BlackRock Investment Institute

Macro insights

Where the coronavirus shock could leave long-term scarring

Countries are gradually restarting activity, shifting the focus to potential longer-term scarring in the real economy. Such scarring could dent potential output growth in the coming years and challenge the market consensus that the coronavirus shock – while causing great structural change – won‘t weigh on aggregate trend GDP growth. This is a key difference between the recovery from this shock and from the global financial crisis (GFC) – and will matter for financial markets.

U.S. unemployment breakdown, 2006-2020

Sources: BlackRock Investment Institute and the U.S. Bureau of Labor Statistics, with data from Haver Analytics, June 2020. Note: The chart shows the total number of unemployed people in the U.S., and the proportion of this number made up of permanent job losers, leavers and new entrants (yellow bars) and temporary layoffs and temporary job completions (green).

The coronavirus shock could scar capacities in three main areas. First, the labor market could see the destruction of company-specific human capital, a higher degree of economic inactivity and an increase in the mismatch between worker skills and jobs available. Second, elevated uncertainty could potentially weigh on business investment decisions – even in the absence of the deleveraging cycle we saw after the GFC. Third, the creation/destruction of firms may curb innovation – yet R&D spending could pick up as companies adapt to structural trends.

The labor market provides the timeliest reading on potential long-term scarring. There has been a huge jump in unemployment in the U.S. and use of short-time work programs in Europe. Could this morph into a long-term rise in unemployment? Labor market churn means that workers are leaving jobs where experience has been accumulated. The picture in the U.S. is reassuring for now, with most of the unemployment categorized as temporary layoffs. See the chart above. If these job seekers return quickly to work, a rise in long-term unemployment can be avoided. Yet there is already some pickup in permanent layoffs, especially among older workers who are unlikely to re-enter the workforce.

U.S. capital expenditure and BII capex tracker, 2018-2020

Sources: BlackRock Investment Institute and the U.S. Bureau of Economic Analysis, with data from Haver Analytics, June 2020. Notes: The chart shows the annual growth rate of private nonresidential capital expenditure in the U.S., and BII’s capex tracker. This tracker is a nowcast of nonresidential private investment. Inputs to the tracker include national and regional surveys such as the Empire State manufacturing survey, the Federal Reserve Bank of Kansas City’s manufacturing survey, and the Institute for Supply Management report.

Business investment – the other major supply side input – is likely to take a hit near-term. A plunge in demand and heightened uncertainty – about the near-term outlook and the long-term future of some industries – is weighing on investment. If weak capex persisted, this could drag on the amount of physical capital available per worker and on labor productivity growth. This happened after the GFC. Yet our capex tracker shows that investment plans are recovering from a very low level. See the chart above. We could see a rise in corporate savings as companies build buffers against future shocks. On the other hand, accelerated structural change could lead to more investment as companies adapt to shifts in consumer preferences, stricter health and safety regulations and other structural trends. This could offset the some of the headwinds from the shock.

The pace of innovation is another key driver of growth. The impact of coronavirus on long-term growth depends on R&D spending, flexible labor and product markets, and strength of global trade. As businesses adapt to new structural trends, R&D should pick up – not just in healthcare, but in automation, digitalization and robotization. Company creation and destruction is a key driver of productivity. Less efficient firms exit and innovative firms enter. The coronavirus shock threatens “viable” firms, wiping out some of the intangible capital that’s estimated to total 6% of GDP. We should keep an eye on the rate that companies start and fail and on the emergence of zombie companies unable to earn their cost of capital.

Bottom line: Aggregate potential output does not seem to have incurred permanent scarring. This is an important difference from the GFC – when a decade of deleveraging dragged down trend growth. After the coronavirus shock, we will be looking for signs of sclerosis setting in on the back of unprecedented government involvement in the corporate sector and financial markets, and in the face of accelerated structural change in the coming years.

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