I hope you and your loved ones are staying safe.
In the previous edition of The Difference Principle, I chose to focus just on the coronavirus. This month, the structure will be returning back to ‘normal’ (whatever that means for a newsletter that is just now publishing its third edition).
First, a few quick updates. I’ve received helpful feedback from readers and have made a few changes:
Unemployment may rise to as high as 30 percent. By contrast, this number was 10 percent at the peak of the 2008 Financial Crisis. And in some states, one-fifth of workers are already unemployed. Meanwhile, the International Monetary Fund put out a grim report that stated this recession will feature a fall in output of three percent. This number was less than 1 percent from 2008-2009, making the Coronavirus Recession (or Great Lockdown) the worst recession since the Great Depression. The biggest hit will come in the second quarter, when the US economy is estimated to shrink by $1 trillion, according to the Congressional Budget Office.
It’s no surprise that banks are putting aside lots of money in preparation for a big recession and that a Gallup poll finds that 50 percent of Americans now say their financial situation is getting worse— the highest number in Gallup’s polling in two decades.
Why are things so bad? After all, the coronavirus is less deadly than the 1918 flu pandemic and so far no deadlier than the 1957 and 1968 pandemics. Much of this has to do with the changing nature of the economy. The shift from an agriculture and industry-based economy, with less close personal contact, to one dominated by services means that more occupations are affected. As high as 47 percent of GDP last year came from services. These are baristas, Yoga instructors, musicians, and so on.
One particular way this economic shock is manifesting is in the rise of defaults. Nearly 60 percent of Americans lack the savings or the ability to borrow from friends or family in order to withstand an emergency like this and cover three months of living expenses. It’s consequently little surprise that the housing market is now preparing for a wave of defaults. The Federal Reserve reports that in Dallas “credit quality eroded across most loan types and most bankers expect further deterioration.” In San Francisco, “several banks readied emergency credit lines and expected credit quality to deteriorate as broad economic conditions turn for the worse.” Already, millions of homeowners are skipping their monthly payments and the number of home loans in forbearance is rising. If predictions about an even worse second-quarter meltdown are true, it seems that these trends will continue. The “Spotlight” piece in this newsletter will discuss the problems with American private debt in greater detail.
So how is the US responding to this economic crisis? And what does it mean for inequality? First, the Federal Reserve cut interest rates to near zero and is pursuing quantitative easing, among a number of other approaches that you can read about here. The total $2.3 Trillion Injection far exceeds its 2008 rescue. To help out mortgage firms, Fannie Mae and Freddie Mac may soon purchase loans in forbearance, taking those “bad loans” off those firm’s balance sheets. And despite the exhortations of many writers against a corporate bailout of the airline industry, which spent considerable money on stock buybacks throughout the past decade, the US government offered $25 billion in payroll support, another $25 billion in loans for passenger airlines, and more than $10 billion in grants and loans for cargo airlines and aviation contractors.
All of this is why it might make sense that stock prices have gone up in some cases all while the economy contracts. Much of the corporate world seems to feel secure that they will be bailed out by the US government no matter what.
Unfortunately, the rest of America seems set to both foot the costs of these bailouts (today and in the years to come), and smaller businesses and lower-income individuals are losing out in the stimulus. The rollout of the stimulus dedicated to helping smaller businesses that couldn’t afford to finance themselves through traditional means has been a disaster. More than 80 public-sized companies used up emergency funds that were designated for smaller businesses. Within just days, the first round of money ran out and countless small businesses were shut out from access. On the state level, things ranged from worse to even worse, as many quickly burned through their low levels of unemployment insurance, and many individuals may not get their checks until August.
In general, I try hard to be impartial when writing these newsletters in order to give space to the amazing researchers and journalists who can help shed light on the nature of economic inequality. Yet it’s difficult to escape a deeply troubling conclusion about the nature of the US economy. Far from “capitalism” (whatever that means), the American economy practices socialism for a rich asset-holding class and rugged individualistic capitalism for the rest.
On that cheery note, here are, once again, some resources to help you pass the time during this quarantine:
Please take care of yourself and those closest to you.
Thank you for reading. See you in June.
—Julian, writing to you from Ghent, Belgium
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A Crisis of Deflation and Debt May Cause Higher Inequality
In economics, deflation simply refers to a decline in the prices of goods and services. This reduction in prices is typically associated with a collapse in the supply of money and credit. Deflation can be a consequence of a recession, but deflations are also rare because employers are more likely to fire workers than lower wages. Japan is notable for experiencing a deflation crisis on and off for 20 years. Yet the US hasn’t seen deflation since the Great Depression. A major report out of the Massachusetts Institute of Technology and a number of articles published in the past month show that the US may be on the verge of deflation. This could be catastrophic for economic inequality.
First, the MIT piece. The authors summarize their findings with the statement that “supply creates its own excess demand”. What they mean is that a negative supply shock—e.g. the social distancing measures and shuttering of many firms—can cause a demand shock—i.e. A reduction in how much consumers are spending—far greater than the initial supply shock. This is particularly pronounced, the authors find, when shocks are concentrated in certain sectors more than others, as they are with the current shut down. If the MIT article’s predictions are correct, the US will begin to experience deflation. A recent article in the Financial Times explains this in detail. According to Keynesian economic theory, if the collapse in demand falls more than supply, prices will begin to fall, which means the purchasing power of each dollar will be greater.
Why does this matter so much? The answer in a word is debt. When deflation occurs, the real value of debt rises, making it harder to pay off. So if I borrowed $10,000 to fund a year at college, a rise in deflation would mean that the real value of that $10,000 is now greater than the $10,000 I initially borrowed. And so that debt has just become harder to pay off. Good thing, then, that the US doesn’t have historically high levels of private debt…
This month, the New York Times reported that corporate debt soared over $10 trillion among nonfinancial corporations. The Wall Street Journal reported that millions of credit card users are already missing their payments as the “debt bubble” bursts. Banks will only be able to shoulder this financial burden for so long, and Capital One stated that a rising number of its credit card accounts were already enrolled in a deferral program. For young people, things are particularly grim. Prior to the crisis, roughly 40 percent of students were on track to default on their loans by 2023. Unfortunately, this makes sense — as Rana Foroohar of the Financial Times reports in a column this month, students have been saddled with massive amounts of student debt for degrees that can be worthless and are producing diminishing returns to wages (see Spotlight from last month).
The fact that less-wealthy individuals and families are saddled with historically high debt appears incontrovertible. If the real value of that debt increases while people simultaneously losing their source of income, how are they supposed to pay that debt off?
Savings would be a start. Unfortunately, the high levels of private debt are matched by low levels of savings—since the 1980s the US has incentivized debt over savings and encouraged the growth of the financial sector. In addition to spurring higher inequality, this economic philosophy is also responsible for a world in which less than 50 percent of Americans have enough savings to survive three months, according to a Wall Street Journal report this month. And oh, by the way, their definition of “savings” includes the possibility of selling assets (e.g. your home and, presumably, also your limbs) to survive as well as an individuals’ abilities to borrow from friends and family, which would probably be limited during a historically bad recession.
By contrast, a report this month in the National Bureau of Economic Research showed that the wealthiest Americans had built up a “glut of savings”, rather than spend their excess cash on productive investing, as conservatives argued. Moreover, the study found that the emergence of this glut in savings is causally linked to the dramatic rise in household debt for the bottom 90 percent of US households.
All of this is why a Coronavirus Recession in which deflation occurs will spur even higher economic inequality in an already unequal country.
So what is to be done? A recent article in Bloomberg argues that “the Fed will not be complacent to the deflationary implications of falling wages, but at the moment it is primarily focused on ensuring smooth functioning in financial markets via a wide array of liquidity programs. The goal of these programs is to prevent a financial meltdown that would only intensify the deflationary pressure.”
Unfortunately, it seems that this will not be enough. Nearly all the pieces I have discussed in this month’s “Spotlight” seem to underscore the point that the convergence of debt and deflation could spur a dramatic rise in economic inequality as well as a potential second-wave of this recession. A serious fiscal response and movement for progressive economic redistribution may be essential.
If you’re interested in hearing more about this, I have a long-form feature on this topic coming out in a national magazine in the next few months. You can sign up to receive that piece here.
~Business and Finance~
As American incomes take a hit, stress in the housing market will make this recession steeper and longer-lasting
In a recent appearance, Former Federal Reserve chairman Ben Bernanke stressed that, though the financial imbalances and risks that ultimately spurred the 2008 financial crisis grew over the course of years, the Coronavirus Recession is unique and perhaps unprecedented in its scope, cause, and severity. Yet just as a spike in mortgage defaults corresponded with the 2008 crisis, we are now in the midst of a spike in missed mortgage payments. As part of the stimulus package, households are able to request forbearance for up to 12 months, and the number of households electing for forbearance has increased—this has hurt mortgage firms, which originate 60 percent of all US mortgages. In the presentation published in the American Enterprise Institute, the author explains that the set up of the housing market and its stressors ensures that the economic recovery from the Coronavirus recession will last longer than optimists think (a V-shaped recovery, and not a U-shaped recovery). The government has extended forbearance for up to 12 months to 93 percent of all mortgage loans (100 percent of single-family mortgage loans). And yet during a steep recession, the author argues that delinquencies will rise despite the stimulus provisions. Meanwhile, the servicers of loans will need to find some way to pay investors. The presentation outlines a number of steps the US could take to address these challenges, warning about the risks of greater economic suffering if bold action is not taken. Read
The Coronavirus Recession has caused massive dislocation among small businesses
By surveying 5,800 small businesses, this report offers a portrait of how the Coronavirus Recession is affecting US small businesses. In the sample, companies cut their staff by an average of 40 percent, and 43 percent of businesses were completely closed. These small businesses are also financially fragile, with the median company having less than one month of cash on hand. As for the stimulus, 70 percent of respondents stated that they planned to take advantage of aid in the CARES Act. Of the remaining 30 percent that did not apply, most companies cited concerns over administrative complexity and eligibility. The study’s final observations are that companies had ranging opinions on how long the Coronavirus’s economic effects would last. Read
Estimating returns on undergraduate and graduate degrees
This study provides a comprehensive survey of how both undergraduate and graduate degrees affect future earnings and which degrees see a higher wage premium. The report is particularly interesting because it attempts to estimate what individuals would receive in their preferred profession had they not received the degree. The findings, which are effectively summarized in the figures at the end of the report, unsurprisingly shows that graduate degrees in medicine, law, and businesses-related fields see its members command the highest wages. The humanities, art school, and social work come at the bottom. And while some graduate degrees have particularly diminished returns on wages, BA degrees were all indispensable in spurring higher future earnings. Read
Previous pandemics have reduced inequality. Will the coronavirus?
In the last edition of this newsletter, we discussed Walter Scheidel’s research in “The Great Leveler”, in which he shows that plagues are one of four types of catastrophes that have reduced inequality throughout history. In the past few weeks, a number of pieces have come out that speculate about how the coronavirus will affect the gap between the rich and the poor. One of them is by Walter Scheidel himself. Writing for the New York Times, he makes the case that although pandemics have certainly reduced inequality in the past, many of them did not. First, there are many instances of countries stifling the effects of a plague on redistribution by forcing workers to perform their tasks at pre-crisis wages (e.g. the Mamluks of Egypt). What’s more? When inequality did collapse during a pandemic, it was short-lived and lasted only as long as it took the population to recover. Real and lasting change, Scheidel argues, is ultimately up to policymakers. Meanwhile, writing for the Financial Times, Angus Deaton provides a brief history of how recent developments in health care might limit the effects of the coronavirus on redistribution. You can also check out a blog I wrote on the topic here. I argue that the coronavirus will impact inequality differently to any previous pandemic because of the fundamentally different nature of a digital economy. Read Scheidel. Read Deaton. Read the blog post.
Households’ spending habits are sensitive to bad economic news as well as the stimulus.
In the “Spotlight” section, we explore the possibility and implications of deflation due to a considerable decline in aggregate demand, brought on in part by a decline in consumer spending. These two pieces are important because they can give us a picture of how both the deluge of bad economic news and the stimulus are affecting consumer spending. The first of these by economists at NBER finds that households’ spending habits appear very sensitive to macroeconomic news, even when the news is not real. Following the announcement of a local unemployment rate reaching a 12-month maximum, consumers in that area reduced their spending by 2 percent and their credit card repayments by 3.6 percent relative to individuals in other places that did not receive the announcement. These effects were even more pronounced among low-income households. How is the stimulus package addressing this? A report in the Becker Friedman Institute finds that each dollar of stimulus money increases consumer spending on average by $0.25-$0.35 within ten days, and this effect is greater in less wealthy households. Read NBER. Read Becker Friedman
~People and Places~
Women work in occupations particularly hurt by social distancing restrictions
In past recessions, men’s employment was usually more severely harmed than women’s employment. Yet this report in the National Bureau of Economic Research shows that the Coronavirus Recession and social distancing measures are affecting women’s employment more than a “regular” recession. This is because, the authors explain, women often work in sectors where social distancing measures have been particularly damaging, such as in child care. The report argues that the effects of the crisis on working mothers may also be persistent even after the crisis is over. Yet the authors do note that the breaking of traditional social norms around the division of housework means that more fathers are responsible for child care. This may offset some of the effects of the Coronavirus Recession on gender inequality. Read
~Social Security and Taxation~
Reforming Unemployment insurance
Last month, we discussed how many US states were resoundingly unprepared for this recession and the need to dish out more money in unemployment insurance (UI). In this report published in The Brookings Institution, the authors highlight many of the major problems with the UI system prior to the crisis. For instance, the authors show that many states only replaced 36 percent of a production and nonsupervisory worker’s average weekly earnings.Tipped workers—restaurant staff, for example, fared even worse because 52 percent of tips are not reported (Treasury Department figures). Many states had not fully replenished their reserves after the 2008 Financial Crisis, and states like Florida decreased the amount of time someone could receive benefits to just 12 weeks. Since the lockdowns began, the US has made unemployment insurance more generous, but many states are struggling to deal with an overhauled system while simultaneously using old technology to process a deluge of new claims. The report concludes with a series of suggestions about how UI might be permanently improved after the Coronavirus Recession is over. A report in the Upjohn Institute reaches similar conclusions. Read.
Does the US tax code favor automation?
Daron Acemoglu and co. are at it again. If you are interested in learning about how automation is affecting workers, I strongly recommend checking out this group’s past work. In this paper, the authors find that the US tax system is biased in favor of capital (labor-saving machines, in this case) and against workers. They argue that this privileging of automation cooked within the US tax system has produced inefficient levels of automation because many automated tasks may displace workers without actually producing significant productivity gains. The end result is that employment is lower than it should be. Acemoglu and co. show that reducing labor taxes or increasing automation taxes, among other suggestions, can increase employment by slightly over four percent. This would also restore automation to its optimal level, boost labor's share of income, and ward against wage stagnation. Read
Internet access, the coronavirus, and inequality
In April, this newsletter discussed how the effects of social distancing have been particularly damaging to low-wage workers, whose occupations are disproportionately physical. In a recent blog, the Economic Policy Institute shows that low-income students are more likely to face long-term academic disadvantages from the shift to e-learning. The piece argues this is a consequence of the “technology divide”—for example, the fact that a quarter of lower-income eighth graders don’t have access to a computer at home and seven percent don’t even have internet. In a somewhat related report, the National Bureau of Economic Research published a working paper that tracked 20 million mobile devices to learn about peoples' ability to self-isolate and work from home during the global pandemic. They found that wealthier individuals were more likely to have high speed internet and consequently more likely to be able to stay at home. On the other side, consider a report in the New Republic that found millions of Americans were leaving their homes to work jobs that pay $15 an hour. Read Economic Policy Institute. Read NBER
What Else I’m Reading
The IMF is predicting the worst downturn since the Great Depression (International Monetary Fund)
Pandemics, unlike even wars, catalyze persistent macroeconomic effects up to 40 years after they occur (National Bureau of Economic Research)
The Great Recession hit smaller communities hardest. This recession is hitting the biggest cities first. (Brookings Institution)
The recession is disproportionately hurting rural people, especially those with disabilities. (University of Montana Rural Institute)
A primer by Brookings on which workers have already been affected by the Coronavirus Recession. (Brookings Institution)
Wealthier New Yorkers are less likely to contract the coronavirus and more likely to have access to testing. (National Bureau of Economic Research)
Since the White House announced this “historic public-private partnership,” 63 sites testing sites have opened nationwide. Just eight are in black neighborhoods. (Vox)
The 600 dollar bump in unemployment insurance through the CARES Act has widely different purchasing powers by state, showing that equal does not imply equitable. (St. Louis Federal Reserve)
The coronavirus disproportionately threatens businesses owned by women and minorities. (Brookings Institution)
An excellent survey of major economists on whether to allow the lockdown to continue or to open up the economy. Nearly all supported the idea that a sustained lockdown was preferable to opening up the economy. (University of Chicago Booth School of Business)
The impacts of the coronavirus on stock prices have ranged based on 1.) a firm’s reserve cash and debt, 2.) it’s supply chain’s exposure to the virus, 3.) it’s levels of corporate social responsibility, 4.) the level of entrenchment of a firm’s executives. (National Bureau of Economic Research)
Some companies spent money on stock buybacks. Now they want a bailout. (New York Times)
Private equity is winning the coronavirus crisis. (Vanity Fair)
The Fed has given its blessing for banks to pay dividends, which will total $40 billion for the largest lenders this year. (New York Times)
During economic booms, corporate fraud increases. This recession will reveal decades of it. (The Economist)
41% of global startups have less than 3 months of cash left. (Venture Beat)
Delays in processing unemployment claims are keeping workers from receiving the aid they need. Consider this example from New Jersey (NorthJersey.com). Some workers may not be able to get stimulus checks until August. (AP News)
Individuals—mostly lower-income—who do not have automatic payments set up will need file tax returns if they want their stimulus money, creating a barrier to entry. (New York Times)
Stimulus Loan rules exclude industries seen as morally questionable, including strip clubs and marijuana shops. (Wall Street Journal)
From Subway to Walmart to IHOP—a list of the companies that are and are not offering paid sick days during this pandemic. (New America)
Tens of millions of Americans Are risking their lives for less than $15/hr. (New America)
States can quickly expand Medicaid to provide coverage and financial security to millions. (Center on Budget and Policy Priorities)
Americans are still being evicted during this pandemic. (City Metric)
Households’ inability to obtain a mortgage refinance during the coronavirus will limit the ability of homeowners to find security. (The Brookings Institution)
Coronavirus bursts the US college education bubble. (Financial Times)
The coronavirus is going to explode the achievement gap in education. (Economic Policy Institute)
When privileged college graduates marry, they increase inequality. (National Bureau of Economic Research)
Emmanuel Macron says we may need to rethink capitalism in response to the coronavirus. (Financial Times)
How technological innovation in competing firms affects workers’ wages at other firms. (National Bureau of Economic Research)
Relationships and autonomy are the greatest contributors to a “meaningful job”—income comes near the bottom. (Brookings Institution)
From the Bookshelf
“Crime and Punishment: An Economic Approach”, Gary S. Becker (1974)
This study by Gary Becker—a Nobel-prize winning economist—offers a hypothesis about how high levels of inequality might produce a higher crime rate. His argument was that potential criminals might adopt a cost-benefit assessment in which the rewards of breaking the law exceed the threat of punishment. In simple terms, inequality might make crime seem worth it to a greater number of people. I chose to highlight Becker’s study this month because, since this study was written, modern research has come to support Becker’s theory. According to a study by Gallup, which surveyed 148,000 people in 142 countries, more unequal countries have higher rates of crime and perceptions of danger. And research by Daniel Hicks and Joan Hamory, shows that these trends are also true domestically among US states. A 2002 study by the World Bank goes even further, arguing that the correlation between crime and inequality is deeply causal, even controlling for other factors affecting violent crime rates. Read
What I’ve Been Working On
Quote of the Month
“US universities are world-class. But the system as a whole is in trouble. Cost is a big part of the problem… Soaring tuition fees, worthless degrees and dicey investments made by both universities and the government have become a huge headwind to economic growth and social mobility. If you don’t believe me, take it from the New York Fed, which two years ago called out student debt and the dysfunctions of higher education as problems for the overall US economy. That’s a sad irony, given that a college degree is supposed to increase wealth and productivity. Unfortunately, the US system of higher education — like healthcare, housing, labour markets and so much else in America today — is bifurcated. Those with fancy brand-name degrees from top schools do great. So do many who attend high-quality, low-cost community and state programmes. But millions in the middle get neither a cheap nor a useful education.”
—Rana Foorohar, “Coronavirus bursts the US college education bubble”, 2020
Thanks for reading! See you in May.
That’s a wrap on this edition of “The Difference Principle”
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