You have White House officials pondering whether more fiscal relief is truly necessary. Citing “the momentum that we’re beginning to see over the last couple of weeks of data,” Trump economic adviser Kevin Hassett argued “one might conclude that the stimulus that we’ve already passed is enough."
On the other side, Federal Reserve Chair Jerome H. Powell issued a warning in a speech last week: “The record shows that deeper and longer recessions can leave behind lasting damage to the productive capacity of the economy. Avoidable household and business insolvencies can weigh on growth for years to come. Long stretches of unemployment can damage or end workers’ careers as their skills lose value and professional networks dry up.”
The policy implications of Powell’s view are the opposite of Hassett’s: Powell holds that if recessions cause lasting damage, there is a strong imperative to make sure they are as shallow and brief as possible, and aggressive policy to jump-start the economy is called for. Accordingly, the Fed chair urged Congress to act quickly.
We think Powell is right and Hassett is dangerously wrong. To follow the latter’s advice — as both congressional Republicans and President Trump are doing by calling for a pause to assess whether another relief package is warranted — is economic malpractice that needlessly and recklessly risks long-term damage.
To understand why, we must explain the phenomenon of “scarring effects.” Research has found that even short-lived recessions cause lasting damage to both labor and product markets. Workers who are displaced or unable to find jobs at the beginning of their careers are slowed in their progress. It takes them many years to make up lost ground, and they have lower employment and earnings in the meantime, even if the overall economy has recovered.
The same goes for businesses. Research on the last recession found that the increase in firm “deaths” and the decline in “births” had lasting negative impacts of job growth, productivity and gross domestic product. Strong job recoveries depend on the rapid growth of relatively new firms providing job opportunities for many new workers. A period of depressed births in the recession means there are fewer firms poised to grow in a recovery, making that recovery harder.
For these reasons, even short-lived recessions have the potential to generate lasting scarring effects, with impacts that extend well beyond those that are apparent during the recessions themselves. And recessions that drag on because of insufficiently aggressive stabilization policies only multiply those costs. New research by one of us finds that for every year unemployment remains elevated, a new class of college graduates is permanently scarred, with reduced employment throughout their careers.
We can’t avoid the coronavirus recession. But we can act aggressively to try to prevent results like these from befalling those who are beginning their careers at an especially tough moment. For these workers and the business that will employ them, a dollar spent on speeding our recovery today will pay off with dividends across the decades to come.
Among the policies that can reduce scarring effects, enhancement of unemployment insurance ranks high. It offers a double benefit: Recipients are likely to spend their payments quickly, which supports demand. And benefits allow workers to either search for a job that can support their careers or hold out for their old employers to reopen.
We can tap a similar dynamic by providing robust aid to state and local governments, which are required to balance their annual budgets but now face record shortfalls. Absent support, they will have no choice but to lay off teachers, police and health-care workers, with commensurate scarring effects to both these workers’ career growth and states’ recoveries.
Finally, in places where labor demand is slow to return, direct job creation programs have been shown to be important for economically vulnerable workers, especially people of color. For these workers, many of whom entered the labor market within the last few years, a protracted period of unemployment risks leading them to permanently abandon the job market, creating a lasting cost to themselves and the broader economy.
The imperative to avoid scarring also elevates the need to both preserve businesses through virus-induced shutdowns and create fertile ground for start-ups on the other side. Congress has legislated business-preservation programs, but they’ve focused too much on payroll maintenance and too little on helping firms avoid bankruptcy through meeting their non-labor costs.
Many European countries have done both — simultaneously ensuring payroll and preventing bankruptcy. Based on our analysis, this should pave the way for quicker recoveries in those countries. It’s not too late to emulate their approach, and a group of Senate Democrats recently introduced a smart, efficient plan designed to equally support workers and businesses as they gradually reopen.
Powell is correct that it is not too late to make these anti-scarring investments. But if we take the White House’s wait-and-see approach, what we’re sure to see is a lot of long-term, avoidable suffering.