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The Great Shutdown, which aptly describes the motivating force behind the current recession, ushered in what is probably the first downturn in history to be led by the services sector of the economy.
That in itself, if not the unique nature of the recession — workers ordered to stay home, businesses told to cease operations — poses distinct challenges to the recovery, arguing for a long, drawn out slog to regain lost output.
With the goods sector of the economy, a recession causes inventories to pile up. Deferred sales aren’t lost; just delayed.
With services, there is no backlog to sell at a later date. Vacations not taken, concerts and sporting events cancelled, restaurant meals forsaken: that business is gone for good.
Regaining lost output will require a restoration of confidence, for which there is no easy formula, no quick monetary or fiscal fix. Relief measures enacted by Congress will help to sustain those who have lost their means of support. But a full-scale recovery will remain elusive until there is a vaccine or an effective treatment for COVID-19, the disease caused by the novel coronavirus.
Services, which are labor-intensive, comprise the lion’s share of U.S. economic output. Private services account for about 70% of private gross domestic product, which is 88% of total GDP. (The other 12% is government.)
The news emanating from the services sector has been bleak. Just this week, the Institute for Supply Management reported that its non-manufacturing purchasing managers index fell 10.7 points to 41.8 in April, the lowest since March 2009. (Any reading below 50 signals a contraction.) The overall index was boosted by a huge jump in the index of supplier deliveries, which enters inversely.
Normally slower delivery times are associated with a strong economy struggling to meet demand. The current slowdown in delivery times — the rise in the index to an all-time high of 78.3 — was purely the result of supply disruptions related to the coronavirus, according to the ISM.
IHS Markit’s services PMI for April was even more downbeat across all components, with the index contracting a record 13.1 points to 26.7.
Real consumer spending on services plunged at a 10.2% annual rate in March, the biggest decline going back to 1947. Nothing even comes close. And the quarterly data reflect only half a month of shuttered activity.
“While manufacturing may see a rebound in production as increasing numbers of factories are allowed to re-open, prospects look bleaker for many parts of the services economy, especially where businesses rely on travel, social gatherings or close contact with customers,” according to a statement accompanying the report by Chris Williamson, IHS Market chief business economist.
Think about that. “Not only is this a services-led recession, but we expect manufacturing to lead us out?” says Jim Bianco, president of Bianco Research.
Reopening businesses will help to some degree, but consumers aren’t about to resume past behavior at a time when scientists are warning about the ongoing threat of the coronavirus, which may get worse as states reopen for business and people emerge from their homes, relax social distancing rules and refrain from wearing masks.
The pandemic may usher in some major structural changes in the way the nation conducts business and how we interact with one another. Some of the imposed lock-down measures, such as working from home, may become commonplace. Business travel may no longer be the norm, given the ease of video conferencing and cost-savings in terms of time and money.
Firms opting for staggered worker shifts will need less office space, making commercial real estate “the worst business to be in,” Bianco says.
In other words, we may not return to pre-pandemic life as we knew it.
And when it comes to assessing the rebound from what will be the deepest downturn since the Great Depression, “the mistake everyone is making is looking at the restart in absolute terms,” Bianco says. “You unlock door, customers walk in.”
But “the question is relative,” he says. “Do enough customers walk through the door to maintain the level of hiring and profitability that existed before the crisis?”
Real GDP fell an annualized 4.8% in the first quarter of 2020, a number that is likely to be revised lower. If consensus forecasts for a 30% annualized decline in second-quarter real GDP are realized, the economy could be looking at an output hole on the order of 10%.
By way of comparison, the Great Recession witnessed a 4% total loss in real GDP, peak to trough, Bianco says. In other words, 96% of output was maintained. “Yet that was enough to create a bad recession, a 56% correction in the stock market, 10% unemployment, social unrest — the Tea Party, Occupy Wall Street — and heightened political polarization.”
There are no specific tools to revive an economy from a forced shutdown and a recession driven by services. Lower interest rates? Been there, done that. Besides, manufacturing and housing are much more cyclical in nature than services.
Fiscal relief? Some $2.5 trillion has been enacted and more is on the way.
Short of a vaccine, Americans won’t be eager to board an airplane, sit in a crowded theatre or pack into a sports stadium. Nor will they head to the mall on a shopping trip if they can’t try on clothes in the store.
Not only will the public be reluctant to engage in what were normal, pre-pandemic activities, but they also will be more careful about spending money. The personal savings rate shot up 5 percentage points in March to a four-decade high of 13.1%.
Another impediment to a quick rebound is the labor-intensive nature of services compared to manufacturing, which has become increasingly automated over the years. It explains why employment is falling faster than GDP, highlighting the human toll in terms of lost wages and livelihoods.
Looking at the bright side, I read the other day that there’s a lot of “pent-up demand, even for haircuts.”
Yes, I need a haircut. Badly. But I don’t need two: the one I missed a month ago and the one I need today, which I won’t get either. Imagine the level of my pent-up demand next month.
Sorry, it doesn’t work that way with services. With services, it’s here today, gone tomorrow. The old rules don’t apply. Which is one reason why there is no playbook for this recovery. It will be a learning experience for all of us.
