The Scarring.
by Michael Roberts
Optimism reigns in global stock markets, particularly in the US.
After falling around 30% when the lockdowns to contain COVID-19 virus
pandemic were imposed, the US stock market has jumped back 30% in
April. Why? Well, for two reasons. The first is that the US Federal
Reserve has intervened to inject humungous amounts of credit through
buying up bonds and financial instruments of all sorts. The other
central banks have also reacted similarly with credit injections,
although nothing compares with the Fed’s monetary impulse.
As a result, the US stock market’s valuation against future corporate
earnings has rocketed up in line with the Fed injections. If the Fed
will buy any bond or financial instrument you hold, how can you go
wrong?
The other reason for a stock market rally at the same time as data
for the ‘real’ economy reveal a collapse in national output, investment
and employment nearly everywhere (with worse to come) is the belief that
the lockdowns will soon be over; treatments and vaccines are on their
way to stop the virus; and so economies will leap back within three to
six months and the pandemic will soon be forgotten.
For example, US Treasury Secretary Mnuchin, reiterated his view expressed at the beginning of the lockdowns that “you’re going to see the economy really bounce back in July, August and September”. And White House economics advisor, Hassett reckoned that by the 4th quarter, the US economy “is going to be really strong and next year is going to be a tremendous year”.
Bank of America’s CEO, Moynihan reckoned that consumer spending had
already bottomed out and would soon rise nicely again in the 4th
quarter, followed by double digit GDP growth in 2021!
That US personal consumption had bottomed out seems difficult to
justify when you look at the Q1 data. Indeed, in March, personal
spending in the US dropped 7.5 percent month-over-month, the largest
decline in personal spending on record.
But it’s not just the official and banking voices who reckon that the
economic damage from the pandemic and lockdowns will be short if not so
sweet. Many Keynesian economists in the US are making the same point.
In previous posts,
I pointed to the claim by Keynesian guru, Larry Summers, former
Treasury Secretary under Clinton, that the lockdown slump was just the
same as businesses in summer tourist places closing down for the winter.
As soon as summer comes along, they all open up and are ready to go
just as before. The pandemic is thus just a seasonal thing.
Now the Keynesian guru of them all, Paul Krugman, reckons that this
slump, so far way worse on its impact on the global economy than the
Great Recession, was not an economic crisis but “a disaster relief situation”. Krugman argues that this is “a natural disaster, like a war, is a temporary event”. So the answer is that “it
should be met largely through higher taxes and lower spending in the
future rather than right away, which is another way of saying that it
should be paid for in large part by a temporary increase in the
deficit.” Once this spending worked, the economy would return just
as before and the spending deficit will only be ‘temporary’. And Robert
Reich, the supposedly leftist former Labour Secretary, again under
Clinton, reckoned that the crisis wasn’t economic but a health crisis
and as soon as the health problem was contained (presumably this summer)
the economy would ‘snap back’.
You would expect the Trump advisors and Wall Street chiefs to
proclaim a quick return to normal (even though economists in investment
houses mainly take a different view), but you may find it surprising
that leading Keynesians agree. I think the reason is that any Keynesian
analysis of recessions and slumps cannot deal with this pandemic.
Keynesian theory starts with the view that slumps are the result a
collapse in ‘effective demand’ that then leads to a fall in output and
employment. But as I have explained in previous posts,
this slump is not the result of a collapse in ‘demand’, but from a
closure of production, both in manufacturing and particularly in
services. It is a ‘supply shock’, not a ‘demand shock’. For that
matter, the ‘financialisation’ theorists of the Minsky school are also
at a loss, because this slump is not the result of a credit crunch or
financial crash, although that may yet come.
So the Keynesians think that as soon as people get back to work and
start spending, ‘effective demand’ (even ‘pent-up’ demand) will shoot up
and the capitalist economy will return to normal. But if you approach
the slump from the angle of supply or production, and in particular, the
profitability of resuming output and employment, which is the Marxist
approach, then both the cause of the slump and the likelihood of a slow
and weak recovery become clear.
Let us remind ourselves of what happened after the end of the Great
Recession of 2008-9. The stock market boomed year after year, but the
‘real’ economy of production, investment and workers’ incomes crawled
along. Since 2009, US per capita GDP annual growth has averaged just
1.6%. So at the end of 2019, per capita GDP was 13% below trend growth
prior to 2008. That gap was now equal to $10,200 per person—a permanent
loss of income.
And now Goldman Sachs is forecasting a drop in per capita GDP that would wipe out even those gains of the last ten years!
The world is now much more integrated than it was in 2008. The
global value chain, as it is called, is now pervasive and large. Even
if some countries are able to begin economic recovery, the disruption in
world trade may seriously hamper the speed and strength of that
pick-up. Take China, where the economic recovery from its lockdown is
under way. Economic activity is still well below 2019 levels and the
pace of recovery seems slow – mainly because Chinese manufacturers and
exporters have nobody to sell to.
This is not a phenomenon of the virus or a health issue. Growth in
world trade has been barely equal to growth in global GDP since 2009
(blue line), way below its rate prior to 2009 (dotted blue line). Now
the World Trade Organisation sees no return to even that lower
trajectory (yellow dotted line) for at least two years.
The massive public sector spending (over $3trn) by the US Congress
and the huge Fed monetary stimulus ($4trn) won’t stop this deep slump or
even get the US economy back to its previous (low) trend. Indeed,
Oxford Economics reckons that there is every possibility of a second
wave in the pandemic that could force new lockdown measures and keep the
US economy in a slump and in stagnation through 2023!
But why are capitalist economies (at least in the 21st
century) not jumping back to previous trends? Well, I have argued on
this blog in many posts that there were two key reasons. The first was
that the profitability of capital in the major economies has not
returned to levels reached in the late 1990s, let alone in the ‘golden
age’ of economic growth and mild recessions of the 1950s and 1960s.
And the second reason is that in order to cope with this decline in
profitability, companies increased their debt levels, fuelled by low
interest rates, either to sustain production and/or to switch funds into
financial assets and speculation.
But linked to these underlying factors is another: what has been
called the scarring of the economy, or hysteresis. Hysteresis in the
field of economics refers to an event in the economy that persists into
the future, even after the factors that led to that event have been
removed. Hysteresis is the argument that short-term effects can manifest
themselves into long term problems which inhibit growth and make it
difficult to ‘return to normal’.
Keynesians traditionally reckon that fiscal stimulus will turn slump
economies around. However, even they have recognized that short-run
economic conditions can have lasting impacts. Frozen credit markets and
depressed consumer spending can stop the creation of otherwise vibrant
small businesses. Larger companies may delay or reduce spending on
R&D.
As Jack Rasmus put it well in a recent post on his blog: “It
takes a long time for both business and consumers to restore their
‘confidence’ levels in the economy and change ultra-cautious investing
and purchasing behavior to more optimistic spending-investing patterns.
Unemployment levels hang high and over the economy for some time. Many
small businesses never re-open and when they do with fewer employees and
often at lower wages. Larger companies hoard their cash. Banks
typically are very slow to lend with their own money. Other businesses
are reluctant to invest and expand, and thus rehire, given the cautious
consumer spending, business hoarding, and banks’ conservative lending
behavior. The Fed, the central bank, can make a mass of free money and
cheap loans available, but businesses and households may be reluctant to
borrow, preferring to hoard their cash—and the loans as well.” In other words, an economic recession can lead to “scarring”—that is, long-lasting damage to the economy.
A couple of years ago, the IMF published a paper
that looked at ‘scarring’. The IMF economists noted that after
recessions there is not always a V-shaped recovery to previous trends.
Indeed, it has been often the case that the previous growth trend is
never re-established. Using updated data from 1974 to 2012, they found
that irreparable damage to output is not limited to financial and
political crises. All types of recessions, on average, lead to permanent output losses.
“In the traditional view of the business cycle, a recession
consists of a temporary decline in output below its trend line, but a
fast rebound of output back to its initial upward trend line during the
recovery phase (see chart, top panel). In contrast, our evidence
suggests that a recovery consists only of a return of growth to its
long-term expansion rate—without a high-growth rebound back to the
initial trend (see chart, bottom panel). In other words, recessions can
cause permanent economic scarring.”
And that does not just apply to one economy, but also to the gap between rich and poor economies. The IMF: “Poor
countries suffer deeper and more frequent recessions and crises, each
time suffering permanent output losses and losing ground (solid lines in
chart below).”
The IMF paper complements the view of the difference between
‘classic’ recessions and depressions that I outlined in my book of 2016,
The Long Depression. There
I show that in depressions, the recovery after a slump takes the form,
not of a V-shape, but more of a square root, which sets an economy on
new and lower trajectory.
I suspect that there will be plenty of scarring of the capitalist
sector from this pandemic slump. Min Ouyang, an associate professor at
Beijing’s Tsinghua University, found that in past recessions the
‘scarring’ of entrepreneurs from the collapse of cash flow outweighed
the beneficial effects of forcing weak companies to shut down and
‘cleansing’ the way for those who survive. “The scarring effect of
this recession is probably going to be more severe than of any past
recessions….If we say that pandemics are the new normal, then people
will be much more hesitant to take risks,” she says.
Households and companies would want more savings and less risk to
protect against possible future shutdowns, while governments would need
to stockpile emergency equipment and ensure they could rapidly
manufacture more within their own borders. Even if the pandemic turns
out to be a one-off, many people will be reluctant to socialize once the
lockdown ends, extending the pain for companies and economies that rely
on tourism, travel, eating out and mass events.
And this slump will accelerate trends in capitalist accumulation that
were already underway: Lisa B. Kahn, a Yale economist has found that
after slumps companies try to replace workers with machines and so force
workers returning to employment to accept lower incomes or find other
jobs, which pay less. Research
After all, that is one of the purposes of the ‘cleansing’ process for
capital: to get labour costs down and boost profitability. It scars
labour for life.
“This experience is going to leave deep scars on the economy and
on consumer/investor/business sentiment. This is going to scar a
generation just as deeply as the Great Depression scarred our parents
and grandparents.” John Mauldin
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