It’s now a trope to point out that the COVID-19 pandemic is unprecedented. Populations around the world responded to the threat of COVID-19 by changing their behaviour and governments moved in to reinforce those behaviours with varying levels of “stay in place” rules.
The economic shock – and how governments responded to that shock – has been equally unprecedented. Nearly every government pumped out vast quantities of cash to replace lost income and lost revenue to keep their population and their businesses, respectively, afloat.
The global economy is now in the depths of a recession. We know what got us here – collective protection against a deadly virus – but how we get out of here is an entirely different question.
Traditional recessions are the result of a drop in spending induced by a loss of confidence on the part of individuals and/or businesses – or as an economist would say, a drop in aggregate demand. Rising interest rates, a financial crisis, or too much personal and corporate debt can all cause companies and individuals to lose confidence and spend less, which causes economic activity to slow – sometimes into recession. The government playbook for a demand-side recession is to pump more money into the economy through monetary policy – lower interest rates – and/or replace some of that lost private demand with public demand through government spending.
Contrast that with the oil shocks of the 1970s and early 1980s. Higher oil prices drove up the cost of producing, driving and living. That instantly reduced the value of investments across the economy – the gas-guzzling land yacht of a car bought in 1972 was worth much less in 1973. Higher energy prices increased the cost of producing goods, transporting those goods and consuming those goods – that is, living. This loss of investment and rising costs are what economists call supply-side shocks.
There is no single public policy playbook for a supply-side shock. If they persist, the economy has to adjust over time to the loss of investment and higher costs. A supply-side shock requires a shift in investment away from more costly ways of producing, driving and living, toward cheaper ways of producing, driving and living. More energy-efficient production, econo-boxes replacing land yachts, and energy-efficient windows and furnaces are all result of the oil shocks of the 1970s and ’80s. The appropriate response to a supply-side shock is micro, not macro.
Which takes us back to the present. Our economy has experienced a demand shock. Demand for restaurant food, travel, sports and entertainment have all been drastically reduced. Wages have fallen off a cliff, reducing consumer income and confidence. These are all reducing aggregate demand. We responded with the Bank of Canada pumping money into the economy and federal and provincial governments pumping cash into families and businesses.
Yet behind the drop in aggregate demand is supply-side shock. Ongoing physical distancing, heightened personal hygiene and ongoing disinfecting will impose a supply-side shock every bit as powerful as those oil shocks – reducing the value of investments and increasing costs.
Consider the airlines. If we stop selling tickets for middle seats, the value of a plane will immediately drop – a large loss of capital. Or a shopping mall. If we limit the number of people allowed inside due to physical distancing, the value of the mall will drop – another loss of capital. Same for stadiums, childcare centres, hotels, barbershops and bars.
Now consider a family with children. The loss of childcare spaces and the need to watch (and teach!) school-aged children at home will severely curtail the ability of primary caregivers – mostly women – to return to work, even if they have a job to return to. All of this adds up to a large loss of labour to the economy – a female labour supply-side shock.
Now consider almost any workplace or factory. Physical distancing, heightened personal hygiene and ongoing disinfecting will constrain how efficient each employee will be. Meat-packing plants will never operate at anywhere near their former levels of efficiency. Across the economy, this will mean a loss in productivity.
These capital, labour and productivity supply-side shocks will persist until we can return to the way we lived, worked and raised our families before COVID-19. At the very least, that will require a vaccine. But supply-side shocks have a way of persisting and changing behaviour long term – when was the last time you saw a land yacht? Even today’s popular SUVs have two or three times the gas mileage of those old boats.
The enduring economic pain from COVID will be a supply-side capital shock that will particularly hit investment in service, travel and entertainment industries, a supply-side labour shock that will hit primarily female employment, and a supply-side productivity shock due to new health and safety requirements.
Our governments will have to respond to these supply-side shocks by increasing the return on investments – for example, lowering business taxes – and targeting specific issues such as childcare.
Like COVID-19 itself, this will require an unprecedented policy playbook.
Ken Boessenkool is a public policy economist who has spent 25 years writing and providing public policy advice to political leaders in Canada.
