The Pandemic Productivity Shock
“Creative destruction” was Joseph Schumpeter’s classic description of how bad businesses fail to make room for new ones. This pandemic, not unlike a meteor from space, has wrought much “destructive destruction” as well, and the job for investors remains to assess what will be created when the world returns to shaking hands, swarming shops and filling sports arenas.
The economic consensus continues to predict more years of low inflation, low interest rates and low returns, but there will also be significant pockets of rising productivity and handsome returns. The tricky part for markets will be balancing the financial promise of innovative business models with the political risk of rising joblessness.
In the very short term, productivity gains will come from the plain old cost cutting that every recession triggers. Recall a year ago, when market watchers worried the U.S. expansion had surpassed previous records leaving firms increasingly lazy and fat.
The initial lockdown shock and brutal labor-shedding delivered at least a temporary boon in the United States, where second quarter productivity shot up 10.1%. This will not last through the fall and winter as more employees return to work, but the labor-intensive hotels, stores and restaurants that have been hardest hit by the lockdown will not be bringing everyone back anytime soon. This is where the longer-term problems begin.
The next job cuts may be more gradual as U.S. unemployment benefits and European furlough programs inevitably phase out. Still, there will be more when bills come due for firms that look liquid but are not necessarily solvent. Bankruptcies and consolidation will deliver their own productivity gains.
“These changes look good for productivity overall and profitability for those investors who can identify the patterns and locate the best firms and managers to drive innovation. The common thread that binds all of this progress, however, is job destruction at existing firms.”
But productivity has been trending lower in the U.S., Europe and Japan through several business cycles, making the problem more than cyclical and leaving many economists scratching their heads. Some blame underinvestment, some say the statistics don’t capture real gains and still others blame government bailouts and easy money that have kept so-called “zombie” firms alive.
LABOR PRODUCTIVITY, ANNUAL GROWTH RATE (%)
The “undead” have indeed been a significant drag as a new study by the Bank for International Settlements reckons their share of firms across 14 countries more than tripled in last three decades. Worse, only a quarter of them went out of business, while some two-thirds actually emerged from formal zombie status to lumber along with suboptimal profitability compared to their peers.
A further boost to productivity will come, however, from an impending wave of technological innovation that was already gathering momentum before the lockdowns and now may only accelerate.
Thomas Edison filed his patent for the electric light bulb in 1879 (yes, building on the inventions of others before him), but it took decades before the ability to work in the dark transformed production patterns and business models. If we have exhausted the initial gains from globalization and the Internet, we have not yet begun to fully benefit from cheap mobile telephony, vast cloud storage and the earliest promises of artificial intelligence.
These will come even faster as firms apply the technology to new post-pandemic demand patterns. Sooner or later, those patterns may creep back to resemble the world before 2020, just as they did in the wake of the September 11 attacks, when airline travel looked like it would never be safe again. But if we do resume attending splashy business conferences, they will include more ways to participate remotely. If we do start to fill rows of open-plan desks again, it may not be for 40 hours a week. There will likely be better ways of organizing production lines and staffing hotels, too.
All of these changes look good for productivity overall and profitability for those investors who can identify the patterns and locate the best firms and managers to drive innovation. The common thread that binds all of this progress, however, is job destruction at existing firms. If robots have laid waste to many manufacturing jobs, we are on the cusp of change in which remote technology and data algorithms will destroy a large share of clerical and middle-management jobs. And without the right government policies, we will face a rising share of unemployed or underemployed workers.
All of which brings us back to Schumpeter, whose most famous words were actually inspired by a close reading of none other than Karl Marx. Capitalism, Schumpeter wrote, unleashes a “process of industrial mutation that continuously revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” In much the same way, however, he warned that a process that relies so heavily on destruction also risks undermining its own foundations.
As productivity improves and investment opportunities emerge from the destruction of the great pandemic, there will also be challenges. Overdue attention to corporate profitability and powerful technological change may fuel further waves of social discontent that put these gains at risk.