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How The Past Can Shed Light on the Post-COVID Economy

What happens when the economy is perturbed by an extreme but temporary external shock.

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Jake VanKersen: COVID-19 caused major changes in how we did everything. But how many of those changes from 2020 are here to stay? Well, we're not going to be able to tell you the future, but we can take a look to the past for some guidance.

Preston Caldwell:
Well, first off, we wanted to create a framework for how a disruptive event like COVID-19 could impact the economy and society in the long run. Most people take it for granted there will be such an impact, but we wanted to be precise in our thinking. So, we identified three specific causal channels for the pandemic's long-run impact.

First, habits could change during the pandemic as people get used to doing less of certain activities, like eating out, and that could cause lasting changes in consumer behavior. Second, fear of the next pandemic could make consumers reluctant to engage in activities involving a high degree of social contact. Third, sunk costs incurred during the pandemic could change the long-term economic calculus of consumers and firms. As a concrete example of sunk costs, retailers' increased investment in e-commerce capabilities during the pandemic could have a long-term positive impact on the online shopping experience for their customers.

With this framework in hand, we analyzed several historical episodes. In selecting these episodes, our goal is to understand in general what happens when the economy is perturbed by an extreme but temporary external shock. Pandemics are one type of this class of events, but so also are wars, political upheaval, and other disruptions. We look at this broader class of events rather than just strictly pandemics, and this makes us different from any of the other research out there that I've seen.

VanKersen: The first event you looked at was World War II and how that caused disruption in the U.K. supply chain, which led to nationwide rationing.

Caldwell: Rationing in the U.K. was severe, affecting many commonly used items like butter, meat, and gasoline, and lasted to some extent for the better part of a decade.

Why is this an informative episode for today? It provides a clear example of people being deeply deprived of goods for several years for reasons outside their control. So, this is somewhat analogous to the situation today of people being deprived of consumer services because of social-distancing needs.

Did consumers' habits change? Did long-run consumption of rationed goods remain depressed even after people regained access after the war? Our analysis says no. A wartime rationing didn't have a large long-run impact as demand for rationed goods generally mounted a full recovery after the war.

VanKersen: Now, 2020 was a time in which we all went home to work, but we often think of World War II as a time when many women left the home and went to join the workforce.

Caldwell: Indeed. One other historical episode in which people drastically changed how they worked was the surge in U.S. female labor-force participation during World War II. However, many of these women left the workforce after the war ended, and while certainly U.S. female labor-force participation did steadily climb throughout the 20th century, it doesn't appear that World War II itself did anything more than modestly accelerate this pre-existing trend.

VanKersen: Moving a little further down the road, the oil-price shock of the 1970s caused a temporary period of very high oil prices, which naturally cut into the demand. Yet, when the prices did come down again, the demand never really jumped up to what it was before, right?

Caldwell: Right. So, with the conventional economic model, you'd expect that once prices went back down, consumers would go back to their prior consumption levels. But that didn't happen. One reason is that it appears the oil-price shock catalyzed a long period of fuel-efficiency improvements due principally to new technologies, and these fuel-efficiency gains didn't reverse once the oil prices eventually fell in the late 1980s.

Tying this back to the framework I mentioned earlier, this would be an example of the sunk-cost channel. Those fuel-efficiency improvements wouldn't have been generated in the absence of that temporary oil-price shock, but because they were sunk costs, for example, R&D, that had already been spent, they had a lasting impact after the shock had passed.

VanKersen: 9/11 understandably had an impact on air travel. What were the long-term effects of that?

Caldwell: U.S. air travel was down for several years owing to the fear created by 9/11, but this fear eventually faded, and by the late 2000s, air travel essentially fully recovered from the impact of 9/11.

VanKersen: Of course, COVID-19 is not the only pandemic we have seen. What are some of the other major pandemics, and what impact did they have?

Caldwell: Even some of the more noteworthy pandemics in recent history, like SARS in the early 2000s, didn't have a big impact even in the short-run. So, these episodes aren't really good guides to the long-run impact of COVID-19, which clearly has had a massively disruptive impact in the short-run. That's why we opted for a different approach, looking at other kinds of events, like wars, which while not strictly pandemics, had a short-run impact on society, much more akin to COVID-19.

VanKersen: Preston, taking a look back at these events has been fairly heavy. Still, given that you have taken such a high-level look at them, do you see any upshot for us coming out of this moment in time?

Caldwell: There's little support for the idea that a change in consumer habits or lingering fear will reshape the post-pandemic economy based on these historical episodes. Now, that's not to rule these factors out because this is just one way of looking at the problem. But at the very least, we should think carefully before we proclaim a new normal in the world after COVID. And if there is a reshaping of the post-pandemic economy, sunk costs appear to be one of the more credible channels.

So, for example, these e-commerce investments that retailers are making or the experimentation by new online shoppers are sunk costs, which could cause lasting changes in e-commerce adoption even after the pandemic. By contrast, if we look at the idea that eating out in restaurants will be permanently lower or that air travel will be permanently lower, those would seem to rely heavily on changes in habits or lingering fear. And again, based on this analysis, there isn't a lot of support for that notion.

VanKersen: Thanks, Preston. While we don't know what lies ahead, looking through the rearview mirror can give us some idea of the way forward.