Thermometer of the economy dropping below zero

By 6 minute read

Since the global outbreak of the coronavirus, many governments have imposed stay-at-home orders in an attempt to get control of the spreading of the virus. Most developed economies have closed schools, bars, and restaurants. People are advised to work from home as much as possible, and in some industries factories have been closed. All these interventions resulted in a sudden halt of economic activity. Governments are aggressively expanding their budgets to support households and corporates.

As we are still in an early stage of this 'Great Lockdown', it is uncertain what the exact impact on the economy will be. Some early indicators illustrate that economies are heading for unchartered territory, though. In recent weeks one of the most discussed indicators has been the US initial jobless claims. This indicator reports how many people in the United States, the world's biggest economy, have applied for unemployment benefits for the first time. It is published on a weekly basis, which gives us an early indication of the direction and size of the official unemployment numbers.

Chart 1 shows the course of the US labor market since 1967. Periods of recession are shaded in dark blue. The chart displays two major indicators for the US labor market; (1) the unemployment rate, measured as the share of people in the labor force who are actively looking for a job. The unemployment rate is published each month, reporting over the previous month. It thus reports on the state of the labor market with a delay of one month, and (2) the US initial jobless claims. Since 20 March, a cumulative number of 30 million jobless claims were filed. The size of this number dwarfs any period in history in our dataset. As the current size of the US labor market is 164 million people, the enormous amount of jobless claims implies the unemployment rate has risen by an unprecedented amount in such a short period of time.

Chart 1: US Labor Market – initial jobless claims and unemployment rate. Source: Aegon Asset Management, Bloomberg

The current implied level of unemployment is also exceptional in historical perspective: US unemployment peaked at 10% during the financial crisis, and at 11% during the early 1980s recession. The 1930s Great Depression is the only period that tops the current job market misery, when unemployment peaked at 25%. However, we are not out of the woods yet and initial jobless claims are expected to remain elevated in the weeks to come.

Contrasting economic growth impact in previous job market crises

As the job market is generally among the most watched indicators for the state of the economy, we think it is interesting to put the current scenario in a historical context, by evaluating the total economic impact from peak to trough during comparable job market crises. We see that the economic impact ranges from 3.9% to 26.7%, in recessions that lasted between 5 and 14 quarters.

Duration and Economic Contraction of previous crises
Recession Duration Peak to trough contraction
Great Depression 14 Quarters 26.7%
1980s Recession 5 Quarters 2.6%
Global Financial Crisis 6 Quarters 3.9%

Source: Aegon Asset Management, National Bureau of Economic Research, Bloomberg

Is this time different?

So can we deduce the impact by simply looking at previous crises? We believe it is important to comment on specific government measures, the current job market structure and the nature of this crisis via the imposed standstill.

1. Government measures

  • The conditions for applying for unemployment benefits have been loosened. For instance, the self-employed are temporarily added to the pool of eligible people for receiving unemployment benefits.
  • The US policy approach in fighting this crisis while trying to keep the economy afloat is partly assisting employers with their labor costs in order to survive. Companies are offered funds if they utilize at least 75% of this for payrolls. Laid-off workers are also offered more generous unemployment benefits to overcome this period.

2. Job market structure

  • Compared to previous periods of crisis the number of self-employed and freelancers has risen significantly while labor unions have lost power. That makes the labor market more responsive, meaning higher employment when the economy flourishes, but deeper unemployment when economic turmoil kicks in.

3. Government-imposed standstill

  • A consequence of the sudden standstill of the economy is that the number of jobs is falling at an extremely fast pace. Even in a deep recession, unemployment tends to rises more gradually. In this case, however, the unique feature of putting a halt to economic activity overnight has forced companies to lay off workers almost immediately. As a comparison, between the aftermath of the 2008-2009 crisis and the beginning of 2020, the number of paid jobs in the US (measured by US-Non-Farm Payrolls) increased by around 20 million jobs. That number, created over a period of ten years, has been wiped out in a matter of weeks.

Chart 2: US job creation. Source: Aegon Asset Management, Bloomberg

The path ahead: Misery or potential for an evenly fast-paced recovery?

The job market breakdown raises the question to what extent the job losses will be temporary or permanent. The eventual outcome is closely connected to two factors.

  1. The duration of the most stringent measures largely determines whether businesses and households can survive. If the most impactful restrictions can be lifted rather soon, more businesses will survive the lockdown period and can rehire laid-off workers. Having said that, presumably some measures will last longer. That implies that some sectors, such as leisure and travel, have to wait longer before they can revert back to normal. Apart from that, both consumer and business confidence is likely to be negatively impacted, resulting in a prolonged period of suppressed spending and investment.
  2. The potential for labor market resilience. To what extent are employers inclined to rehire workers once demand is reviving (elasticity of demand for labor)? This is related to the type of labor that is impacted the most by the stay-at-home orders. In essence, "non-essential" parts of the US economy were shut down. That includes among others services, retail, leisure, travel, manufacturing and wholesale trade. Most of these industries are labor-intensive, meaning that a significant share of the cost base consists of labor costs. The strength of the demand revival will therefore determine hiring. In addition, mostly the lower-skill, lower- income type of jobs have been hit the hardest by this sudden standstill. By definition, lower-skilled jobs tend to be more elastic than higher skilled jobs. That is because it is more challenging for employers to substitute work that requires a high degree of specialism instead of work that requires a low degree of specialism.

For now we see that the majority of labor suffering from stay-at-home orders is fairly elastic and labor markets should therefore be able to reverse the patterns once measures are lifted and demand returns. Although policymakers do whatever they can to limit permanent economic damage, it is unlikely that the economy, including labor markets, will return to pre-corona levels anytime soon.
In the end, the employment and economic impact is determined by any progress in containing or treating the virus as well as by the decisions of politicians on the way out of this crisis. Methods like contact tracing apps, large scale testing, better treatments and eventually a vaccine can assist in any return to normality. On the downside, risks of second wave of infections loom if measures prove to be ineffective.

Rocky road ahead

The current state of the job market signals 'Great Depression' territory which could mean a long period of subdued economic growth and financial markets heading towards a long period of stress. However, we see clear differences with previous recessions, as government measures, the current job market structure and the nature of this crisis via the imposed standstill are unique features of this economic crisis. The distribution of job losses tell us that the potential for a fast-paced recovery is still alive. It will be a rocky road in the rest of the year, but our base case is that the recovery will also be sharp. However, it is likely to take 1.5 to 2 years before economic output reaches pre-corona levels and we expect US unemployment to be around 7% at the end of 2021.

Bram van Santen

About Bram van Santen

Portfolio Manager