Historical Trends and Post-COVID Economic Insights
When the national unemployment rate went from 3.5% in February 2020 to 14.7% in April 2020, the U.S. economy underwent a fundamental change that few are yet to comprehend. During those three-plus months when downtowns were deserted, highways empty, and airports shuttered, consumer and business spending patterns changed, and those newly formed habits won’t be easily unwound. Some won’t ever be unwound.
In this brief narrative, let’s explore some of those fundamental shifts and how recent history has shown us what the next few years will look like.
The Impact of Unemployment
Unemployment peaked in April 2020 and then fell to 10.2% in July (7.4% in Colorado), but prior to this year, the highest unemployment rate the U.S. ever experienced was 10.8% in December 1982, when the Federal Reserve tanked the economy to push unemployment up in an effort to reduce inflation. It took six years and three months for unemployment to drop to 5.0%, which it finally did in March 1989, just before the next big downturn.
The peak unemployment rate from the last recession was 10.0% reached in October 2010. It took five years to drop down to 5.0%.
We are starting from a higher unemployment base this go-around so it is likely we will be looking at more than six years before the national economy approaches 5.0% again. This is especially true today because some businesses that existed pre-COVID won’t exist post-COVID requiring some workers to develop different skills as they transition to different industries.
A case in point: pre-COVID, one in twelve employees in Colorado worked in the restaurant industry. Quite a few restaurants have already decided not to reopen after shutdown orders were lifted, and many that have reopened are operating at 50% capacity or less. Outdoor seating that has spilled onto the sidewalk or into the road is helping keep some restaurants going now but won’t help once winter arrives. In Denver, we have seen around 200 new restaurant openings each year for the last few years. Restaurants that were just getting by in the past, won’t survive today because of higher operating costs and the fact that some consumers won’t return to indoor dining for a while, if at all. It is likely that many former restaurant workers will need to find other careers.
The negative side effects of sustained high unemployment are well documented. The lifestyle changes that result drastically change spending patterns and result in an increase in evictions and homelessness, higher divorce rates (already on the rise as a result of COVID confinements), more domestic violence, more suicides, increasing mental health issues, and also more physical health issues that can shorten lifespans. Prolonged unemployment can also lead to an erosion of skills while also drastically changing how individuals plan for their futures.
Labor Force Participation
A less obvious but more critical difference between the three dates referenced above, December 1982, October 2010, and July 2020, is the labor force participation rate at each of these points in time. In December 1982 the labor force participation rate was 64.1%. In October 2010 it was comparable at 64.4%. But in July 2020 it was only 61.4% (61.7% in Colorado).
The labor force participation rate highlights the proportion of working age adults that are either working or are actively looking for work. With the CARES Act providing reasonably generous federal unemployment payments (a University of Chicago study showed that 66 of recipients were receiving CARES Act benefits that exceeded lost wages, including 20% who received benefits at least twice as high as lost wages), one might imagine that the labor force participation rate would have fallen a little, but a decline of this magnitude is unprecedented. You have to return to 1974, when women comprised only about 28% of the workforce, to find a rate equally as low. (Women comprise about 46.8% of the workforce today).
So why have almost 40% of all potential workers in the United States stepped away from employment? There are apparently many reasons. Baby boomers like me are continuing to retire. There are more stay-at-home dads these days as well. Then there's globalization (and let me return to the “China Effect” a little later on), which has given consumers access to a greater variety of goods and services at lower prices than ever before, while emptying out large parts of the US industrial heartland. A failing education system is also part of the mix, as is a rampant opioid addiction problem in many parts of the county. A lack of basic work and skills training for non-college-bound students is in there as well, along with the fact that there are millions of people with criminal records, about a third of all the men who have removed themselves from the workforce, who can't get hired. With job prospects bleak, many potential workers end up filing for disability support.
A participation rate as low as it is today combined with an unemployment rate as high as it is today, doesn’t bode well for the US economy over the next few years, and once all the trickle-down and trickle-up effects of federal, state and local government stimulus move through the system, the small business sector will find fewer customers willing to spend as much as they previously did on things they thought they wanted, so business itself will change.
Consumer Spending Patterns
The largest single component of Gross Domestic Product (GDP) is consumer spending, which has grown steadily over the decades to around 67% of GDP today. (GDP is the value of the goods and services produced in the United States and its growth rate is a good indication of the nation’s overall economic health.)
Real GDP decreased at an annual rate of 32.9% in the second quarter of 2020, hard on the heels of a 5.0% decline in the first quarter. You can see in the chart below how personal consumption expenditures took a deep breath as the county shut down, and then let that breath part of the way out as CARES Act stimulus checks arrived.
If you can convince consumers to keep spending money on goods and services, the economy usually hums along even during a recession. But when people stop spending, which they will do if faced with unbounded uncertainty, they will try to save what they can for a rainy day and/or pay down as much of their personal debt as they can.
There was a lot of this after the last recession, when the personal savings rate temporarily jumped to a level not seen in decades. We will also see a lot more saving this time around. And if people are saving, they aren’t spending so the demand for goods and services will likely decrease.
The last recession was driven by the financial sector. This one by the pandemic. Accordingly, we won’t have to put up with the “too big to fail” rhetoric that we had to endure last time. Banks are in a very strong position to ride out this recession.
An FDIC report from 08/25/20 on the 5,066 banks they insure, highlighted the fact that although banks reported lower profitability in the second quarter of 2020 than the comparable quarter in 2019, that decline in profitability was primarily due to increases in “provision expenses” of $49.1 billion, to bring bank rainy-day-loan-loss-reserve funds up to a collective $61.9 billion. They are anticipating more loan defaults and losses, yes, because we are now in a recession. And this one will be the biggest since the 1930’s.
It is also worth noting that for the second successive quarter, deposits into banks from businesses and individuals increased by more than $1 trillion. That is a lot. Banks thus have strong liquidity and are well capitalized.
The Board of Governors of the Federal Reserve System also publishes quarterly updates on bank charge-off and delinquency rates. There was a very slight uptick in delinquency rates for the second quarter of 2020, primarily related to residential, agricultural, commercial building, leases and business working capital loans, and a slight reduction in delinquency rates on consumer loans (consumers have been working to pay off existing debt), but this notwithstanding, overall, banks have MUCH lower delinquency rates now than they had in the few years leading up to the last recession, so there are no immediate concerns about the banking industry or the need for any support for that sector.
What we will likely see, however, is a reluctance for banks to make new loans in the very near term. This happened for the few years immediately post-stimulus support during and after the last recession, and there is no reason to anticipate anything different this go around. You can lead a banker to a borrower, but you can’t force a banker to make a loan, especially when the regulators are pressuring banks to not make loans. One very large bank is already telling new customers that they are no longer making small business loans.
Usually government supported programs like the Small Business Administration (SBA) 7(a) guarantee and SBA 504 owner-occupied commercial real estate loans are utilized more heavily by banks in recessions; but this wasn’t the case last time and given all the COVID uncertainty associated with this recession, it appears likely that fewer SBA loans will be processed by banks over the next few years as well.
With the likelihood of fewer lenders being willing to make as many loans to businesses and consumers as they did pre-COVID, the ball will firmly move into the nonprofit lenders’ court for that sector to try and help as many small businesses as possible survive and rebuild during the upcoming post-COVID years.
State and Local Government Sector
It doesn't take a crystal ball to see that even as the economy begins to recover in 2021, many states and localities will remain underwater because of the revenue losses this year, causing them to lay-off staff while simultaneously struggling to maintain public services in the face of continuing revenue shortfalls. How communities change as a result of this is still to be seen, but there will be changes. And likely higher fees and taxes to ensure that at least basic services are maintained.
Small Business Sector
When it comes to the small business sector, let’s look at Colorado as a bellwether for what we might see in the rest of the country. (Just don’t look up the word “bellwether” until later.)
Colorado is a relatively pro-small business state and thus more entrepreneurial than many. Twenty-three out of the last twenty-six years, ALL the net new jobs created in Colorado were created by startup businesses within their first year of operations. The three years that startups didn’t create all the net new jobs in Colorado were the three years after the last recession.
Let me illustrate with some numbers from the Bureau of Labor Statistics (BLS) who does a wonderful job tracking business births, survival rates, and job impacts each year, in every state. Let me qualify these numbers in advance by stating that BLS only tracks businesses with employees because these businesses are trackable. For every four businesses in a state like Colorado, only one will have employees. All the others are sole proprietors without employees, gig workers, independent contractors and the like. These solo types of businesses are hard to track because they come and go like “sands through the hourglass”. Anyone can start a gig business today and shut it down next week, and no one would probably know. Having employees involves filing documents with the IRS, so someone knows you are out there.
But back to Colorado.
In 2007 there were 16,053 new businesses with employees launched in Colorado that year, creating 71,928 new jobs (4.5 jobs per company) but by 2010, the number of startups that year had declined by 25.6% to 11,427 with new firms creating just 47,035 new jobs (4.1 jobs per company). A similar pattern is anticipated over the next three or four years, with, yes, some new startups creating some new jobs, but fewer startups and fewer jobs overall.
Last December, the annual Colorado Business Economic Outlook predicted the state would add 40,100 non-farm jobs in 2020, all of them created by startup firms (when you factor in openings, expansions, closings and downsizings by the age of the small business, per the 2019 chart below).
The Leeds Business Research Division at the University of Colorado Boulder recently issued their mid-year update, and this is now predicting the loss of 128,500 non-farm jobs in Colorado this year.
With that many people out of work in Colorado by the end of the year, and federal stimulus unemployment payments no longer available, some businesses will not have the customers they had pre-COVID just because consumers will reduce expenditures as they focus more on “needs” and less on “wants”.
There will be fewer businesses around, period, because fewer small businesses with employees will be able to launch and other businesses providing goods and services that consumers will forgo in the depths of a recession, will not survive long into 2021. Yes, there will more individuals starting or attempting to start solo businesses because they won’t be able to find meaningful employment, and after the last recession we saw a lot of people working to reinvent themselves as solo business owners, but this row will be a hard one to hoe for many, and the ability to create businesses big enough to have employees will be challenging because limited, reasonably-priced financing won’t be available from typical financing sources (other than from nonprofit lenders).
The “China Effect”
Imports of good into the U.S. from China totaled $539.5 billion in 2018, up 6.7% from 2017 and up 59.7% from 2008. This 2018 number represents some 21.2% of overall imports into the U.S., which is a fairly significant percentage. In the regulated lending industry, anything more than 20% represents a concentration which any regulator worth their salt would write up as representing “too big of a risk”.
Cheaper Chinese goods flowing into the country have arguably improved the quality of many lives by making goods more affordable and thus available, but America’s dependence on Chinese supply chains is troubling in the context of geopolitical risk. Many businesses, big and small, are overly dependent on products sourced in China and during a pandemic or when hostilities breakout in Southeast Asia (who else has Taiwan for 2022?), those dependent U.S. businesses will have to scramble to survive.
As a nonprofit lender on the economic development side of the fence, I would certainly prefer to make a loan to a small business that didn’t have all its eggs in a Chinese wicker basket, for a myriad of reasons including those above. I love to see small new manufacturing firms being established and growing in Colorado. Even as a consumer, I will go out of my way to avoid buying Chinese goods because by doing so I am tacitly supporting a country I don’t wish to support, but I digress, as I am often to do … as both of my regular readers know.
Too Small to Survive
Where does all this leave us?
Well, many federal, state, and local government programs and a plethora of private sector initiatives have already been activated to help small business survive and rebuild. All existing businesses ought to equally be able to access these programs and hopefully use the breathing space that grant funding or very low interest rate loans provide, to ensure their business model is sustainable in the coming economy. If that business model is no longer sustainable because, for example, in a post-COVID world, people aren’t attending sporting events so there are no crowds to sell bottles of water to outside a baseball stadium on a hot day, how is that business going to reinvent themselves?
Small businesses survive and thrive by creating opportunities out of problems. We will have many more problems in search of opportunities in the years ahead. Those problems will be different from those we’ve had before, but there will still be opportunities. Many of them.
And yes, unfortunately, some small businesses will be too small to survive the transition from a pre-COVID world to a post-COVID world. Most nonetheless will.
The objective of this wandering collection of thoughts is not to paint a future that is all doom and gloom. We have been through worse than this before. The future will necessarily be a little different from the recent past. High levels of unemployment are likely to widen the gap between the “haves” and “have nots”, which will result in more social unrest in this county (because this is what has always happened in the past … remember the Occupy Wall Street movement of 2011?), and then if you throw in a polarizing national election that no side is truly capable of winning into the mix, you have a recipe for a very different small business world at the start of 2021 than we left behind earlier this year. Sure as eggs is eggs.
And in four more months, you’ll positively be able to tell everyone that hindsight is 20/20.
I know I will.