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Q&A: The COVID-19 Crisis and The Economy

Bush Institute-SMU Economic Growth Initiative Director Cullum Clark shares his thoughts on the U.S. economy and what lies ahead.

Article by J.H. Cullum Clark May 13, 2020 //   13 minute read

The U.S. and global economies are already in a recession. What can policy makers do to speed the recovery and strengthen the global economy for the years ahead? 

First of all, do more of what policy makers are already doing: lend without limit to employers. Many employers face a severe cash flow crunch because revenues have collapsed while costs like payroll and rent continue. Congress has wisely devoted most of the $2.8 trillion in rescue funds it’s approved over recent weeks to lending money to good businesses to help them survive this crisis. 

Address obvious flaws in the “Paycheck Protection Program,” which is directing $675 billion toward forgivable loans to employers with fewer than 500 employees as well as larger companies in certain industries. Loosen rules on how employers must spend the money, which have proven too inflexible. Tighten conditions for forgiveness, and, in particular, require any business that ends up profitable over the next 12 months to use any profits to pay the government back. The public sector shouldn’t subsidize the profits of private business – and doing so will generate public backlash as the facts of what’s happening become clear. And increase the size of the program, as demand for loans still far exceeds supply. 

Ramp up the new “Main Street Lending Program” for mid-sized employers quickly. Ignore complaints about restrictions on dividends, stock buybacks, and executive compensation, since these conditions provide a useful incentive for firms to raise new private-sector capital and pay the government back. 

Second, permit a cautious re-opening of closed workplaces, as state and local policy makers are starting to do. Providing safety for employees and customers will impose considerable costs, while consumers may be slow to embrace some kinds of “face-to-face” services. Businesses need to start adapting. 

Third, make clear that Washington understands the significant costs associated with America’s exploding national debt – which will top 100 percent of the nation’s GDP this year – and signal a shift toward fiscal restraint as soon as the emergency allows it. Restrict new rescue funds for state governments to specific challenges posed by the crisis, such as funding strained hospital budgets and safe school re-openings, rather than providing open-ended bailouts of overextended pension funds and other excesses. 

And fourth, trust in the recuperative powers of the market economy. Avoid new burdens on private business. Make permanent the loosening of occupational licensing rules that has taken place in some industries in response to the crisis, and deregulate more occupations. Resist the siren song of “stimulus” spending, as past experience shows these programs have little useful effect.  

The last decade has seen continuous job growth and low unemployment but also relatively weak average wage growth and rising income inequality. How well prepared is the typical American household for the shocks now unfolding to employment and household income? 

It’s important to recognize there’s no “typical” household, but rather vast diversity in how well prepared people are for this shock. A majority of working Americans experienced reasonable wage growth over the last decade, and many came into the crisis with good buffer-stocks of savings that will help see them through near-term setbacks. Even though unemployment has reached shocking levels, perhaps 18 to 20 percent if we measured the unemployment rate today, a large majority of people outside the most stricken industries still have their jobs and may even be more productive than ever working from home. 

On the other hand, at least a third of households don’t have sufficient savings to make it through even a small financial setback. One of the more cruel features of this crisis is that it has inflicted the greatest economic pain on people the least well positioned to absorb it –lower income people who disproportionately work in retail, restaurants, hospitality, and other face-to-face service industries. 

For lower-income people who’ve become unemployed or seen their hours cut back, the good news is that America’s safety net – for all its inefficiencies – does a good job of covering necessities in most circumstances. In the deep 2007 to 2009 recession, total spending on basic consumption items declined only slightly, since unemployment benefits heavily cushioned income losses for the unemployed. 

The bad news: labor markets are like Humpty Dumpty, in that, once they fall off the wall, it’s very hard to put them back together again. The unemployment rate can move up shockingly fast, but it comes back down much more slowly. And a prolonged spell of unemployment typically has lasting effects on a person’s earnings trajectory. Also, for families with low savings, even a modest hit to their financial well-being can undermine upward mobility for the next generation, especially by reducing post-secondary education options. Policy makers need to focus on these long-term effects. 

We are seeing the lowest oil prices in decades. Steep declines in demand coupled with a price war between the Saudi Arabian and Russian governments threaten the survival of large parts of the U.S. oil and gas industry. What do you think the future holds in store for the energy industry? 

Obviously, current conditions in the energy industry are dire. But commodity markets work. Historic lows in oil and gas – as in past downturns – will lead to rapid declines in drilling, which over time will bring supply down. Demand will recover as workplaces re-open. In the meantime, a number of companies will need to raise new capital or file for bankruptcy. But the commodity reserves and the expertise for recovering them will still be there, and the industry will ultimately come back. 

How do you think the recession will affect the Texas economy? 

The Texas economy is now highly diverse, urbanized, technology-enabled, and globally connected. This means it inevitably moves up and down with the global economy in the short term. 

But these new realities also mean the state’s vulnerability to energy downturns is much smaller than it was for most of the 20th century. And the competitive advantages that have drawn so many people to Texas – its pro-growth policy orientation, relatively affordable housing costs, and high quality of life – are likely to remain intact for the foreseeable future. The future of Texas is still bright. 

Considering the increasing criticisms of globalization, will the pandemic lead countries – including the United States – to change their approach to the global economy? 

Like almost all economists, those of us at SMU and the George W. Bush Institute who focus on economic policy issues understand what overwhelming evidence shows: rising trade and economic interconnectedness have contributed to economic growth and prosperity in America as well as other countries. Critics of globalization mostly ignore this evidence. 

That said, they do rightly point out, in line with classical economic theory, that growing international division of labor leaves a minority of people worse off. In the United States, such people tend to do relatively low-skill jobs in certain industries, and they disproportionately live in a number of specific, heavily affected parts of the country. This effect has led to growing support among economists for “place-based” policies to help hard-hit local economies as well new policies to expand opportunity and geographic mobility for lower-income Americans. The Bush Institute’s Blueprint for Opportunity Initiative is focused on advancing such policy ideas.

The COVID-19 pandemic hasn’t changed these realities. Any country that responds with an indiscriminate retreat from international openness and trade will almost surely set back their own recovery and stunt their long-term growth.   

That said, America does have a long history of policies to ensure domestic supplies of certain essential products, in sectors like food, energy, and, more recently, semiconductor technology. In light of the current crisis, it would be sensible to extend these policies to essential medical goods in a narrowly tailored way. 

Will the pandemic undermine international economic institutions like the International Monetary Fund (IMF) and regional integration efforts like the European Union and the U.S.-Mexico-Canada Agreement (USMCA)? 

The pandemic has brought out a degree of “everyone-for-themselves” among nation-states that I’ve found discouraging – particularly as COVID-19 is a global threat that cries out for a global response.

It’s premature to conclude the crisis will undermine international institutions and trade agreements. More likely, it accelerates trends that were already underway. In the case of international financial institutions like the International Monetary Fund (IMF), there’s been a trend away from old-fashioned assistance packages demanding stringent fiscal tightening as a condition for short-term loans for lower-income countries – as we saw with Latin American and East Asian borrowers in the 1980s and 1990s. The current crisis has reconfirmed the relevance of the IMF, as dozens of countries have asked for help. But this help is likely to come with lighter conditions. 

In Europe, the crisis has reconfirmed a core challenge that became clear during the Eurozone sovereign debt crises of the last decade. Voters in the economically stronger countries of Northern Europe oppose “mutualizing” the debts of the weaker southern countries. But the southern countries – which also happen to be experiencing the worst COVID-19 crises – don’t have a central bank to backstop the massive fiscal response their governments think they need. Europe will continue to wrestle with the mismatch between its common currency and its lack of strong central fiscal institutions.  

In North America, the crisis seems unlikely to undermine the compelling logic driving economic integration. Despite campaigning against the North American Free Trade Agreement in 2016, the Trump Administration made only moderate changes to it in its renegotiated United States-Mexico-Canada Agreement (USMCA). The three governments have more work ahead to implement the new provisions of the USMCA, but the COVID-19 crisis hasn’t stopped that work. 

Could you take out your crystal ball and tell us how long and deep the downturn will be? Will we see a V-shaped or U-shaped recovery, or might we end up with an L-shaped depression? 

I wish I had a crystal ball! It seems clear now that the re-opening of workplaces will be slow and staggered. America has neither the technology in place nor the tradition of intrusive government that would allow it to pursue testing, contact tracing, and enforced quarantining to the degree that some Asian countries have implemented. So we’ll have to proceed cautiously. 

Also, demand for many kinds of goods and services is likely to experience a slow recovery. In addition to people’s natural hesitancy in returning to crowded restaurants, hotels, and theaters, households and businesses will emerge from the recession with depleted savings and increased debt. They’ll likely spend cautiously for at least a couple years to repair broken balance sheets. 

At the same time, some activities – elective healthcare, home construction, manufacturing, and logistics, for instance – should be able to resume normal levels of activity fairly quickly. 

My base-case scenario is that the economy traces a path between a “V” and a “U” – something like a Nike “swoosh,” with output per capita surpassing 2019 levels by about 2022, adjusting for inflation. The unemployment rate will likely take several years to fall back to the mid-single digits. I hope I’m wrong and the recovery comes faster.

A version of this Q&A was originally published in SMU's John Goodwin Tower Center for Public Policy and International Affairs Dedman College of Humanities and Sciences newsletter.