Recovery With Crippled Small Businesses Looks Awkward

We have just seen the beginning of post-COVID economic data, and the numbers are literally off the charts. My feeling is that aggregate numbers will be meaningless, and we will need to look at industry-level data. I just wanted to look a bit ahead, to the post-lockdown future. My main concerns revolve around the small business sector, which I fear will be taking a bigger hit than larger businesses. The issue is that small businesses are a major driver of employment -- and we are likely to start with elevated unemployment levels, even after the "re-start" phase hits.

Current Economic Situation

The medical news is obviously the most important right now. Will lockdowns help reduce the pace of infection? Unfortunately, the outlook for the virus has been split on a partisan basis. This is obviously not helpful, and I do not want to add to any misinformation floating around by giving my takes.

Economically, I think aggregate production data is not particularly meaningful. What I think matters are some key industries, as well as bankruptcy and employment data.

In the coming weeks, the biggest non-health concern will be the food supply. Luckily for Canada, the agricultural industry is wintering when the lockdowns hit. However, the time to seed fields is coming, and that means that the supply chains have start moving. Although I think ending lockdowns because of "the economy" is ridiculous, some industries will need to power up.

My concern for the long-term is the status of small and medium businesses (which I return to later). Failures of larger firms are bad for financial markets, but putting a company into a debt workout is not particularly a problem when activity is supposed to be frozen anyway. In any event, big firms are generally well-connected enough to get their snouts into the bailout trough. (Certain unpopular firms -- e.g., foreign-domiciled cruise lines -- might be thrown under the bus as a sop to populist pressure.)

Longer Term?

There should be decent-looking growth rates when industries are taken out of mothballs. It seems very likely that some will remain shuttered for a long time; possibly until a vaccine is ready. However, the recovery will be partial. Barring a miracle cure (the existence of which has also turned into a partisan divide), there will no return to pre-virus "normal." This means that the "rubber band" theory of recessions will fail -- we will not snap back to pre-recession levels; we will snap back to some midway point.

The issue is what happens after that reaching midway point. The three post-1991 recession recoveries in the United States had a lot in common: they lasted a long time, inflation was stable, but job growth was generally muted. (The closest the job market got to "hot" was at the tail end of the tech boom in the 1990s.) This reflected the policy settings put in place since the early 1990s, best summarised as "neoliberalism."

Will neoliberalism fade away? I certainly would like to see some changes made, but I have deep concerns about the inflexibility of modern societies. Current institutions are very beneficial to the personal situation of the governing elites, and they will be extremely reluctant to make anything other than emergency accommodations to the crisis that we are engulfed in.

The problem is that it will be very easy for small and medium businesses to be swept away in the coming months. Other than imposing top-down freezes on rent and debt payments, the administrative capacity to run a bailout of small businesses does not really exist. Of course, it is in the interest of banks and landlords to be flexible, and so perhaps the business losses may be less than I fear.

Households and small businesses being distressed will create large pockets of weak demand. Very simply, if all the businesses in a small town fail, that town is in a great deal of trouble. Normally, small businesses are an engine of job growth. However, very few people will want to set up a business in a town that has been wiped out economically.

It is clear that governments will have to step in, and force job creation. It seems clear that the optimal way to do so is via a Job Guarantee -- jobs will be created exactly where unemployed people are, and regions that are less hard-hit economically will follow a private sector-led recovery. Meanwhile, I keep reading on the internet that "we are all MMTers now!" Unfortunately, the people saying that typically have a shallow knowledge of MMT (if any), and it is unclear that any of them are even aware of the Job Guarantee.

Structural Uncertainty

This outlook creates an impressive amount of uncertainty about the long-term outlook. If we just look at this from the standpoint of a fixed income investor, we have two broad outlooks. The first is that the system only makes temporary fixes to patch over the crisis, and we are stuck facing another decade of Quantitative Easing, and ultra-low policy rates. The second is one in which governments finally attempt to seriously goose aggregate demand -- in an environment where a lot of productive capacity has been incapacitated. I am not particularly worried about inflation, but if I were, that is exactly the situation to be concerned about. The inflation doom-sayers have been wrong for decades, but they were looking at the wrong things: the money supply and policy rates.

My view is that the subjective probabilities of these scenarios will be dependent upon the length of the disruption to regular activity. We cannot point to the size of relief measures as a gauge of a changing reaction function: the hole is demand is so large, that any plausible package will get swallowed up by it. However, a rapid return to normal will also lead to political complacency. An extended period of disruption will give citizens a very long time to mull over how well the system is working, and create a greater appetite for reforms.

(c) Brian Romanchuk 2020


  1. You pose a puzzle that needs additional specificity. This coronavirus (CV) shutdown affects sectors so differently!

    We need to notice that business shutdowns generally do not effect the paychecks of government workers. This forces a huge wedge between the government and private sectors.

    We need to notice that the amount of debt used by a specific business is an important factor. A self capitalized business (who has no debt) is in a much stronger recovery position than the indebted business.

    We need to notice the role of the entrepreneur. I would suggest that the entrepreneur brings together cash-wealth, real property wealth (in the form of business locations), government acceptance, and customers who can provide cash flow.

    We need to notice the wide spectrum of hurt felt by individuals. Some feel no hurt, some are potentially forced onto the street and into soup kitchens. Clearly, the economic hurt kindled by the CV will not be shared equally.

    If we factor all the above background into our thinking, we might come to a different place in economic thinking. I am led to consider that local government (including state government) is likely to have a huge tax deficit. Considering government and private sectors, how should a deficit be cured? We can ponder on that question on another day.

  2. Roger, if this thing gets much worse I would think the government is not going to enforce debt obligations, or rather just postpone them- pretty much all of them as in the sheriff is not going to evict people for not paying their rent or mortgages and courts will delay all judgements on foreclosures due to debt owed to banks. And banks will as usual get money from the government to keep them afloat.

    But yeah- this will have an unequal effect on people- obviously on the ones that die or get very sick.

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