The Financial Express

Post-pandemic economic future and K-shaped recovery

| Updated: October 25, 2020 20:47:31

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As economies around the world are struggling to shake off the devastating effects of the Covid-19 pandemic on lives and livelihood, worries are growing that the recovery could look like a K. The possibility of such a recovery was brought to the fore when Chris Wallace brought up the issue of K-shaped recovery while moderating the US presidential debate between President Donald Trump and former Vice President Joe Biden.

The economic activity around world in general and developed economies in particular has plummeted in the wake of corona virus pandemic and unemployment soared. In fact, the scale of economic challenges created by  the pandemic  has not been faced by developed countries in close to a century. In developing countries like Bangladesh, it not only negatively impacted on their growth trajectory and exposed the serious weaknesses in the health care system but also exposed economic vulnerabilities.

However, the increasing complexity of economic interconnectedness between developed and developing countries through trade and investment flows makes  them critically  dependent on how developed economies recover from the pandemic-induced recession, in particular the US economy which accounts for almost a quarter of global GDP. The economic activity of the US declined in the wake of the Covid-19 pandemic and unemployment soared due to the measures taken to slow the spread of the virus. The depth and speed of the decline almost corresponds to the Great Depression of 1929-33.

But it was not an unexpected decline in economic activity, in fact it became very clear at the very early phase of the pandemic that it would create a recession. According to the National Bureau of Economic Research (NBER), the US economy entered the recessionary phase by the end of the first quarter, 2020 ending the record setting 128 months of growth or put it differently, the first downturn since 2007-09.

While economists often define a recession as two consecutive quarters of contraction (a technical definition of recession), but the NBER uses a range of factors such as domestic production and employment to determine and signal that a recession has begun. In June this year, using its own criteria, it concluded that the unprecedented decline in output and employment warranted the current episode to be designated as recession. 

US GDP fell at a rate of 31.4 per cent in the second (April-June) quarter and the government will not release its third (July-September) quarter GDP data until October, 29, just five days before the election counting on an economic recovery to give President Donald Trump an electoral boost. But economists think such a rebound this year is a long shot.

Joseph Stiglitz, Nobel Prize-winning economist and Professor at Columbia university pointed out that the speed at which it hit the economy was surprising, particularly the rapid rise in unemployment which soared to millions very quickly and continued to rise each week. While the recession of 2008-09 began in finance and then trickled down to the rest of the economy, the current recession is the result of the pandemic and the public health response. This is a very unusual recession in the sense that it is a self-induced one. So, the current downturn has very different characteristics and dynamics than the previous ones.

But as Stiglitz points out the most distinguishing feature of this economic downturn is that it is so pervasive affecting everyone and hitting everywhere all at once. Also, it makes the job of the government more difficult to boost economic activity to end the recession through the public sector alone at a time when the private sector is not fully functioning. The public sector  usually  stimulates economic activity through public work programmes like building and renewing publicly funded infrastructure programmes using large number of workers working together. But the government does not necessarily want that to happen now for fear of spreading the virus. That restrains what the government can do to stimulate the economy.

The difference between this corona virus induced economic recession and  previous downturns makes it very difficult to determine the path of economic recovery and the actual outcome. Therefore, reviving the pace of economic recovery and to maintain the pace now primarily depends on controlling the virus and the fiscal package.

Now economists are debating on the shape of the recovery path with very serious implications for the economy. Now both economists and analysts are describing their projections for the length of recession and the  shape of potential recovery using letters like V, U, Z, W, L and I.

A V shaped recovery is the most optimistic outcome indicating a sharp decline in economic activity followed by a sharp rise while a U shape is similar but the period of unemployment and low economic activity will persist much longer than in a V shaped recovery. But even a more optimist outcome than  a V shape outcome is a Z shape recovery path where after suffering the downturn, the economy bounces back up above the pre-pandemic baseline as pent up demand creates a boom. A W shaped  recovery factors in a second surge in Covid-19 i.e., two down turns and two rapid recoveries. Now the question here is what will happen with multiple surges of covid-19 infections and what shape of the recovery look like in such a situation. The most pessimistic outlooks are depicted by L and I shaped recovery suggesting high unemployment and low spending with other ramifications such as debt defaults and very high levels of business failures.

Now there is an ongoing debate about the very possibility of a K shaped recovery, a term also coined by economists depicting a recovery path where high income people in the US have jobs come back while this is not the case with middle and lower income jobs.  Technically it is a cross between V and L, but where one will stand in this situation depends on who one is. Even in this corona virus induced recession industries such as technology, sections of retail and software services have done well while travel, entertainment, hospitality, personal care and domestic and food services continue to suffer job losses. Therefore, a K shaped recovery would entail continued growth, but split sharply between industries and economic groups.

In  the current  economic situation there are  clear indications emerging in the US economy that the economy is bifurcated between the financial economy and the real economy. In that bifurcated economy,  where the upper rising segment is clearly the financial economy as reflected in a very buoyant  stock market since late March and the downward sloping segment is the real economy as reflected in rising unemployment, particularly hitting hard lower income groups and thousands of small business failures. These two economies are completely separated now so much so that the financial economy (interest rates, foreign exchange rates and stock prices) does not reflect what is happening in the real economy (profits, growth and job growth) anymore. Such distortion of the underlying fundamentals of the economy will make it more difficult to go past the current economic crisis.

It is estimated that about 95 per cent jobs in the financial services sector  in the US have already recovered to the pre-pandemic level but employment in the real economy remains far behind at about 70 per cent. According to a MIT Report low wage workers could face long-term unemployment after the pandemic crisis subsides. More worryingly, low wage jobs like hospitality staff, transportation, cleaners and similar services sector jobs are least likely to come back. Overall, on the one side technology based fortunes reached all time high, while lower income, blue collar workers and those who can not work remotely suffered the most and will bear the heavy costs of the labour market adjustments in the post pandemic period.

The K-shaped  recovery is now gaining increased traction as the tale of two recoveries conform to outperformance of the financial economy relative to the real economy. Furthermore,  the crisis has already spurred the use of automation not only in small medium enterprises in the manufacturing sector but also in the services sector. The consequence of this uneven growth would further accelerate already existing wealth and income disparities in the US.

For developing countries like Bangladesh the fear is a substantial long term demand contraction arising from  a K-shaped recovery in the US and  if that happens, the EU as well will negatively impact on  exports such as RMG. Apparel prices in the US are down by close to 9 per cent since March this year. Also, people are fearful about the future, even when the US economy opens up again, they may be unable or unwilling to spend as readily as they did before the pandemic.

Such an external shock  will cause significant job losses or lock-in  of existing Covid-19 induced job losses in the tradeable sectors in Bangladesh, notwithstanding overall labour market adjustments that will ensue once the pandemic is over. The ensuing labour market adjustments will heavily weigh against unskilled and semi-skilled workers who are largely employed in the informal sector and live a precarious life. These are the people mostly bearing the brunt of Covid-19 induced economic slowdown. Now all these will not only exacerbate the already rising income and wealth inequality in Bangladesh, but will also cause increased levels of poverty.

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