The 95% Economy

As economies re-open in coming weeks, much of economic activity will get back to near normal. But income will be down so people will have less to spend. Also they will likely save more out of what they have. The savings rate always rises in a recession. But this time some sectors won’t get back to normal for a long while. Our estimates suggest that at least 5% of the economy and 10% of employment could still be either shut down, or facing weak demand until we have a solution to Covid-19. So, for a while at least, we may have a 95% economy.

Looking at the GDP data, the sectors most affected are arts and entertainment, hospitality and food (away from home), transport, education, retail and personal services. In total these account for about 16% of US GDP and 32% of jobs (see table). Why so many jobs compared to the output? Because restaurants and retail have a lot of part-time workers and also a lot of low-wage workers.

During the current lockdown these sectors are heavily impacted but they are not at zero (though some businesses are of course). Food and drug retailers are still operating, as are most distribution systems (included in wholesale trade and transport and warehousing), also some take-away food restaurants, some on-line entertainment and some personal services. But bear in mind that there is a supply chain for the businesses that are shut down. So some firms in other sectors face a knock-on effect from the closures in these sectors. For example, how many restaurants are paying for designs or fit-outs or new kitchen equipment? How much is the demand for cars cut back because car rental companies are not renewing fleets, which are currently sitting largely idle.

Some potential for bounce-back

Some businesses in the worst-hit sectors will bounce back quite quickly and there may even be a backlog of business to be enjoyed. Garden centres for example are closed in many countries and may be inundated once they reopen. And despite the risk from such personal contact I suspect hairdressers could do a roaring trade once they are allowed to reopen. But this surge might last only a few weeks. If the virus is still a threat, then once people have had their long-awaited cut, they may leave it longer than normal before they have the next one. Business could be lean for many months.

Restaurant, bars, cinemas, theatres and sports venues will have an even more difficult time. Even when they are allowed to open they may be required to operate at 50% occupancy or face other restrictions. That means higher prices which will keep many people away even if fear of the virus doesn’t.

Some spending will be diverted to other things

Over time there will be some diversion of spending. If people can’t spend on going out (or prefer not to) they will spend more on other things. They are already spending extra on food at home of course. They might also spend more on entertainment at home too, whether Netflix subscriptions, new TVs or other electronic goods, or on hobbies. Or perhaps, when we can drive again, people will buy a new car or boat. If you can’t go to restaurants, concerts or sports games at least you can enjoy a new car or boat.

This diverted spending isn’t going to happen straightaway of course, especially the new car. And that’s because of the ‘ordinary’ recession going on. People will be cautious at first, even when things start to improve, worried about their job, their business or their stock portfolio. As I said, the savings ratio always goes up in recessions. But, over time, even if we never ever went to restaurants again, people would once again spend all or most of their money. We would gradually move from the 95% economy back to a 100% one, just without any restaurants. And restaurant workers would work somewhere else. By the way, I think restaurants will be back, at least eventually. I am just trying to point out the way demand can shift.

Three implications

What are the implications of this analysis? First, the 95% economy means that a V-shaped recovery is out. We went down the left-hand side of a very steep V in March. I think we might start up the right-hand side in May/June quite steeply, some of the way as things reopen. But then the recovery will slow before getting back to the top and gain ground much more gradually, as people only cautiously return to entertainment venues, or alternatively divert their spending to other things.

Secondly, obviously some sectors are going to be negatively impacted for a long time while other sectors (electronics, hobbies) could start to do well. Finally, there will be a continued need for major government support in the form of wage replacement or unemployment benefits for a large number of people, keeping government deficits high and debt rising. Hopefully the entertainment sector will eventually come back in full, once the virus is tamed. It did in Hong Kong after SARs in 2003.