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BIS Bulletin No 33: What comes next? Recovery from an uneven recession

Core Content

This BIS Bulletin, authored by Daniel Rees, explores the uneven impact of the Covid-19 crisis on different industries and its aggregate economic implications. It highlights how the recovery is not uniform across sectors, with customer service industries suffering disproportionately due to both supply-side constraints (e.g., regulatory restrictions, reduced customer numbers) and demand-side shifts (e.g., behavioral changes in consumer preferences). The analysis suggests that while some economies may recover more quickly, others may face prolonged periods of economic underperformance.

Key Takeaways

• Uneven impact of the pandemic: The effects of the Covid crisis have been uneven across sectors, with customer service industries experiencing significant declines in output.
• Persistent weakness: Even after containment measures are relaxed, customer service industries may remain below pre-Covid output levels for several years.
• Aggregate implications vary: The recovery of the overall economy depends on the nature of the industry-level disturbances (supply vs. demand) and the composition of the economy.
• "98% economy" scenario: Large advanced economies could experience a GDP recovery to at best 98% of pre-Covid levels due to ongoing constraints on customer service sectors.
• China's outlook is more positive: China's economy, which is less reliant on customer service industries, is expected to recover closer to its pre-crisis trend by late 2021.
• Uncertainty remains: The timing and severity of the recovery depend heavily on the development of vaccines and the effectiveness of public health measures.

An Uneven Recession and Recovery

• The Covid recession has shown unusually large sectoral dispersion in GDP growth, more so than previous crises like the 2007-09 financial crisis.
• The recovery has also been uneven, with some industries rebounding quickly, while others like hospitality and tourism are recovering more slowly.
• Constraints on customer service industries persist due to regulatory restrictions and behavioral changes in consumer habits.
• These constraints could last until a vaccine or effective treatment becomes widely available.

Aggregate Implications of Industry Disturbances

• The aggregate economic impact depends on the source of industry-level disturbances:
  • Supply disturbances reduce overall efficiency, leading to a decline in aggregate GDP.
  • Demand disturbances result in a smaller or even positive impact on GDP, as income shifts from one sector to another.
• The model simulations suggest that:
  • Large advanced economies may face a "98% economy" due to lower potential output.
  • China is expected to recover closer to its pre-crisis trend, as its economy is less dependent on customer services.
  • The persistence of constraints on customer service industries is a key determinant of the recovery speed.

Industry-Level Recovery Projections

• The model projects that customer service industries will remain below pre-Covid output levels for several years.
  • In large advanced economies, output is expected to be 10% below pre-Covid levels until these constraints ease.
  • In China, the deviation is expected to be around 5%.
• Other industries may recover more quickly due to income and substitution effects:
  • Income effects reduce output due to lower aggregate economic activity.
  • Substitution effects shift demand away from customer services to other sectors, helping the rest of the economy recover.
• Intermediate input effects also play a role, as reduced demand for goods and services in customer service production affects other industries.

Outlook and Uncertainties

• The model results are based on assumptions about the persistence and severity of constraints on customer service industries.
• If vaccines are effective and public health measures are relaxed, the recovery could be much faster, with GDP returning to pre-Covid levels by late 2021.
• However, if constraints remain tight (e.g., until mid-2025), large advanced economies may face a "96% economy".
• Second waves of the virus could lead to precautionary saving and delayed investment, further slowing the recovery.

Conclusion

• The uneven recovery at the industry level has significant aggregate implications, particularly for customer service industries.
• While demand stimulus is necessary, it may not be sufficient to restore pre-Crisis GDP levels without controlling the virus and reallocation of resources.
• The model does not account for financial stability implications, such as increased corporate bankruptcies, which could arise from an uneven recovery.

References

• Banerjee, R, G Cornelli and E Zakrajšek (2020): "The outlook for business bankruptcies", BIS Bulletin, no 30, October.
• The Economist (2020): "The 90% economy that lockdowns will leave behind", 30 April.
• Gourinchas, P-O, S Kalemli-Özcan, V Penciakova and N Sander (2020), "Covid-19 and SME Failures", NBER Working Papers, no 27877.
• Guerrieri, V, G Lorenzoni, L Straub and I Werning (2020), "Macroeconomic Implications of COVID-19: can negative supply shocks cause demand shortages", NBER Working Papers, no 26918.
• Rees, D (2020): "What comes next?", BIS Working Papers, no 898, November.
• Woodford, M (2020): "Effective demand failures and the limits of monetary stabilization policy", NBER Working Papers, no 27768.