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Commentary: Don’t expect the economy to rebound to pre-pandemic demand

Recent trends in US consumer spending suggest that the natural forces of pent-up demand may largely be spent, says Stephen S Roach.

Commentary: Don’t expect the economy to rebound to pre-pandemic demand

FILE PHOTO: People shop at the Citadel Outlet mall, as the global outbreak of the coronavirus disease (COVID-19) continues, in Commerce, California, U.S., December 3, 2020. REUTERS/Lucy Nicholson/File Photo

NEW HAVEN, Connecticut: As the second vaccine shot went into my arm, I could almost taste the instant gratification of deferred desires. Having done without for nearly a year, it was time to indulge.

While I was lucky enough – actually, old enough – to be included in the first wave of inoculations, the rest of America is about to follow. The possibility that broader vaccine distribution will lead to “herd immunity” by the end of 2021 is no longer fanciful.

And with the end of the COVID-19 nightmare, goes the argument widely discounted in financial markets, long-deprived US consumers can finally relax and enjoy the glorious V-shaped recovery. If only.

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PENT-UP DEMAND LARGELY SPENT

The concept of pent-up demand is well studied in economics. While it typically applies to the consumption of durable goods – cars, furniture, appliances, and the like – it has also been used to describe residential construction activity and business investment in plants and equipment.

The idea rests on a basic premise of dynamic demand models known as the “stock adjustment” effect: An unexpected development that prompts a deferral of spending on long-lasting items with a finite lifetime does not mitigate obsolescence (physical or technological) and the associated need for replacement.

It follows that once the interruption ends, a surge of postponed, or pent-up, replacement demand can spark economic recovery.

Typically, the bigger the shock and the associated deferral of replacement demand, the stronger the rebound. I tell my students to imagine a big rubber band: The more you pull it, the greater the snapback when you release it.

This works well in explaining the temporary impact of what economists call exogenous shocks like natural disasters, strikes, political upheavals and wars. It works less well for shocks that can cause lasting economic scarring – like financial crises and, yes, pandemics.

FILE PHOTO: Healthcare personnel surround a patient who died inside a coronavirus disease (COVID-19) unit at United Memorial Medical Center in Houston, Texas, U.S., December 12, 2020. REUTERS/Callaghan O'Hare/File Photo

Recent trends in US consumer spending suggest that the natural forces of pent-up demand may largely be spent. Over the final eight months of 2020, the post-lockdown rebound of durables consumption was fully 39 per cent greater than what was lost during the lockdown in March and April.

As a result, durables consumption rose to 8.25 per cent of GDP in the second half of 2020 – the highest share since early 2007 and well in excess of the 7.1 per cent average over the 2008 to 2019 period.

There is probably some more to come. On the heels of another tranche of federal relief checks issued in December (US$600 per eligible recipient), the 5.3 per cent surge in retail sales reported for January – dominated by outsize gains for durable items such as electronics, appliances and furniture – provides further evidence of consumer euphoria.

And with an even larger round of US$1,400 checks in the offing as President Joe Biden’s “American Rescue Plan” takes hold, additional impetus from consumer durables seems likely.

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AN UNDERCURRENT OF CONSUMER SKITTISHNESS

At that point, however, pent-up demand should be exhausted. This is even more apparent when assessing the extraordinary power of the recent surge in consumer durables relative to pent-up demand cycles in the past.

Since the early 1990s, recoveries in personal consumption have been relatively muted. 

But in the seven cyclical expansions from the mid-1950s through the early 1980s, the release of pent-up demand boosted consumer durables’ share of GDP by 0.6 percentage points, on average, in the four quarters following business cycle troughs.

From this perspective, the recent increase in consumer durables’ share of GDP of fully 1.35 percentage points from the 6.9 per cent low hit in the first quarter of 2020 is all the more extraordinary. At more than double the earlier cyclical norm, it is all the more unsustainable.

At the same time, the powerful release of pent-up demand, aided by unprecedented support from fiscal and monetary policies, is masking a lingering undercurrent of consumer skittishness that is likely to endure long after the bulk of the US population is vaccinated.

FILE PHOTO: Travelers wearing protective face masks to prevent the spread of the coronavirus disease (COVID-19) reclaim their luggage at the airport in Denver, Colorado, U.S., November 24, 2020. REUTERS/Kevin Mohatt/File Photo

The so-called long shadow of earlier major pandemics offers ample historical precedent for this scenario.

So do recent data showing signs of scarring in the services sector – especially in activities that require face-to-face contact such as travel, leisure, and entertainment.

Vaccines or not, face-to-face interactions are at odds with a now deeply-engrained awareness of personal health risks that will most likely influence consumer behavior for years to come.

READ: Commentary: What vaccine-led recovery? A double-dip recession looks more likely

SERVICES STILL HELD BACK

That’s what the numbers show. Unlike the powerful rebound of consumer spending on durables, the post-lockdown rebound of services from May to December 2020 recouped just 63 per cent of what was lost during March and April.

Unsurprisingly, services, which make up a little more than 60 per cent of total US consumption, are being held back mainly by face-to-face activities such as transportation (travel), recreation (leisure), and restaurant dining.

Collectively, these three spending categories, which accounted for fully 61 per cent of the lockdown-induced plunge in total consumer services, remain 25 per cent below their peak in the fourth quarter of 2019.

READ: Commentary: When economies reopen for business but families are reluctant to spend

This same hesitation in consumer services demand is mirrored by comparable trends in the US labour market. While there has been a significant rebound of hiring since lockdowns were lifted last spring, total nonfarm jobs remain 9.9 million below the February 2020 peak.

Again, the reason is hardly surprising. Fully 83 per cent of that shortfall has been concentrated in face-to-face private services such as transportation, leisure and hospitality, accommodations, food services, retail trade, motion pictures and sound recording, and non-public education.

FILE PHOTO: Servers package food at a table at a pop up restaurant set up in Times Square for 'Taste of Times Square Week' during the coronavirus disease (COVID-19) pandemic in the Manhattan borough of New York City, New York, U.S., October 23, 2020. REUTERS/Carlo Allegri/File Photo

New research points to more of the same: Post-COVID-19 headwinds in services are likely to be an enduring feature of the US labour market.

So, notwithstanding the predictable release of pent-up demand for consumer durables, face-to-face services show clear evidence – in terms of both consumer demand and employment – of permanent scarring.

Consequently, with the snapback of pent-up demand for durables nearing its point of exhaustion, the recovery of the post-pandemic US economy is likely to fall well short of vaccine development’s “warp speed”.

Stephen S Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency Of America And China.

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