A few weeks ago, the expectation was that the onset of the third quarter would mark the close of a highly damaging and uncertain second quarter for the U.S. economy and, importantly, herald a sharp and durable reversal.
Instead, with health concerns forcing a growing number of states to either stop or reverse their reopenings, and with some businesses and households withdrawing from active economic re-engagements, a cloud is now forming over the third quarter, threatening the depth and breadth of the economic recovery.
With an initial phase of seemingly healthy reopenings, and with government relief measures in full force, high-frequency indicators of economic well-being (household confidence, new jobs and retail sales) started improving in May or deteriorated at a slower rate (jobless claims).
Such absolute and relative improvements were countering what was shaping up to be a brutal set of economic data for the second quarter as a whole, including the largest contraction in gross domestic product on record. But with a continuing uptick in economic data that repeatedly beat consensus expectations, the thinking was the hit to this year’s GDP could be contained to 5% to 8%, with the prospects of recovering the entire loss of output in 2021.
Since then, however, confidence in improving high-frequency data has been dented by indications that the “R-naught” of Covid-19 — the average number of people who catch the virus from a single infected person — has increased above 1 once again in a majority of states. Even though hospitalizations and deaths have not surged at the same rate as the sharp increase in positive cases because of the much lower average age of the newly infected, there is little confidence that this will continue given the material risk of younger people, especially those who are asymptomatic, turning into super-spreaders — a concern accentuated by evidence that this group has shown little inclination to modify its behavior yet. Policy makers are reacting, including either halting or reversing economic reopenings in about 40 states, according to Goldman Sachs, but many health experts view the cumulative response by local, state and federal officials as too incremental and overly hesitant.
Consistent with these developments, the highest-frequency indicators of household economic activity, such as mobility and restaurant bookings, have already flattened or started to head back down in a growing number of states. Some businesses, such as Apple, have decided to reclose stores in certain places. And this process has been accelerated in recent days with some states and cities closing bars and barring in-restaurant dining.
Over the next few weeks, this will lead economists and Wall Street analysts to revise down growth projections for the third quarter and to push out the process of recovery. Both will be less consistent with a sharp and lasting V-shaped recovery and more likely will align with my previous characterization of a square-root-shaped recovery. And with certain relief measures scheduled to sunset soon, including the Paycheck Protection Program and the supplementary unemployment benefits, the U.S. economy would be exposed to a bigger risk of short-term problems becoming structurally embedded. This would include a significantly larger number of corporate bankruptcies and greater risk of long-term unemployment in which jobless workers run a high risk of becoming unemployable.
Absent any policy and behavioral changes, the overall impact of these measures would most likely be an overall GDP contraction for 2020 in the 8% to 12% range, assuming no second round of infections in improving states such as New York. Moreover, the recovery of lost output would not be completed in 2021. And the uncertainty surrounding these predictions would notably increase, with the balance of risk tilted to the downside.
Such a diminished outlook would worsen the already-concerning inequality trifecta of income, wealth and opportunity at a time of greater recognition and heightened sensitivity to long-standing social injustices. It would also undermine the type of synchronized global recovery in which external demand reinforces domestic economic improvements. It would increase the likelihood of more protectionism and faster deglobalization. And it would risk pulling down longer-term economic growth and prosperity.
The answer is not to roll back health measures aimed at regaining control of what is a worrisome acceleration of infections. Rather, it is to ensure changes in behavior and policy that allow for healthier and sustainable economic reopenings during this tricky period of living with Covid-19.
A necessary component of the answer is to combine policy relief measures with greater emphasis on steps to reduce the risk of infection and deal better with the ill, as well as to counter more quickly a post-virus world of low productivity and high household insecurity. But it is imperative the private sector joins in — whether through individuals and companies better adopting health safeguards or by working harder to protect the most vulnerable segments of the population.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include 'The Only Game in Town' and 'When Markets Collide.'
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