Wednesday, 8 July 2020

'Snap-back', 'gone forever', and the economic impact of the coronavirus pandemic

Ordinarily, I don't post on macroeconomic topics. However, this blog post by Bruce Wydick was so interesting, I couldn't resist following up:
My main contribution here is to categorize different types of goods and services in ways that will help us better understand the economic situation we are in.  I will do it across two dimensions.  First is the distinction between purchases of what I’ll call “Snap-Back” goods and services and those that are “Gone Forever.”  In the Snap-Back category are things that we couldn’t buy during the heaviest COVID lock-down period, but these purchases were simply delayed.  There is good reason to think that as the economy begins to open up, purchases of these items might even be higher than normal due to pent-up demand.  Even during COVID, things like household appliances break or need fixing, and because over the long run purchases tend to even out, buying less now means buying more later.
“Gone Forever” goods and services, in contrast, are just like the term suggests: gone forever.  Like me, you may have foregone several haircuts during shelter-in-place because you didn’t want to get (or give) coronavirus to your barber.  But when it becomes safe to go back to the barber chair, you’ll still only get one haircut.  The rest of your haircuts disappeared into the economic ether; they were (mutually beneficial) transactions that COVID—what we might call the “invisible anti-hand”—prevented from happening. 
The second distinction is more standard and will be familiar to anyone who has studied introductory economics.  These are the differences between goods with low versus high income elasticity.  To those untutored in navigating the dense forests of economic jargon, income elasticity measures the percentage increase in purchases of a good when incomes go up by 1%. It measures how sensitive purchases of different items are to changes in income. 
Wydick's categorisation leads to four different types of goods and services, as shown in his diagram reproduced here:

The key point about this categorisation is to identify what sectors of the economy are likely to be hurt most by the coronavirus pandemic lockdowns and the associated recession. The lockdown hurts the "gone forever" goods and services, because the "snap-back" goods and services receive catch-up spending after the lockdown is released, while "gone forever" goods and services don't. The associated recession and high unemployment will lower incomes, so those goods and services where purchases are more sensitive to changes in income (high income elasticity), will be worst affected longer term.

So, when goods and services are both "gone forever" and have a high income elasticity, we can expect the impact of the coronavirus pandemic to be most severe. Wydick identifies air travel, tourism, sporting events, hospitality, and transport (but not public transport). Everything else either snaps back and experiences some catch-up spending, or isn't as affected by lower incomes.

Mostly, that suggests that a lot of the economy will survive fairly intact. However, that potentially misses the key point. Tourism and hospitality is going to be crushed, and continue to be in severe trouble for a long time. That's potentially a problem for a country like New Zealand, where the economy is (maybe overly) dependent on tourism and hospitality (tourism alone, not including hospitality, generates nearly 6 percent of GDP according to Statistics NZ's Tourism Satellite Account). It is also a problem because it is a sector with relatively high employment density (the Tourism Satellite Account shows about 8.4 percent of total employment is in tourism, again not including hospitality).

That means New Zealand faces a big and lasting hit to GDP, and (perhaps more importantly) a big and lasting hit to employment. Trying to prop up those sectors (like giving millions of dollars to bungy operators) may be an overly expensive way of retaining employment. Instead, perhaps using those millions to promote re-training and up-skilling of displaced workers might be money better spent. On the other hand though, keeping an existing business at a minimum viable level and ready to ramp back up when conditions improve is potentially less costly to the economy than closing the business down, losing the specific human (and other) capital, and then setting up a new similar business later.

What is best here probably depends on what you believe about the longevity of this crisis. The government's approach suggests that they think the economy will bounce back quickly. I would have erred in the other direction, taking this as an opportunity to up-skill the workforce. Of course, given that I work in the education sector, you'll just have to accept that I may have some bias here.

[HT: Marginal Revolution for the Wydick post, and Michael Doyle on the Waikato Economics Discussion Group for the bungy subsidy article]

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