Out of the rubble of World War II, we collectively and deliberately built an institutional order that established norms of acceptable behavior and placed constraints on powerful nations.  While work remains to create broader economic opportunity and some regions have suffered terrible conflict, the economic and financial globalization that this order fostered nevertheless yielded the greatest period of peace and economic prosperity that humanity has ever known.  The more than 70 years since the war’s conclusion are, however, very atypical, and we are now returning to a setting far more familiar to any student of history, where strength and power supersede norms and rules.  The world is characterized by a renewed struggle between illiberal autocracy and liberal democracy.

What does this mean for business leaders who have to navigate an environment that is fundamentally more dangerous?  Among many concerns worth considering, there are three that deserve particular attention: de-globalization, unreliable access to energy and a risk to U.S. dollar dominance.

Without any hyperbole, we are facing a risk of significant de-globalization, yielding a fragmentation of economic activity that will be increasingly delineated by spheres of influence.  In such a setting, political risks – or the notion that various governments may engage in actions that negatively affects a firm’s assets or operations – become first order.  An obvious consequence is a further acceleration of the conversation about supply chain resilience.  While political risks resemble the low-probability/high-impact supply chain disruptions that are now far better appreciated post-pandemic, resilience, like all forms of business insurance, is costly.  Further, as capital expenditures and other business initiatives are impeded, otherwise compelling growth opportunities are left on the table. These lost opportunities come not only at the expense of multinational firms and their investors, but also are felt sharply by recipient countries (including many striving to develop). Finally, to the extent that this fragmentation engenders a reversal in the multi-decade reduction in global tariffs, households around the world will pay more for lower-quality products. 

Second, critical commodity markets will be less reliable in an economically fragmented world.  Given the growing divide between exporters and importers, energy markets are particularly vulnerable and will be characterized by both higher and more volatile prices. Firms will have no choice but to internalize these challenges. However, policymakers need to provide a thoughtful, two-pronged strategy to remove some pressure. We need to use this rift as a spur to push alternative energy technologies that are critical to drive the health of the planet going forward.  However, as these technologies cannot replace the current energy needs of the world, we need to lean into the remarkable technological advances in traditional energy extraction that have transformed America into an energy powerhouse. Further, these sources of traditional energy are both relatively cleaner and offer the benefit of sidelining disruptive actors. (On the latter, I can hardly imagine anything more beneficial from a national security perspective.)

Last, while it seems almost inconceivable that the dominance of the U.S. dollar in facilitating global transactions is in doubt, this episode must serve as a reminder that our current institutional order and the centrality of the dollar are intertwined. While this arrangement has offered global businesses tremendous benefits in the form of predictability and limited transaction costs, a fragmentation in trade and finance will risk a balkanization of transaction modes. The current weaponization of the dollar trading system as part of the sanction machinery – while entirely appropriate – does elevate the incentives for potentially sidelined global players to consider alternatives. One must ask whether this is the ultimate push that transforms cryptocurrency. Or might this fragmentation offer new opportunities for the Chinese central bank’s digital RMB experiment?  While these are interesting questions, global businesses currently move trillions of dollars around the world every day at extremely low cost. Fragmentation is inevitably costlier.

Amongst the nations committed to liberal democracy, it’s long past time to appreciate and defend our institutional order.  The unfortunate irony is that the peace and prosperity that we achieved has been with us for so long now that it has bred a lack of appreciation and even complacency; the generational memory of those who witnessed the treacherous other side, and then engaged in the hard work of building their future, is increasingly no longer with us. Perhaps the inspirational example of the Ukrainian people resisting the danger in the interests of something larger than themselves can rekindle this understanding among the rest of us. No matter what, however, this will not be without inevitable costs that both we as individuals and business leaders must bear.

This commentary was written by Kenan Institute Director of Research Christian Lundblad. Lundblad is also the Richard "Dick" Levin Distinguished Professor of Finance at UNC Kenan-Flagler Business School.

• Inflation hit a 40-year high of 7.8% in February.
• We estimate energy prices will raise inflation by another percentage point in March.
• If sustained, the runup in gas prices will take a $100 billion-sized bite out of households’ wallets, weighing on consumer spending – and ultimately, inflation.

I have been fairly sanguine on the medium-term outlook for inflation – believing that most of the spike in inflation reflects the combination of an unprecedented shift in goods demand running into supply constraints exacerbated by COVID-19 related labor shortages. As the pandemic abates, I anticipated we would see a deceleration in inflation as demand shifts toward services and supply constraints loosens. Even though inflation hit a 40-year high of 7.8% in February, there were some promising signs as used vehicle prices were down and new car prices showed more modest gains for the second consecutive month. Unfortunately, in the near term, inflation is going to move meaningfully higher on the back of energy prices.

While energy represents only 7.5% of an average household’s spending, as the chart below illustrates, the large swings of energy prices make for a key driver of inflation. AAA reports that national gasoline prices are currently $4.33, up from $3.48 from a month ago. This is likely to raise inflation by about one percentage point in March, with the potential for even larger gains given the impact of oil prices on airfares and shipping costs. The surge in other commodity prices, such as food and industrial metals, will also weigh on inflation but to a much lesser extent, as they represent a much smaller share of the final cost of consumer goods. (Recall the adage that what’s inside a box of cereal costs less than its packaging and advertising.)

Unfortunately, a runup in energy prices often precedes recessions – the gray bars in the chart below – though the relationship is much more complicated than can be illustrated in a simple picture.¹ What we can say is that higher gasoline prices clearly weigh on consumer spending. We estimate that if gasoline prices stay where they are, they will take a $100 billion-sized bite out of households’ wallets over the course of a year, which could cut consumer spending by about one-half percentage point. While we don’t think this is enough to put the U.S. economy into recession, especially since the U.S. has a large energy sector that benefits from higher energy prices, the slowdown in demand is likely to soften overall inflation pressures in the future.

That is why the Fed is unlikely to tighten more aggressively than expected a month ago – in fact, most observers anticipate the Fed will begin raising rates next week followed by a modest path of rate increases over the next year. However, it does make the Fed’s communication challenges even harder. The Fed keeps saying that inflation is expected to slow over the coming months – but that forecast keeps getting pushed out. Another challenge for policymakers is that higher energy prices hit lower income households hardest as gasoline represents a larger share of their spending basket. These households are also more likely to have jobs that require commuting. While proposals to soften the blow by cutting gas taxes may seem like a good idea, they aren’t targeted enough to the households that need the most support (and they work against long-term climate goals). Instead, expanding the Earned Income Tax Credit, which is targeted to lower income working households, would produce the greatest benefit at the lowest cost.²

This commentary was written by Kenan Institute Chief Economist Gerald Cohen.

¹ https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2745171

² For a more in depth discussion of the tradeoff see https://archive.massbudget.org/report_window.php?loc=The%20Pros%20and%20Cons%20of%20Higher%20Gas%20Taxes,%20and%20How%20They%20Could%20be%20Offset%20for%20Lower-Income%20Families%20-%20MassBudget.html

Together with many business and economic leaders around the globe, we at the Kenan Institute of Private Enterprise support the harshest feasible sanctions against Vladimir Putin in the immediate interest of Ukraine and its people. More broadly, we view such measures as vital to the long-term survival of democratic values. But as the Russian invasion continues, seemingly unabated by unprecedented economic and financial sanctions, we must ask: what more is feasible? And for how long can such restrictions be sustained?

To answer those questions, we must first acknowledge that Russian sanctions cannot be contained. Restrictions will increasingly impact the global economy and supply chain, putting advanced economies – those responsible for the toughest and most meaningful sanctions – under pressure. Whether that pressure will be enough to prompt policy changes, though, is uncertain. To that end, we set out to better understand the forces at play through analysis of sanctions’ effects on western economies.

We examined the impact of economic sanctions as related to three important factors: divestment, inflation and economic growth.

First, large investment pools – especially in the U.S. and Europe – have pledged to abandon or liquidate investments tied to Russia. Similarly, many multinational companies have announced a suspension of business in Russia. Are these pledges credible and sustainable? We believe they are. From our discussions with investors and business people, Russia represents a small share of investment and income, and these assets are already likely to be impaired. While there was no legal obligation -- and perhaps the opposite -- to divest, institutional values dictated the response and important stakeholders appear very supportive.  

Most institutions have very little direct investment exposure to Russia and Ukraine; by our estimates, less than 2% of total portfolios. Much of this is via emerging market equity indices and emerging market debt (EMD). While EMD is probably most at risk and will see some form of default, total risk is on par with risk-budget expectations for the asset class. Likewise, there have been quite modest effects to date on broad equity and fixed income market indices. The concern is that increased costs of capital (higher risk premia) and declines in wealth from falling equity prices. Yet, most equity markets are down just a few percent from pre-invasion levels, and interest rate spreads between high yield and risk-free bonds have risen by less than 1% since news of a possible invasion first surfaced. In short, the pure financial impact of sanctions, while potentially devastating for Russia, will be small for most other countries.

The economic effects of sanctions on advanced economies is a bigger threat. Here, we need to be careful to differentiate between Europe and the rest of the world. Beginning with non-European advanced economies, the conflict in Ukraine raises two main concerns: higher inflation driven largely by energy prices and falling consumer spending. If the current jump in energy prices holds, it is likely to increase headline inflation by roughly one-to-two percentage points in March. Will this cause the monetary authorities (e.g., the Fed) to accelerate the tightening of monetary policy and increase the risk of a hard landing? We believe not. The lessons learned from previous energy price spikes is that they act as a tax on consumers which slow the economy, and so central banks are likely to look past energy price increases that are driven by geopolitical conflict.¹

But will the “energy tax” depress consumption significantly on its own? We estimate the current increase in energy prices will cost consumers roughly one-quarter of a percent of GDP, though some of this will be offset by increased income and investment in the energy sector (particularly in the U.S. which, because of increased energy independence, will have a much larger offset than 20 years ago). Effects from declining wealth on consumption are also likely to be very small. For example, a change in equity value of $100 has historically induced just a $3 change in annual household spending.² Historical macroeconomic models suggest that even a sustained 10% decline in the equity market lowers overall GDP growth by only about two-thirds of a percent of GDP over the next year.³

Another direct channel is the impact on international trade. For example, U.S. exports to Russia total about $11 billion per year, while Ukraine is less than half of that. If exports completely stop to both countries, that would cut less than 0.1% from U.S. GDP growth. Most non-European countries have similarly low export exposures, suggesting modest effects to economic growth.

Taken together, current conditions imply a total drag of less than 1% on GDP growth over the next year for advanced economies outside of Europe. While this is undesirable, it is unlikely by itself to substantially alter the sentiments around sanctions.

The real economic risk lies in Europe. Effects on both inflation and the real economy will be much greater. However, the saliency of Russia’s hostility there is also greater. On net, these appear to tip in favor of continued support for severe sanctions, but the rest of the world should not take this for granted. Direct assistance from non-European countries, such as the U.S., should soften the blow being felt by Europe. While some of the challenges Europe faces over the next year may be extreme, coordinated economic responses could be effective. Imagine a “Marshall Plan” that goes full-bore over the next nine months to help replace Russian natural gas with LNG and Russian wheat with North American and Asia-Pacific wheat by rapidly expanding production and transport capacity. This could also support developing economies which could be hit hard as they tend to have greater energy and food dependency.

The unified and strong reaction to Russia’s aggression is encouraging, but we believe it is also most likely to succeed if policy coordination can work quickly and deliberately to diminish the impact to the economies at greatest risk.

1 These are a negative supply shock. Demand driven energy price increases which are the result of strong economic growth should be treated differently.

² https://www.nber.org/papers/w25959

³ https://www.dallasfed.org/~/media/documents/research/swe/2001/swe0105b.pdf

The jumps in the inflation rate over the last few months have been larger and longer-lasting than expected.  For much of 2022 economic forecasters, including those at the Federal Reserve, assumed that higher inflation rates would be short-lived—or “transitory” using the preferred jargon of the day. Inflation was expected to start shifting back towards the Fed’s 2% target as supply-chain bottlenecks were resolved and a pandemic-induced shift in demand for consumer goods swung back toward consumer services.  Instead, recent inflation prints have set 40-year records and we are seeing more discussion about the possibility of a “wage-price” spiral. 

In this data commentary, we examine the factors which can lead to a wage-price spiral and assess the risk of a spiral causing even higher and more persistent inflation in the U.S. over the next few years.

What is a wage-price spiral?

The basic idea behind a wage-price spiral is simple: higher inflation causes workers to command higher wages.  In turn, higher wages increase companies’ production costs who then push those higher costs on to consumers.  This becomes a self-reinforcing cycle.

There are some necessary conditions for a wage-price spiral to take hold.  First, labor must be in relatively short supply thus giving workers enough bargaining power to drive up wages.  Second, the increase in wages must exceed growth in productivity that business can achieve through more efficient operations (e.g. from capital investment or better use of labor inputs) and thus put pressure on businesses to raise prices. A corollary to this is that the economy must be strong enough for consumers to absorb the higher process.  Finally, a strongly self-reinforcing wage-price spiral requires that workers and employers expect future inflation rates to stay high.  

In theory, a variety of mechanisms could spark a wage-price spiral.  For example, a negative supply-shock could cause a supply-demand imbalance that ignites inflation.  Alternatively, and excessively loose monetary policy or very stimulative fiscal policy could elevate income (and/or wealth) which stimulates higher demand.

Do we see evidence of a wage-price spiral in the data?

The best measure of wage inflation in the U.S. comes from the U.S. Bureau of Labor Statistics report on Employment Cost Index, or ECI.  The ECI measures the various components of workers’ incomes and allows us to home in on changes in the wages and salaries of private industry workers.  The blue line in Figure 1 shows the year-over-year percent change in the ECI for the last decade (through the end of 2021).  While annual wage growth had been increasing from about 2% to 3% per year, wages started to jump rapidly in 2021 and ended the year 5% higher than 2020.  The red line in Figure 1 shows that the consumer price index excluding food and energy, or so-called “core-CPI,” also jumped in 2021 and ended the year with annual inflation of 5.5%.  While correlation does not mean causality, the recent data does seem consistent with the early stages of a wage-price spiral.

What about other factors?

Given that we see ECI and core-CPI data consistent with formation of a wage-price spiral, it is natural to look more closely at the other necessary conditions.  First, there is strong evidence of a very tight labor market.  The unemployment rate of 4.0% in January is at a level widely considered to be near full employment. Additionally, new claims for unemployment insurance are at an all-time low (as a percent of people in the labor force).  Similarly, government data show that the ratio of the number of open positions to the number of workers seeking work is at an all-time high (see www.bls.gov/jlt/). In addition, in January 57% of businesses reported a shortage of skilled labor.¹  This evidence also suggests the broad economy is quite strong making it more likely prices increases will stick.

There is a caveat to the implications from the wage and salary data: different occupations experience quite divergent rates of increase.  For example, professional workers’ wages grew 3.7% in 2021 whereas those in service occupations (typically lower paid workers) grew 8.1%.  These differences suggest the possibility of a resetting of wages based on a new demand mix in the economy versus an across-the-board wage spike. So, rather than a permanent increase in wage inflation, we could just be seeing a one-time increase in relative wages for lower wage workers.

Another important condition is that labor productivity growth is insufficient for offsetting the growth in wages. Afterall, growing wages are a good thing as long as the gains are sustainable.  Productivity growth effectively defines that sustainable growth rate.  Here the news is mixed.  Labor productivity growth in the 4^th quarter was a very strong 6.6%.  However, much of this gain was a reversal from a week 3rd quarter and when we look at productivity growth for 2021 as a whole it averaged just 2.0%.  Consequently, it seems very unlikely that productivity growth has been sufficient to justify the 5% growth in wages and salaries.  An alternative view is that that lower skilled workers wages haven’t keep up with long-term productivity gains so an increase in wages is justified.  However, even a justified increase in wages will increase business costs and these increases could flow through into output prices.

Finally, we look at the evidence on expectations for future inflation.  Here the news is mostly good.  Despite, the significant jump in wages and inflations, the expectations of consumers about longer-term inflation has remained fairly modest.  Figure 2 plots data from a NY Fed survey showing that inflation expectations for the 1-year horizon recently jumped to 6% but only moved up to 4% for 3 years ahead.

Similarly, longer-term future inflation expectations from the bond market are also reassuring.  Differences in yield between regular US Treasury securities and Treasury Inflation Protected Securities provide a market-based assessment of inflation expectations at different horizons.  The most recent data show that expectations for inflation the next 2 years have jumped up some, but inflation expectations for 5-10 years into the future have remained unchanged at roughly 2%.  This is strong evidence that the Fed has maintained its credibility as a long-run inflation fighter even if it may feel to many like the Fed is currently behind the curve.  (But of course, the bond market has been wrong before—so this is no guarantee!)

What, me worry?

The bottom line is that the near-term economic data appear quite worrying.  There are signs that consumer price inflation and wage inflation are moving up together quite rapidly.  Add in the covid-related supply-chain disruptions, very accommodative monetary policy, and historically large fiscal stimulus, and it is a prescription for concern.  Nonetheless, the Fed increasingly appears to be on the case and markets (where investors put real money on the line) seem very confident that long-term inflation will not follow the path of the 1970s when wage-price spirals drove inflation to double digits.

¹ https://nabe.com/NABE/Surveys/Business_Conditions_Surveys/January-2022-Business-Conditions-Survey-Summary.aspx

As part of President Joe Biden’s efforts to refocus the Federal Reserve Board, the Senate conducted confirmation hearings for several nominees this past week.  While these hearings traditionally raise spirited exchanges about the nominees’ views on monetary policy and bank supervision, a new and more controversial topic involves the extent to which the Federal Reserve should internalize climate risks into its purview.  Before wading into central bank wonkishness, it is important to make clear that climate change represents a serious risk to not only the U.S. economy but to humanity itself.  Nevertheless, we need to be very deliberate in the assessment of the available policy tools, with an eye to where unintended consequences may reside.

With respect to the Fed’s proposed engagement with climate concerns, an understanding of the presumed directionality is required.  Specifically, is the idea to include climate risk as an input to assess financial stability more holistically?  Many have promoted the construction of a kind of augmented climate-related stress test.  Or, are we instead discussing a marked shift in the regulation of financial institutions to force them to serve as a mechanism to promote climate risk mitigation policy. This far more aggressive direction has been promoted by the more progressive wing of the Democratic Party.  In sum, we need to understand whether the argument is climate risk as an input to bank regulation vs. bank regulation as an input to climate risk mitigation.  If the intention really is the latter, we need to better appreciate how this could work. 

The Fed has two (main) functions – monetary policy and financial stability.  On the former, any climate-related monetary policy objective would reflect a significant shift relative to the Fed’s current inflation and labor market mandates.  Leaving aside the fact that Congress would have to formally legislate such an alteration, the Fed is ill-equipped to tackle climate mitigation in the context of its traditional monetary policy toolbox.  To be clear, there is already significant disagreement regarding the appropriateness of the Fed’s current policy stance [we have recently conducted a debate on whether the Fed is behind the curve regarding its inflationary mandate]. Further, while climate risk mitigation is a laudatory objective, there is an auxiliary danger of a politicization of our central bank.  This is not a trivial issue – the Fed’s independence allows it to swiftly respond to economic conditions in a technocratic manner largely free of political influence; a real, or even perceived, erosion of that independence will do nothing but impair its ability to operate when needed.  As a cautionary tale, there is a well-established literature that documents a link between high inflation and the lack of central bank independence.¹

An alternative angle for central bank climate consideration relates to the Fed’s other role in bank supervision (and overall financial stability).  Policies that incorporate climate risk into financial stability calculations seem reasonable. However, , proposals such as adjustment of capital adequacy regulation that would require banks to hold more capital against lending tied to borrowers that are negatively contributing to climate change are more problematic.  Unfortunately, such a modification of capital adequacy risk-weights would simply join a colossal jumble of regulatory complexity that Admati and Hellwig (2013), amongst many others, have shown to be easily gamed with sizable unintended consequences for systemic risk.²  Their work is actually an indictment of the complexity of current capital adequacy regulation; couple that concern surrounding the incentives for regulated bodies to engage in regulatory arbitrage with other important concerns about ESG greenwashing and the challenges of valid climate impact measurement [we will offer a new Kenan Insight on ESG measurement on February 16].  How confident can we be that the disincentives for bank lending would correctly identify borrowers tied to climate risk?

None of these concerns provide justification for Congress’ abdication of its responsibility to attack a very real issue.  However, the avenue for the most effective climate policy is through formal legislation.  Rather than continually trying to outsource its job, legislation is the natural avenue through which we can force the largest contributors to climate risk to internalize the costs of their actions.  As we have argued, a direct carbon tax is likely to be far more effective.  Further, with an appreciation for the fact that the largest carbon producers reside outside the U.S., such tax policy would need to address the cross-border nature of the issue carefully and credibly.  The Fed has virtually no direct role to play in cross-border economic activity.

Climate mitigation is an imperative, but the discussion should revolve around how best to move forward in a manner that more directly targets the intended consequences with an eye to limiting the unintended consequences.  At best, the Federal Reserve will appropriately calculate the financial stability risks of climate change. However, doing more than that could be quite damaging to the institution’s credibility or unintentionally distortionary to the allocation of capital.   The lingering question is instead how do we seriously tackle the challenges of climate change, inequality and beyond when Congress is inactive?  This is not easy stuff, but we need to be very careful in how we go about trying to circumvent those very real limitations.

This article originally appeared on Fortune.com

¹ Alesina, Alberto; and Summers, Lawrence H. "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence.” Journal of Money, Credit, and Banking, Vol. 25, No. 2, May 1993, pp. 151-62.

Crowe, Christopher; and Meade, Ellen E. "The Evolution of Central Bank Governance around the World." Journal of Economic Perspectives, Vol. 21, No. 4, Fall 2007, pp. 69-90.

² The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It. Anat R. Admati and Martin Hellwig, Princeton University Press, 2013

Inflation hit its highest level in almost forty-years, with overall prices up 7% in 2021. Is this a transitory increase as a result of COVID-driven demand and supply shortages, with inflation likely to decelerate to around 2% over the next year? Or, is inflation the result of a meaningfully overheated economy and likely to remain meaningfully higher than the Fed’s 2% target precipitating changes in business behavior and an aggressive policy response?

Figure 1: Highest Inflation in 40 Years

Greg Brown, Kenan Institute’s Executive Director: I believe the U.S. economy is boiling over! I estimate that the GDP-gap, the difference between the actual level of GDP and its potential is +5.9%, which means that the economy has never been more overheated. As a result high levels of inflation will remain with us until the economy slows down meaningfully.

Gerald Cohen, Kenan Institute’s Chief Economist: I believe that most of the inflation reflects a combination of a COVID-driven shift in demand toward goods and housing and supply shortages. Families stopped going to restaurants and started remodeling their kitchens. Meanwhile, appliance makers had their factories shut down and then when they restarted, they ran at a lower capacity because of pandemic precautions. As a result, inflation for goods like dishwashers and cars was up 10.7% in 2021, the fastest pace in decades (Figure 2). However, manufacturers are responding to these price signals – though Omicron has thrown some sand in those gears – but as supply shortages abate, goods inflation should follow suit.

Figure 2: Goods vs. Services Inflation

Some of these supply-demand imbalances have bled into the services sector. For example, rental car prices came from a combination of rental car companies selling off their fleets to remain afloat during the spring 2020, then facing an inability to rebuild fleets because of the chip shortages. But overall, service price inflation has remained relatively muted, with recent acceleration more about a return to trend after below trend growth.

I also believe that when COVID-19 subsides, there will be a shift in demand back to services. As more people dine out and take more extensive vacations they may regret some of their goods purchases. I wouldn’t be surprised to see cancelled backlogged orders of furniture and appliances, and lightly used boats or exurbs homes on the market at cut rate prices. This would lead to a return to the goods deflation we experienced for much of the last 20 years. 

Greg:  I don’t feel as complacent about services inflation given the most recent data. Inflation in the service sector experienced a dramatic spike toward the end of 2021. The inflation in services is widespread as well: housing, healthcare and personal services (i.e haircuts) inflation all clocked in at an annual rate of more than 4% in the fourth quarter. Thus it seems very clear to me that we are in a position of too many dollars chasing too few goods – another way of defining overheating. 

As a result, we are starting to see signs of a wage-price spiral, where workers who are already in short supply are demanding wage increases to keep up with inflation. This would inflation even higher, creating a vicious cycle. Without an immediate an immediate increase in the Federal Funds rate to at least 5%, inflation will not abate!

To learn more, see Is the U.S. Economy at a Boiling Point, or Just Simmering?

As we begin the new year, we wanted to highlight five topics, beyond the impact of COVID-19 and related uncertainties, that we believe businesspeople and policy makers will be grappling with in 2022. Throughout the year, we will focus our efforts to provide solutions-focused analysis on these topics as well as a host of others.

Will labor shortages abate?

Despite strong demand for workers and rising wages, the U.S. labor force is still 3.5 million people smaller than it was prior to the COVID-19 pandemic. Meanwhile, there are 10.6 million job openings, 3 million higher than the record set in late 2018. While the number of people quitting jobs has increased (as Chart 1 below illustrates), that trend doesn’t account for all the job openings. How much of this job shortfall reflects caretaking needs and COVID-19 concerns which, as they hopefully lessen, will bring people back into the workforce? Or is there a permanent shift in people’s work choices?

Chart 1

What are the risks of a wage-price spiral?

Inflation hit its highest level in almost 40 years, with overall prices up 6.8% from a year ago. To date, the majority of pickup is the result of an increase in goods prices (red line in Chart 2), which are being bolstered by COVID-driven demand and supply shortages. The risk is that service inflation starts to accelerate as service prices depend more on labor costs. Will businesses be able to offset higher wages with stronger worker productivity, or are we at risk of a vicious wage-price spiral where workers and businesses start to expect larger price increases or fatter wages? Keep an eye out for shifts in unit labor costs (Chart 3) – the difference between compensation and productivity – and inflation expectations (Chart 4).

Chart 2

Chart 3

Chart 4

How much is the cost of capital likely to rise?

With the Fed now expected to raise short-term interest rates in 2022, the cost of borrowing money from banks and capital markets is likely to increase. The median Federal Open Market Committee member has currently penciled in three rate hikes in 2022. Whether that comes to fruition and impacts longer-term interest rates and capital market prices depends on the answer to the two previous questions. How far are we from full employment?  Will workers come off the sidelines, lessening wage increases and supply shortages? Is the inflation we are seeing temporary or permanent? Watch two-year treasuries (Chart 5) to see how expectations for the Fed are changing.

Chart 5

What is your crypto strategy?

Crypto is now an institutional asset with a growing number of funds investing in crypto and related infrastructure, such as miners and trading platforms, as well as futures trading on the CME. At of the end of the third quarter in 2021, crypto assets under management reached $60 billion worldwide (Chart 6). That number is likely substantially higher today as the SEC only allowed major-market trading of a crypto ETF last October. But the purpose of crypto is as a medium of exchange – a store of value which can be used to pay for haircuts or car insurance. Will businesses start to accept crypto in a widespread manner? Will crypto ownership become diffuse enough to make it a unit of account, where businesses set prices in crypto? Will mainstream payment systems support those  crypto transactions? Will central banks issue government-backed crypto currencies, lessening the value of private-backed crypto?

Chart 6

Is Stakeholder Capitalism the solution?

Stakeholder capitalism is the idea that businesses would improve societal outcomes by focusing on a mandate broader than that which benefits shareholders alone. While this seems like a great idea in principle, it is challenging to implement in practice, especially when the interests of different stakeholders come into conflict and negate win-win solutions. During 2022, Kenan Institute will explore the varied facets of stakeholder capitalism through a series of Kenan Insights, webinars, events and other activities as scholars and business leaders come together to discuss the opportunities and tradeoffs of this complex topic.

Stay tuned for more on these and many other business and policy related topics.

The current narrative around the U.S. labor market is a mixed bag. On the one hand, many companies are struggling to find enough workers to return to a semblance of normal operations. On the other, 8 million fewer Americans were employed in April 2021 as compared to February 2020. We asked three experts from the University of North Carolina at Chapel Hill — Christian Lundblad, Director of Research, Kenan Institute of Private Enterprise and Richard "Dick" Levin Distinguished Professor of Finance, Area Chair of Finance and Associate Dean of the Ph.D. program, Kenan-Flagler Business School; Luca Flabbi, Associate Professor of Economics; and Paige Ouimet, Professor of Finance, Kenan-Flagler Business School — to weigh in on the critical issues behind this dichotomy.

Q: Do you think the United States is in the midst of a labor shortage?

PROFESSOR PAIGE OUIMET:  I think it’s an oversimplification to think of the labor market as one monolithic entity.  Its current characteristics really highlight this point.  There are significant labor shortages, with the number of job openings measured by the Bureau of Labor Statistics reaching an all-time high of 8.1 million in March.  But at the same time, there are 9.8 million unemployed Americans currently looking for work. 

How do we reconcile these two statistics?  I think much of what we are seeing is growing pains from a rapidly recovering economy.  For example, the accommodation and food services industry saw nearly half of its jobs disappear in early 2020.   Many of those workers have since found work.  So as firms in this industry quickly try to rehire as demand is increasing, they’ll have to find new workers.  I think what we’re seeing now is a temporary bottleneck as customers return to some sectors faster than those sectors can add employees. 

PROFESSOR CHRISTIAN LUNDBLAD: We can certainly point to industries and regions that remain economically weak and where excess capacity is undeniably linked to sidelined laborers.  Further, the extent to which many children around the country remain at home in remote learning situations has forced some workers, disproportionately women, to exit the labor force all together.  Representing a significant pool of excess labor, they and other sidelined workers would presumably like to return to work when feasible.  Finally, unemployment benefits and other government support mechanisms have been generous; the unintended consequence is that a subset of workers may delay returning to work until benefits roll off, temporarily limiting supply.  Although it’s hard to quantify these and other competing effects, it‘s reasonable to assume that they’re not permanent.  Collectively, the labor market situation is nuanced.

What’s more complicated is the growing wedge between those workers with skills in high demand and others.  It’s important to characterize the pre-COVID labor market as highly bifurcated; even then, there were significant shortages of certain skills, while other skills were plentiful. Companies often expressed frustration over the rapidly growing costs of certain scarce laborers. So, in a way, the question is whether there is still something particular about the pandemic shutdown that remains the dominant weight on labor markets. Or, are we witnessing an acceleration of the economic reallocations that were already driving this earlier wage divergence?  The pandemic experience has likely pressed fast-forward on that story, and business and workers will need to adjust.  In pockets that are critically linked to many businesses’ most interesting growth opportunities, there is a shortage of skills, and the associated labor costs were already high and continue to rise.

PROFESSOR LUCA FLABBI:  I don’t think we’re in a midst of a labor shortage. Instead, I think employers are finding it difficult to find workers willing to accept their job offers at the speed that they would like. Two main factors that technically have nothing to do with labor shortages but are contributing to this dynamic: wage levels and uncertainty. Two additional factors may also play a role in generating actual labor shortages in specific sectors: labor reallocation across industries and the female labor supply.

With respect to the first two factors, as with any other good, when demand increases, prices should adjust upward if trades are to be concluded successfully. We’re in the middle of a large increase in labor demand, and therefore wage levels should increase. So it’s not surprising that some employers are finding it extremely difficult to find workers at pre-pandemic wage levels. That’s not shortage, it’s a lack of price adjustment. But that’s not the entire story, because we’re starting to see wage increases. So the second factor, uncertainty, may be playing a role. The pandemic is fading, but there is still a significant proportion of people who are not vaccinated, and who may never be. As a result, future pandemic flare-ups in particular regions, industries or occupations are not completely out of the question. Given this lingering uncertainty, workers may wait before accepting a job. They may think that things will be better in the future, and if they wait a little longer, they’ll get a better job. Or they may think things will be worse again in the future in a particular sector (e.g., hospitality or health), and they are therefore looking for a job in other sectors.

This last point introduces the first of the two additional factors: labor reallocation and the female labor supply. Suppose you were working in the hospitality industry before the pandemic. Given your expectations about career and job stability, you were happy to do a given job at a certain wage. Post-pandemic, you’ve learned that jobs in that industry are less stable than you thought they were, so you decide to look for a job in another sector. Such reallocations may be generating genuine shortages in specific industries; even if firms were to pay the maximum wage they can without incurring significant losses (technically, the worker's marginal productivity), there are not enough workers willing to work at that job. At the moment, it is not clear how quantitatively important this labor reallocation is.

With respect to the second factor, female labor supply, overwhelming evidence shows that women are still the main provider of childcare within the family. With schools and childcare facilities closed, women have been forced to spend more time caring for children and less time in the workforce. Some have been forced to leave the labor force entirely. As of today, it’s still not clear if schools and childcare centers will reopen full-time for the entire year. Therefore, many women are reluctant to reenter the labor market, reducing the labor supply overall, but especially in sectors with a predominately female workforce.

Q: What needs to happen for the labor market to fully recover from the pandemic?

OUIMET: One important step is for the employment-to-population ratio, the fraction of working-age individuals in America who are currently employed, to return to more historic levels.  During the pandemic, we saw a large number of Americans withdraw from the labor market due to health worries, caregiving responsibilities or because they were too discouraged to find work.  These people will not be counted as part of the unemployment rate because they are not actively looking for work.  For the labor market to fully recover, we need millions of these American who left the workforce during the COVID pandemic to reenter.  What conditions are required for this to happen?   

First, workers need to feel safe going to work.  Vaccine availability is a game-changer, but as mask requirements are dropped, some workers will be hesitant to return to public spaces.  Second, schools need to open and parents must feel safe sending their kids back to school.  A large number of childcare centers closed during the pandemic due to low demand.  Now they’re trying to reopen and hire, but are having trouble keeping pace with the sudden surge in demand.  If families can’t find childcare, this will also limit labor force participation rates. Finally, we need to be patient.  With 8.1 million job postings —the highest level ever measured — there are great signs for the economy, but we also have to understand that the labor market can’t adjust overnight.  There’s a lot of reallocation involved, and this will take time. 

LUNDBLAD: Leaving aside the pervasive skill mismatch, the underlying drivers of the short-term impediments to full recovery need to be addressed.  

First, nonessential economic activity (the willingness of a customer to walk through a shop door, sit in a crowded theater, book a cruise, and so on) needs to bounce back.  This will not happen until Americans feel comfortable taking on these activities. So no policy is more important than an effective vaccine distribution and, critically, uptake. Americans need to get vaccinated. 

Second, we need kids to get back in school.  While we have long argued for the economic benefits of education on future productivity, we’ve learned that there is a perhaps far more direct link between economic activity and school; if kids are out of school, we really can’t work!

Third, we need to find a way to adjust government support in a way that continues to help the subset of Americans who will still struggle as we navigate through next steps, without dis-incentivizing their return to work. 

Finally, on the international stage, our global trading partners are largely in far worse shape than are we.  This is patricianly true in the emerging world, where economic activity will be constrained for some time as the challenges of the virus remain front and center.  The upsetting pictures from India only reinforce the idea that a global economic recovery cannot happen anytime soon.  At a very pragmatic level, U.S. supply chain, export/import and financial considerations are inextricably tied to the wellbeing of our partners.  Global vaccine distribution is key. 

FLABBI: Three things need to happen before we reach a full recovery of the labor market in particular and the economy in general. First, wages should adjust to the new post-pandemic labor market conditions. Second, the ongoing uncertainty should be resolved. Are we out of this pandemic for sure? Could a similar pandemic reappear in the short-to-medium term? Third, the labor reallocation that seems to be taking place needs to settle. This process may take some time, as workers who decide to change their occupation may need to acquire new skills.

Q: Are there other economic conditions we should watch that could disrupt the labor market recovery?

OUIMET: We‘re currently seeing bottlenecks throughout the economy, not just in hiring.  And these supply shortages, if they persist too long, could slow the speed at which firms can grow and, therefore, hire.  I expect these will keep popping up, especially as COVID-19 continues to surge internationally. 

LUNDBLAD: The most obvious concern is related to the virus itself.  The real wild card is a viral mutation that renders our vaccines significantly less effective.  Although we’ve learned so much about navigating this new world, such a development would endanger much of our economic progress.

Aside from viral developments, there’s also a brewing risk of inflation. The price of many goods is already rising (the recent inflation print was the largest we’ve seen in decades), but many economists, including the Fed, view this development as transitory, with certain price increases reflecting, for example, temporary supply chain disruptions. I’m skeptical — there is a several-trillion-dollar wall of savings, ballooned by federal stimulus, that’s ready to go; this creates a real risk of demand-induced inflationary pressures.  While we’re admittedly far from these pressures manifesting in wages themselves, I fear that sustained inflation is coming, and the Federal Reserve may very well be caught behind the curve.  If they have to significantly increase interest rates to manage inflationary expectations, the labor market will not go unscathed. 

FLABBI: More than other economic conditions, the coordination of actions and expectations in order to accommodate the processes I’ve already mentioned is something we have to watch carefully. This is always true after major shocks hit the economy. In the readjustment phase, economic agents may overreact, magnifying uncertainty and slowing down recovery. For example, some employers may wait too long to increase wages, losing valuable business opportunities in the meantime. Others may increase wages by too much, forcing themselves to increase prices too steeply, possibly generating inflation. As another example, childcare services and schools may take too long to reopen, hindering the reentry of women into the labor market.

Q: What else should we be paying attention to with regard to the labor market?

OUIMET: The one thing I’m watching closely is wage growth.  To the extent that we’re facing a labor shortage, then we should see sustained wage increases.  Right now, we’re seeing wage increases in the leisure and hospitality industry that would annualize to about 16%.  This is consistent with the concerns raised by businesses in that industry about hiring difficulties.  I don’t expect to see similar wage growth in other sectors of the economy; however, if we do, that’s evidence of more significant labor shortages.  And of course it’s important to follow the employment-to-population ratio: are we seeing more Americans reenter the workforce?

Q: What is one policy that the federal government either should or should not adopt in order to support job growth?

OUIMET: I’m less focused on actions to support aggregate job growth.  There will be bumps along the way, but I’m optimistic we’ll continue to see aggregate job growth through 2021. However, I am concerned about the inequities in our labor market that were laid bare during the pandemic.  During COVID, high-skilled workers were mostly protected from job losses and often received wage gains.  Large rewards for high-skilled workers have long been a feature of our labor market and encourage innovation and risk-taking, leading to economy-wide productivity gains.  But we need to ensure that workers and families on the other end of the skill distribution can still meet their basic needs in this labor market.  One policy on which I’m very bullish is the child tax credit that was passed as part of the American Rescue Plan aid package.  I would like to see this become permanent policy.

LUNDBLAD: We need to get kids back in school. That’s perhaps less a federal issue than a state and local issue, but governments need to get kids back into the classroom. Undeniably, part of our labor market disruption remains linked to a sizable fraction of parents still — more than a year later — struggling to juggle work, school and everything else. The labor market will remain jumbled until we figure this out.  Next to vaccine distribution, there’s no more important job for local officials right now, and they need to find the courage to act. 

The most important reason to take action stems from the fear that this educational disconnect will be far more consequential in its long-run implications, with a generation of kids who suffer poorer educational and labor market outcomes over their entire lifetimes. The aggregate economic implications of such a scenario would be staggering.  We know that our children are facing impossible levels of anxiety and depression, and that they’re falling behind in their schoolwork.  We need to foster a less contentious environment in which we can take intelligent risks and conduct policy experiments that allow us to figure out what does and doesn’t work. 

FLABBI: Many of the adjustments taking place in the labor market and the economy will likely be solved through standard market mechanisms once the uncertainty is resolved. But there are two important areas where I think the government has an important role to play.

First, this shock had nothing to do with economic fundamentals; it was a health crisis, so any policy that can make the health sector more resilient to shocks will be helpful. Any such policy will decrease uncertainty because economic agents will know that even if another pandemic hits us in the short- or medium-term, we’ll be better prepared.

Second, any policy favoring the reentry of women into the labor force will be beneficial. To that end, at the top of the list is the provision of child care services; for younger ages, these services are similar to public goods, but in the U.S. have not so far been considered as such — just compare the amount of public money used to subsidize the public school system with the one devoted to the care of preschoolers.   

The 2020 U.S. economic downturn fueled by the COVID-19 pandemic generated both big losers (such as restaurants and the hospitality sector) and big winners (such as high tech and online retail), leading economic commentators to call the recession “K-shaped.”  As the pandemic evolves in 2021, this K-shaped recovery will go global; though some countries, notably the U.S. and China, are securely tethered to the largest economic booster rocket ever built, a sizable swath of the world will continue to suffer weak growth.

In this analysis, we’ll explore how the global K-shaped recovery will affect U.S. businesses and households.

What’s driving the U.S. economy?

The March U.S. employment report reveals that the economy is normalizing more rapidly than expected.  An increase in payrolls (916,000) exceeded forecasts, but more important, strong gains in such sectors as restaurants, hotels, transportation and construction suggest that growing optimism over a light at the end of the pandemic tunnel is being reflected in business hiring.  Although the U.S. still needs to generate 8 million jobs to return to February 2020 employment levels, the pool of unemployed workers still seeking jobs continues to decline.  The result is a U.S. unemployment rate that has dipped to 6.0% — just slightly above the long-run average.  As the pandemic wanes and the economy continues to recover, many workers who have exited the labor force will return to work, which will drive total employment back toward pre-pandemic levels over the next year.  These rapid gains in employment are self-reinforced as workers generate disposable income that feeds more spending and job growth.

But is the downturn really over?  Or, put another way, can we be confident that a fourth wave of the pandemic won’t quash the rebound, as second and third waves did in 2020?

We believe we can be.  It appears that the U.S. has turned the corner and pandemic-related constraints on the domestic economy will end in the second and third quarters.  The game-changing vaccines now being rapidly administered will allow us to reach a critical level of immunityin the late spring or summer.  This will provide businesses and the general public the confidence they need to resume pre-pandemic activities. 

As we’ve been saying for almost a year, nonessential activities away from home should be governed by healthcare capacity.  With high vaccination rates among those most likely to contract a severe case of the virus, the burden on the healthcare system will continue to decline and stay well below critical levels.  When viewed in this light, vaccine dissemination remains the single most important government stimulus effort.

The transition back to a more normal world will release unprecedented pent-up demand for items ranging from leisure travel and entertainment to business investments.  Over the past year, many households have amassed substantial savings and financial gains from asset appreciation that will fuel an enormous spending spree.  In addition, businesses are awash in cheap capital that will be unleashed on capital expenditures to support the spike in demand. 

But vaccination rates are by no means the only factor at work.  The U.S. government has also distributed an unprecedented number of stimulus dollars.  In addition to the 2020 stimulus payments, the $1.9 trillion American Rescue Plan Act of 2021 will generate fresh demand, creating a powerful second-stage booster to an economy that has already blasted off.  Further fiscal expansion (such as the Biden administration’s proposed infrastructure plan) could generate even more thrust.

The government’s extremely accommodative monetary policy also provides powerful fuel for economic growth.  The Federal Reserve continues to signal a lack of trepidation about an overheating economy, and will maintain its unparalleled push to keep rates low for an extended period. 

All of this signals boom time in America, with an expectation that 2021 will usher in one of the largest GDP growth rates on record.  We should note that there are very real questions concerning the implications of such federal support on inflation and government debt capacity.  But the upward trajectory of the U.S. economy — an important component of the upper branch of the K-shaped recovery — is not in doubt.

The global economy

Unfortunately, such forces are not at work uniformly across the globe.  Many large economies are well behind the U.S. in their vaccination rates.  Numerous developed countries, particularly those in western Europe, have experienced significant increases in COVID cases in recent weeks, accompanied by new economic restrictions as vaccination efforts have faltered.  Large developing economies such as India and Brazil are not expected to have substantial vaccination levels until well into 2022. Fiscal and monetary policies will be less successful in these countries because they will be powerless to effectively stimulate restricted parts of the economy, and business investment there will continue to languish as capital is diverted to economies that can normalize business activity (and are thus more productive). 

As a result, a substantial part of the global economy will find itself in the lower branch of the K-shaped recovery.  The economic and social costs of the pandemic will linger in parts of the world for far longer than in the U.S. and China.  Unequal vaccine access will translate into critical differences in economic recovery rates, with less developed countries recovering much less quickly than their more developed counterparts from the pressures of the pandemic.

What does the global K-recovery mean for U.S. businesses?

As we’ve already noted, the business sector in the U.S. will boom in 2021 on the back of rapid domestic demand from consumers, with the industries most affected by the pandemic recovering quickly.  In turn, this growth will generate spillover demand to all industries, even those that have benefited from the pandemic. 

Although this is great news for the economy, it will also generate two important challenges.  First, many businesses in the U.S. will experience labor shortages.  With more than 5 million people exiting the labor force in 2020, some industries have already struggled with staffing.  The March Beige Booksurvey of U.S. businesses by the Federal Reserve found “labor supply shortages were … acute among low-skill occupations and skilled trade positions.”  As the economy gains speed, these shortages will become more severe and especially challenging for small businesses, which are historically less likely to be competitive in tight labor markets (and currently in worse financial shape, on average).

The second major challenge is the fragile global supply chain.  We’ve seen throughout the pandemic how U.S. business operations have been disrupted by long and thin supply chains.  These problems have not been resolved and are getting worse in some sectors.  For example, supply constraints for semiconductors are negatively affecting production of an increasingly wide variety of consumer and capital goods ranging from automobiles to automated machine tools.  With many businesses experiencing simultaneous constraints on labor and capital, it will be hard to manage the impacts through traditional means, such as substitution of one factor for the other.

What does it mean for U.S. households?

Is a massive economic boom good news for U.S. households?  It’s great news for those most negatively affected by pandemic shutdowns. Laborers and sole proprietors in the most distressed industries will be in high demand, as many workers have shifted out of those jobs or left the work force in 2020.  Wage growth overall will be strong in 2021, and low-skilled workers in particular will see strong upward wage pressures and improvements in benefits as companies compete for increasingly scarce labor (and try to entice those who have left the labor force into returning).

But the boom will create challenges for households as well.  Most concerning is the possibility of higher inflation, as demand starts to exceed supply in certain sectors.  This is most evident in housing, where home prices have already shot up at their highest rate since 2006 and rents in some regions also have spiked. While this is good news for homeowners, it’s an added burden to renters and households who are first-time home buyers — exactly, on average, the households disproportionately affected by the 2020 downturn.  Likewise, many consumer goods will experience inflationary pressures on high-demand and supply challenges, which will also most affect households with low disposable income (because goods are a higher percentage of their expenditures).  The roadmap for inflation remains one of the most important issues for a post-pandemic U.S. economy.

Another challenge facing many lower-income households will be overcoming the scarring of their balance sheets and credit ratings.  Those who lost work and accumulated new debts during the pandemic will benefit less from the return to normal as loan and rent forbearance ends.  Such households overlap substantially with those that had low net assets prior to the pandemic.  Although they will end 2021 better off than at the start of the year, their gains will be less, on average, than those of wealthier households who more likely maintained employment in 2020.

A final challenge for households will be managing permanent shifts in the economy.  The pandemic accelerated an existing trend toward jobs requiring certain skills (especially technical skills).  Younger workers will more likely be hired and/or trained for these new jobs, while many middle-aged and older workers will struggle to find opportunities for upskilling to advance their careers.  It’s likely that the shift in skills demanded by the labor market will create near-term frictions that temporarily increase the equilibrium unemployment rate, i.e., NAIRU — the nonaccelerating inflation rate of unemployment.   This bump in NAIRU further increases inflation risks to households.

The bottom line

Although U.S. economic growth in 2021 is shaping up to be among the best in decades, both businesses and households will face some challenges.  Lower-income households should stand to benefit the most from a strong economy, but after a brutal 2020, many will remain worse off than before the pandemic.  Yet there is still time to consider how to more evenly share the benefits of growth as the global economy catches up.  For example, in addition to high domestic demand for capital goods and industrial facilities, the U.S. will discover more opportunities to export high-value goods and services.  Policy can provide additional incentives to encourage low-skilled workers to prepare for these opportunities that will be in high demand in coming years.

Examining the pandemic fallout and looking toward the future.
By Jessica Wilkinson
Economic Development Manager, NCGrowth

2020 brought an end to North Carolina’s decade-long economic expansion that began in 2010 after the Great Recession. It has now been a year since COVID-19 arrived on U.S. shores, and we can see some changes clearly, while others are just starting to emerge from the haze. It will likely be years before we fully grasp the myriad ways COVID-19 has affected the nation’s and the state’s economies. Now seems like a good time to take stock of the fallout from 2020, the trends we’re seeing a year into the crisis and where things are starting to turn around for North Carolina.

What happened?

Source: U.S. Bureau of Labor Statistics, Local Area Unemployment Statistics, North Carolina, Statewide

Source for both graphs: Kaitlin Heatwole and Ethan Sleeman, “Widening Racial Disparities in Unemployment Claims,” Carolina Tracker

• Before the pandemic struck in early 2020, North Carolina was in the middle of experiencing a historically low unemployment rate of 3.6 percent. As we now know, the unemployment rate rose to shockingly high levels shortly after COVID-19 reached our shores. This was largely due to state and local government public health policies aimed at curbing infections, and decreased consumer confidence. At the height of the economic shutdown in April and May, the unemployment rate among North Carolina residents was 12.9 percent, higher than at any point during the Great Recession. Although the unemployment rate has since decreased to 6.2 percent (as of December 2020), it remains higher than it was prior to the start of the pandemic.¹ Compared to other states, North Carolina’s unemployment rate was the 29th lowest in the nation.
• Although we don’t yet have state unemployment rates broken out by gender or race, we do have county-level unemployment insurance claims data broken out this way. This data shows that women filed disproportionately more unemployment insurance claims at the beginning of the pandemic. However, this gap closed during the summer and fall.² While the gender gap narrowed, the racial gap in unemployment insurance claims widened. In the graph to the right titled “County-level initial unemployment insurance claims by race since March 2020,” the black diagonal line is where a dot (representing a county’s unemployment insurance claims) would be if the number of unemployment insurance claims for that county’s racial category were proportional to the percent of county residents identifying with that category. Dots above and to the left of the black line represent disproportionately high unemployment insurance claims in that county. For most North Carolina counties, Black residents filed disproportionately high numbers of claims compared to their white counterparts.
• As stay-at-home orders have phased out, businesses and communities are navigating, with little guidance or research, how to reopen in ways that protect the health of their employees and customers. As such, there is no simple “how-to” guide for how governments and businesses should respond to the economic impacts of COVID-19 or how to strategize for a post-COVID future.  Many local governments are looking to examples set by their peers for guidance and inspiration on crafting a local response.
• In the early months of the pandemic, many state and local governments and private entities across North Carolina offered support for workers and business owners in the form of technical assistance, information sharing, loans and grants. Although the webinars and technical assistance persist, most sources of funding have dried up.
• Rural counties felt COVID-19’s effect on unemployment sometimes months before they felt its health effects. As of March 16, 2020, COVID-19 cases were only in concentrated population centers; however, unemployment claims were comparable across both urban and rural areas.
• According to an October 2020 national Lending Tree report examining consumer spending, small business revenue, job postings and the unemployment rate, North Carolina ranked 10th among states in rate of recovery from the pandemic.³ The North Carolina Department of Revenue reported that every sales tax category is up for August 2020 compared to August 2019. Some business owners speculate that the rise in spending comes from people spending money locally rather than on vacations and travel.
• Despite the pandemic, a number of large companies announced plans in 2020 to open up shop in the state. In November, Clorox announced that it plans to bring 158 high-paying jobs to Durham, In the same month, Chick-fil-A announced its plans to open a large distribution center in Mebane, bringing 160 jobs to the town. In mid-December, Texas-based Taysha Gene Therapies announced that it will open a manufacturing operation in Durham. This venture represents $75 million in capital investment and 201 high-paying jobs with an average wage of $119,751.

Looking forward to 2021

• In general, economic experts across the state are looking toward 2021 with optimism. In recent news reports, Chris Chung, CEO of the Economic Development Partnership of North Carolina, has noted that EDPNC is monitoring 180 active projects statewide, representing 39,000 new jobs and about $11 billion in investment. December 2020 brought 24 new project proposals, ten more than the previous year.

Adapting our strategies for economic development

• As the health and economic effects of the pandemic continue to play out in unpredictable ways, researchers and policymakers will likely find it difficult to offer long-term strategies for economic growth.
• Prior to the onset of COVID-19, the North Carolina Department of Commerce was in the process of developing an updated multi-year economic development strategy. Originally expected in April 2020, the agency’s website now says it will “publish a new strategic plan for economic development later this year that will guide policymakers and practitioners in their work to bring more economic prosperity to the state.” The website does not include an updated release date for the strategy.
• The economic development recommendations outlined in the NC Tomorrow plan released in 2017 remain relevant and general enough to benefit the North Carolina’s communities despite 2020’s challenges:
  • Build on the Region’s Competitive Advantage and Leverage the Marketplace
  • Establish and Maintain a Robust Regional Infrastructure
  • Create Revitalized, Healthy, Secure and Resilient Communities
  • Develop Talented and Innovative People
• According to the plan, economic developers and policymakers should target the state’s “growth clusters.” Indeed, some of these clusters grew in 2020, and some of these clusters operate “essential services,” a term that took on a completely new meaning with the arrival of COVID-19. Although they certainly experienced challenges in 2020, industries such as life sciences, pharmaceuticals, manufacturing, energy, food processing, transportation equipment and financial services all experienced a pandemic-related boom. The only industry listed by the NC Tomorrow plan that took a significant hit due to the pandemic is tourism. However, outdoor recreation, a part of tourism, saw huge growth in 2020. Further, tourism may experience a spike once more people receive their vaccinations or COVID-19 infections begin to subside.

In all, 2020 and the COVID-19 pandemic brought with them shockingly high unemployment rates, but only for a short period. Unemployment rates are now at “precedented” levels again, but are still twice as high as they were at the beginning of the pandemic. Emerging but unsurprising data show that racial disparities persist when looking at key economic indicators such as unemployment claims. Economists often say that recessions create winners and losers. However, they don’t usually call attention to how this plays out along racial lines, with Black people and other people of color generally experiencing harsher economic outcomes compared to white people. The truth is that this has been the reality recession after recession. In 2021, we will continue to look toward policymakers, academics, industry leaders and ourselves to see how we finally attempt to break the cycle.

As a whole, North Carolina looks poised to make real strides toward recovery in 2021. The state’s unemployment rate isn’t nearly as high as that of some states. And existing economic development strategies like the 2017 NC Tomorrow plan still seem relevant, even after one of the most bizarre and difficult economic years on record, indicating that its strategies are long-term, diversified enough and resilient.

September 13 will mark six months since U.S. President Donald Trump declared a national state of emergency in response to the COVID-19 a national pandemic.  And here in North Carolina, Governor Roy Cooper announced last week that the state will transition to “Phase 2.5,” with further easing of restrictions on certain places and types of activities including mass gatherings, playgrounds and gyms, but with other restrictions – such as those on bars and entertainment venues – remaining in place. It seems like a good time to take stock of where we’ve been, where we are now and what lies ahead.

What have we learned?

It’s fair to say that many of the dogmatic opinions from both ends of the political spectrum have been off the mark.  Yet some of what each side has espoused has proved out.  The truth of the situation is clearly somewhere in the middle, and an objective assessment of what we have learned in the last six months suggests the following:

• Mass gatherings are dangerous, community spread is easy and wearing masks is tremendously beneficial.  Pretending otherwise has damaging consequences for individuals and organizations.  There’s no better case in point than the disastrous start of the school year at the large UNC system campuses. While there were substantial direct health consequences to the failed return to campus, the wider impact has been on the students and families forced to manage the fallout, as well as on the institutions themselves. The UNC system is now much worse off than it would have been if a more thoughtful approach had been undertaken (e.g., limiting the number of students on campus as other universities did, implementing widespread surveillance testing programs, and so on).  There is a salient lesson for broader policy in this debacle.  When governments, organizations and businesses make decisions on how to resume more normal operations, they can’t operate based on what they want to be true.  They must take into account the realities of what we know to be true about both the disease and human behavior.
• Smart reopening of the economy without swamping the healthcare system is very feasible.  As we look at North Carolina as an example of “dimmer switch” reopening policy, we see that increased economic activity does not have to result in ping-pong public health policy.  The economy in North Carolina has been on a one-way road to reopening and never faced serious capacity constraints in hospitals (see our regional dashboard page).  Yet it is fair to say that, in hindsight, the state economy reopened too slowly.  A better policy would have been a shorter, but widely enforced, statewide “stay at home” order, broad implementation of mask requirements among businesses and a faster move to the current status.  This is admittedly Monday morning quarterbacking.  Real-time decision-making was difficult because of uncertainty about disease transmission and especially the lack of data on the true number of cases in the state.  Perhaps it was better to have erred on the side of caution than have risked a second full shutdown like some other states, but we should continue to aggressively press ahead with thoughtful reopenings.

Where are we now?

• The broad economy is in limbo.  The August employment report was quite encouraging and showed a labor market continuing to improve.  However, spending is now growing more slowly nationally and has been flat for two months in North Carolina.  Small businesses are still extremely stressed, with the most recent data showing a decline in activity since mid-July.  Industry segments that serve as key indicators, such as apparel, general merchandise and transportation, have all stopped improving both nationally and in North Carolina.  We attribute much of the stall to people’s continued reluctance to undertake nonessential activities away from home because they sense conditions are unsafe.  To this point, our consumer consternation index ticked up in August in North Carolina, and is at the second-highest level above the national index since the pandemic began.
• The healthcare situation is being handled with controlled community spread.  The North Carolina economy is effectively reopening without substantial increases in new cases, hospitalizations or deaths. An August blip in new cases in North Carolina is largely attributable to UNC system students and other young people becoming infected. With any luck, cases will continue to tail off now that many students have returned home (though risks remain for nearby communities from off-campus students who have not returned home). It is probably time to throw in the towel on contact tracing as an effective containment mechanism and admit that it can’t be done currently at the scale necessary for preventing community spread. Those resources are likely better spent on public health awareness programs and better testing.
• Speaking of testing.  We still find it remarkable that there is effectively no national policy on testing, that tests are relatively hard to obtain for some people and results are sometimes reported with significant delays.  This is perhaps the most serious indictment of federal health policy, given that testing is an entirely fixable problem.  The “see no evil, hear no evil, speak no evil” approach to testing has not served the U.S. well, and has likely prolonged and deepened the severity of both the pandemic and the economic downturn.  Again, we can gain wisdom from universities where rigorous testing appears to be limiting spread on campus.  As we’ve been saying for months, testing is not just about limiting the spread of the disease, but also about building confidence among the public as conditions continue, we hope, to improve.  

Where are we headed?

• Additional stimulus is likely needed, but not on the scale previously proposed by congressional Democrats. As noted already, the recent national employment report is very good news for the economy.  There were legitimate concerns that the sudden stop of federal stimulus in August (especially supplemental unemployment benefits) would tip the economy into another downturn.  The continued growth in nonfarm payrolls across almost all sectors of the economy was a huge relief and indicates that we do not appear to have started a double-dip recession in August. It also suggests that the Republicans were closer to the mark in terms of what an additional stimulus package should look like, at least in terms of size.  That said, a lot of people are still hurting. The unemployment rate remains elevated, especially among people of color, teens and those with lower educational attainment.  It remains important to provide additional support for a broad segment of the population struggling to stay afloat financially.  We can see this in our socioeconomic adversity index.  Even as the economy has improved, the index remains extremely elevated and has actually increased disproportionally for many segments of the population, including people under 40, households with children, middle-income households, single people and people of color.
• The broad economy will remain in limbo until a vaccine is available.  Increasingly, it feels as if public health policy is becoming ineffective in generating economic growth.  We’ve said it before, but will say it again: Just because you open a business, it doesn’t mean people will go there (bars being the exception, apparently).  Airlines are a case in point.  There are relatively few restrictions on domestic air travel, yet air traffic remains down 70 percent.  Likewise, most brick-and-mortar retail establishments are open for business, but foot traffic at these locations remains about 20 percent below pre-pandemic levels.  While some permanent decline is to be expected given accelerated shifts to online spending (and business closures), a substantial rebound will occur once vaccinations are widespread.
• We must focus resources on getting kids back to school.  First and foremost, the learning deficit students are experiencing will have significant long-run consequences and is highly inequitable.  However, it’s also important to consider that childcare is a key bottleneck in the economic recovery.  Schools provide about 30 hours per week of free childcare which is crucial for many parents, especially low-income and single parents.  While the unemployment rate has continued to decline, this does not capture the fact that the labor force has contracted by more than 3 million workers, many who have been forced out of jobs because of childcare considerations.  In addition, scores of workers are having to juggle the responsibilities of working from home and attending to children schooling at home.  This lowers hours worked and productivity, and, of course, is also a huge stress on parents.  As vaccine distribution decisions are being debated, we believe that near the front of the line should be primary and secondary school teachers, parents of school-aged children, and as soon as safely possible, children themselves.  We also suggest rapidly expanding programs that put recent college graduates (who are experiencing unprecedented unemployment) to work in virtual and in-person classrooms for the next year or two to help overwhelmed teachers. 

So, putting all these points together suggests that we are stuck in “Phase 2.X” of reopening.  Until a vaccine is widely available and effective, people will not be able (or willing) to resume fully normal activity, and the workarounds of remote work and school are not sufficient for the economy to return to pre-pandemic output levels.  In fact, it’s safe to say that the speed at which the economy can return to pre-pandemic conditions will depend almost entirely on both when a vaccine is available and how rapidly and intelligently it’s distributed.

In this week’s commentary, we’ll discuss North Carolina’s health statistics and current developments in the economic landscape, and offer some thoughts on the reopening of schools and universities.

First, North Carolina continues to show an overall improving trend in relevant healthcare statistics.  The state’s healthcare utilization remains in a relatively good position, and national utilization is starting to improve for first time since April. Despite some major hotspots, hospitalization rates both in North Carolina and across the country are falling, as are positive test rates, overall new cases and the basic reproduction rate (R-naught).  Perhaps most significantly, COVID-related fatalities have leveled off; accordingly, going forward, we expect the number of fatalities – which lag behind other health-related statistics – to fall in a manner consistent with current developments in the rest of our metrics. 

Second, while North Carolina health statistics show some signs of promise, the overall economic situation (both in our state and around the country) has undeniably plateaued. The fears we expressed in our earlier commentary on the general fragility of the economic recovery appear to be frustratingly warranted. We’re witnessing a dip in both aggregate spending and small business activity. As a result, our consumer consternation measure, designed to capture the extent to which households are unwilling and/or unable to engage in nonessential consumption, has also ticked up slightly. Although we witnessed significant improvement in both statewide and national consumer consternation from a peak in April to mid-June, nonessential economic activity has stagnated through most of July and August. A reversal in this statistic — though slight — only highlights the impediments to a more robust recovery. Consumers must both be safe and feel safe before they are likely to engage in nonessential activity. Collectively, these developments, at best, reinforce the likely slow, grinding nature of this economic recovery and, at worst, serve as a possible harbinger of a W-shaped (double-dip) recession.

One modest bright spot we do observe relates to insured unemployment, which has now dipped to 5 percent in North Carolina. Unfortunately, the overall U.S. number remains considerably higher. Despite the fact that significant improvement is still needed on the labor market front, as millions of Americans remain out of work, there are no concrete signs of another stimulus package forthcoming. At best, it may be several weeks before a presidential executive order delivers a $300 unemployment top-up extension (as of this writing, there does not appear to be any roadmap for congressional action, despite both sides of the aisle agreeing in principle on the need for additional support). Given this delay, he relevant questions are: Will businesses continue to recover in the absence of a fresh round of stimulus if their customers’ financial situations become increasingly constrained? And at an aggregated level, will we see a further dip in economic activity as these household savings run out?

As we discuss high-level aggregates, it’s important to remember that economic statistics are not abstract. This dispute in Washington coincides with a frustrating human reality on the ground. The conditions that describe socioeconomic adversity, both in North Carolina and around the country, remain dire. Our measure is designed to capture how likely individuals are to be experiencing moderate or high levels of mental adversity (anxiety, worry and/or depression), healthcare adversity (delayed or unavailable medical attention), and food insecurity (sometimes or often not having enough to eat). Measured in this way, socioeconomic adversity continues to sit well above pre-crisis levels. As a heart-wrenching testament to the personal challenges facing many Americans, nearly 41 percent of respondents to a CDC survey reported “at least one adverse mental or behavioral health condition” (three to four times higher than what the CDC reported at the same time last year). The study also shows that the number of Americans contemplating suicide is soaring.¹ Mental health support systems are “needed urgently,” according to the CDC.

An additional aspect of adversity is the hard-to-gauge, but sizable, cost associated with keeping children and older students out of school. Much has been written about the significant challenges many (particularly women) face with children at home competing with the demands of work. As a result, there is now a far greater appreciation for the extent to which economic activity cannot fully recover until the children of those in the workforce are back in school. However, we also know that the developmental and educational costs of keeping so many children out of schools are immense, and that some of these costs could become dangerously semi-permanent.

In the face of all this, school districts, colleges and universities around the country are struggling with the near impossibility of successfully reaching two competing goals: safety and learning. Despite what appears to be an intractable knife-edge challenge, failing to deliver along either dimension carries serious costs. However, we can learn from continental Europe,² where many schools and universities are already open or cautiously opening. Following their lead, we need to marry an elevated government-level testing and tracing regime with a renewed sense of individual responsibility, in which we diligently practice social distancing, wear masks, wash our hands and stay home if feeling unwell. Ironically, the avenue to economic freedom flows through an effective government bureaucracy, coupled with a personal responsibility to the community.Our children’s future cannot be collateral damage.

¹ Czeisler, M.É., Lane, R.I., Petrosky E, et al.(2020, June 24-30) Mental Health, Substance Use, and Suicidal Ideation During the COVID-19 Pandemic. Morbidity and Mortality Weekly Report 2020; 69: 1049–1057. DOI: http://dx.doi.org/10.15585/mmwr.mm6932a1external icon

² Zakaria, F. (2020, August 16). On GPS: Denmark's top tips on opening schools [Video file]. CNN. Retrieved from https://www.cnn.com/videos/tv/2020/08/16/exp-gps-0816-danish-education-minister-on-reopening-schools.cnn

In this week’s commentary, we’ll discuss the robustness of the improved health statistics, what the president’s executive orders mean for the economy and the first estimates from our undetected cases model.  We do this with an eye toward what could be impending deterioration on both the pandemic and economic front.

The healthcare data mostly show improvement over last week, both nationally and in North Carolina. The number of new cases, hospitalizations, positivity rates and infection transmission rates (“R- naught ”) all declined.  While modest, these sustained declines over the last two weeks indicate that the recent surge of infections might be reversing.  On the other hand, increasing death rates suggest that far too many people are still paying the ultimate price for the carelessness of those who have not taken the pandemic’s risks seriously. And healthcare utilization rates (our primary variable of concern from an economic policy perspective) held steady at acceptable levels.  In North Carolina, the rate has remained in the mid-70 percent range for almost two months now, despite the increase in cases and hospitalizations during the same period.

On the economic front, we see a continued plateauing of consumer spending that is well below pre-pandemic levels.  Spending rates, both nationally and in North Carolina, are essentially unchanged since mid-June across almost all the major industry sectors we’ve identified as most sensitive to the pandemic (restaurants, apparel, transportation, etc.).  In North Carolina, entertainment spending spiked during the last week of July, but we’re unsure if this is anything more than a statistical blip.  Small business activity in the state has stalled, but remains ahead of national activity. Certainly, the best news on the state economic front comes from both the ongoing decline in the insured unemployment rate, which ticked down to 6.4 percent at the end of July, and the continuing separation from the national rate, which remains near 11 percent.  We do not yet know the full employment statistics for North Carolina for July; however, the national numbers continued to improve, so we’re optimistic that North Carolina will follow suit.  Overall, North Carolina continues to rank near the top of all states in labor market recovery.

But is this the calm before the storm?  On the healthcare front, nonessential activity continues to expand, both nationally and in North Carolina.  Most recently, many colleges (including those within the University of North Carolina system) have begun returning to in-person classes.  Some K-12 schools are resuming classes this month.  More people are returning to normal work locations.  A resurgence of cases as a result of these activities could lead to further policy restrictions, but just as importantly, to an increase in consumer and worker anxiety that depresses economic growth.  Our Consumer Consternation Index has remained nearly unchanged on both the state and national level over the last month, and actually ticked up slightly in our most recent reading.  Given how closely the index tracks (and generally leads) broader economic conditions, the uncertainty on the healthcare front for August activity is a concern.

As of this writing, we haven’t seen a compromise in Washington on further economic stimulus. Instead, the president has moved unilaterally with executive orders to extend (at a lower level) federal supplements to unemployment benefits, to suspend payroll taxes for some wage earners and some debt-payment relief and to provide a moratorium on some evictions.  It’s a surprising gamble by both sides.  While the precise impact of the executive orders remains fuzzy, it does appear that they will drive meaningful benefits for some households in the near term.  However, our view is that a compromise package is needed, because many problems can’t be effectively solved by executive orders.  Perhaps the two most pressing issues are continued support for small businesses and broader relief to mortgage, rent and student loan payers.  The benefits outlined in the president’s executive orders are not only less generous than those proposed by the Democrats (which we believe were excessive in some dimensions) but importantly, are below levels received by beneficiaries through July.   Consequently, given that many households and businesses will be worse off now, there’s a significant risk not just to those directly affected but also to the economy more broadly.  In fact, it’s likely that the declines we’ve been seeing in unemployment during the last three months could reverse in August.  This would further adversely affect the already precarious situation facing state government budgets.  We support a return by the U.S. Congress to negotiations around extending the Paycheck Protection Program (PPP) for small companies, providing some relief to states who otherwise will be forced to contract spending soon (including on essential services) and having a more deliberate (but reasonable) unemployment and direct stimulus payment program. 

We conclude with a summary of work we’ve been doing to estimate the number of undetected cases.  One of the challenges facing policymakers, business leaders and the general public in understanding the spread of COVID-19 is the fact that many cases go undetected because of testing shortages or infected individuals not seeking testing (e.g., asymptomatic individuals who may not even consider the need for a test). Having an accurate estimate of undetected infections could help planners make decisions about testing policy and economic openness, let business leaders better understand risks to their workers and customers and inform economic projections. The state of North Carolina provides an interesting case study in infection modeling because the number of positive tests has grown steadily faster than the number of hospitalizations.  Likewise, hospitalizations in the state have grown more quickly than deaths attributed to COVID-19.  A very simple way to understand the disconnect between deaths and reported new cases is to estimate the total number of cases statewide using lagged data on the number of deaths and recent estimates for infection fatality rates that we provide in our COVID-19 statistics dashboard.  The graph shows that these “death-implied” estimates in North Carolina rose rapidly in March and April,  then leveled off.  This is obviously at odds with the number of new positive tests, which was quite low in March and April and has only recently approached the number of death-implied cases.

Of course, much better models have been proposed for estimating the number of undetected infections.  In our analysis (full report available), we examine a specific model and apply it to data in North Carolina.  The model provides estimates of undetected infections (IU) that are plausible, and fits observed levels of positive cases (ID), hospitalizations and deaths very well.  We find that the estimated level of undetected cases grew rapidly in early March (see figure below). Estimated undetected cases tapered off in mid-March, grew in early April, and peaked again in mid-April.  Since late April, estimated undetected cases have declined substantially, but according to our estimates it was not until mid-May that the number of detected cases exceeded the number of undetected cases. Over this period, the total number of estimated cases stayed fairly constant (100-150 per 100,000).  Our results suggest that the substantial increase in testing capacity over the last few months in North Carolina has been successful in identifying a higher percentage of infections.  However, it also suggests that much of the recent increase in the number of positive tests represents actual new cases, as opposed to being a consequence of more testing.  One concern about our analysis is that we are not able to condition on the age of those with detected cases or who are hospitalized, and consequently, we may underestimate undetected cases if the average age of those infected is declining.  Our estimates could also underestimate cases if the quality of care has improved over time and reduced hospitalization and death rates in a way the model does not capture. 

In this week’s data commentary we’ll provide our usual review of health statistics, but primarily focus on what is an increasingly perilous juncture for both the U.S. and North Carolina economies.  Specifically, the failure of Congress to agree on a new stimulus plan is feeling more and more like a game of chicken, with U.S. households standing between the onrushing vehicles.  Hopefully, there is still time to slam the brakes on the rhetoric and approach the problem with solid economic logic.

Latest Data

First, the data.  COVID-19 health statistics have improved both nationally and in North Carolina.  Nationally, it appears that a peak in new reported cases and hospitalizations was reached in late July.  A similar peak occurred in North Carolina. Encouraging trends are starting to show in positive test rates as well.  In contrast, the death rate (which lags new reported cases and hospitalizations) has continued to increase both nationally and statewide.  

This week, we added to the dashboard estimates of “R- naught,” or the virus reinfection rate, which measures the average number of people a currently infected individual is expected to infect.  Values less than 1.0 are consistent with containment of the virus. Estimates provided by Covid Act Now suggest that the rate in North Carolina has fallen below 1.0 recently, and the national number is almost there.  Overall, good news in the battle against the virus, although a sustained value below 0.9 is needed to reliably reduce cases on an ongoing basis.

In contrast, the economic statistics are not as encouraging.  Our measures of consumer spending continue to tread water.  Some important sectors, such as transportation and entertainment, appear to be dipping over the last couple of weeks. The unemployment rate remained steady in North Carolina and ticked up nationally. Small business activity also stayed flat.  As we discussed in last week’s commentary, both economies appear to be plateauing after a period of rapid rebound. Our measures of socioeconomic adversity continue to trend up at the national level, although trends in North Carolina are harder to discern because the data are noisier.

What’s Next Matters

A key pillar of the CARES Act was the federal unemployment supplement of $600 a week.  These payments alone exceeded the weekly unemployment benefits provided by most states, and together, benefits provided income levels of between roughly $21 an hour and $33 an hour (based on a hypothetical 40-hour work week).  These payments actually increased incomes for many people who lost their jobs. In fact, the combination of these payments and other stimulus income led to a second-quarter aggregate disposable personal income growth rate of +42.1% (at an annual rate)—the highest on record.  The payments, while very generous, were important for sustaining the economy during the near-national shutdown.  However, the $600 unemployment supplement officially expired on July 31, and what will replace it remains highly uncertain.  In addition, other terms of new stimulus also remain uncertain. 

The Republicans make the case that an additional supplement of $600 a week is so generous it will discourage lower-wage workers from seeking work.  The Democrats argue that the disastrous state of the economy means that most people seeking work will not find it, so incentives are not a major issue.  Adding to the debate is a study released by the Tobin Center for Economic Policy at Yale University. The findings suggest little effect of unemployment insurance on actual employment levels during the onset of the pandemic or in the weeks immediately following the implementation of benefits.

So who’s right?  Both the Republicans and the Democrats have valid points.  It’s inconceivable that, with a large majority of workers receiving more in unemployment than they would earn if employed, that a large number of lower-wage workers would have much incentive to reenter employment.  Regardless of what happened during the height of the shutdown (when many other forces were at play), benefits will need to come back in line with historic wages if the economy is to fully reopen. It’s important to examine the issue from the perspective of potential employers as well.  If benefits stay at such high levels, many businesses will not be able to afford wages that are needed to reemploy workers.  This is most pronounced in the service and retail industries, where businesses are struggling to survive.  On the other hand, the Democrats have a valid point in that the supply of labor is likely to exceed demand (at the previous equilibrium wage) for the foreseeable future.  Many individuals and households are currently facing dire circumstances through no fault of their own, and government assistance is needed to prevent another contraction.  In addition, there are still very vulnerable segments of the population for whom the health risks of returning to work are substantial.

What, then, is the preferred path forward?  Congress should extend supplemental benefits at a more modest level (maybe $300 a week, which is closer to the $200 a week that the Republicans have proposed), but also provide businesses with a grant of roughly $300 a week per new employee to add unemployed workers to their payrolls at a wage of $600 a week or more.  Extending these benefits for 12 weeks will effectively push the same level of income to many unemployed individuals, while at the same time reattaching them to the workforce and generating economic output.  Such a proposal would be costly for the federal government, but would lead to better outcomes for the broader labor market and economy.  This is just one possible mechanism, but support now needs to be directed toward restarting growth and reemploying people, not to extending incentives to remain detached. Other mechanisms have been suggested that would achieve the same goal.  That said, not everyone will be reemployed quickly, so any package should contain other safety nets for those currently receiving unemployment benefits—such as additional mortgage, rent and student loan payment forbearance.  In addition, consideration should be made for those with high health risks (e.g., workers over 60 years old).

Phase 3?

We are expecting an update on North Carolina’s phased opening this week.  Although conditions are improving, the changes are off of a much worse base than just a month ago. Consequently, it’s hard to make the case that the state is safer than it was on July 14. That said, North Carolina has managed the recent increase in cases well and demonstrated that there is headroom in the healthcare system for controlled upticks in infections.  Is it enough for a move into Phase 3?  Not yet, unfortunately.  The state can undertake some additional conservative reopening measures, but needs to ensure conditions don’t deteriorate significantly as people steadily increase nonessential activities away from home (including tens of thousands of college students returning to campuses).  Let’s hope everyone does their part to contain the virus in the coming weeks, and we’ll revisit the situation at the end of the month.

The health and economic data from this past week brought both good and bad news about the state of affairs in North Carolina. Health data suggest the growth in new cases is slowing, that hospital capacity remains available and that we might be getting a better handle on identification.  While this is certainly encouraging in the battle against the pandemic, a similar levelling off in business activity does not bode as well for the economy. In this week’s commentary we seek to unpack some of the details in the data to understand what may be a new plateau.

Signs of Stabilization in N.C. cases

The most recent data for the state of North Carolina provide some signs of stabilization of new infections. The number of new daily positive tests for COVID-19 has levelled off near 2,000 (or 19 per 100,000). Statewide hospitalized COVID-19 cases stayed close to 1,200 (11 per 100,000).  Likewise, the average number of new daily reported deaths has remained around 20 (0.19 per 100,000).  We even observed a slight tick down in the positive test rate.  Of course, these numbers are just snapshots and not reliable indicators of what will come, but nonetheless provide some hope that new infections may be reaching a plateau.

There was also good news this week on healthcare utilization rates in North Carolina.  First, we continued to see stability in our statewide measure in the 75%-80% range.  Second, we were able to examine regional data for North Carolina for the first time based on new daily statistics reported by NC-DHHS.  We are very excited about these new data because we believe that increasingly decisions on openness will need to be made more regionally.  These data will help both policymakers and business owners understand conditions in specific areas within North Carolina. We are currently working on economic statistics to track economic activity using these regional definitions and hope to have those on the dashboard within the next two weeks.  Perhaps most importantly, these data show what appear to be good conditions in healthcare utilization rates across the state.  All regions appear to have capacity in either available or unstaffed inpatient hospital beds as well as intensive care unit (ICU) beds.  Availability of ventilators is very good in all regions. While a rapid flare-up in a region could quickly utilize capacity, the current conditions are reassuring.

N.C. Economy

Now, the bad news.  We continue to see signs of a stall in economic activity in North Carolina.  Spending data for the week of July 11 (the most recent available) show activity at a level that is roughly equivalent to the week of June 20 and still about 8% below January levels.  While this is a huge rebound from the April trough of -33%, conditions do not appear to be improving further in recent weeks.  We had some hope that the Independence Day holiday was contaminating growth estimates, but this does not seem to be the case.  Of further concern is that we see the levelling-off of activity across all of the sectors that we believe are the best indicators of COVID-19 impacted businesses (such as apparel, entertainment, restaurants and transportation).  Small business activity has also plateaued and may even be showing signs of decline. Labor market conditions have also stopped improving in North Carolina—despite continued declines in June in the insured unemployment rate, the July values are stuck just above 8%.  

We believe that economic conditions in North Carolina continue to track national trends both because the economies are intertwined as well as because N.C. consumer attitudes are shaped by national trends.  For example, in spite what appears to be signs of stabilization on the new infection front in North Carolina, the (preliminary) week of July 18 reading for our Consumer Consternation Index ticked up for the first time in a month.  We see continued signs of socioeconomic adversity both nationally and in North Carolina as further weighing on consumers’ ability and desire to spend. This comes as we approach a possible fiscal cliff for unemployment insurance and the end of forbearance of loans and eviction moratoriums.  Consumers, of course, anticipate these potential disruptions, so the sooner Washington can provide clarity on new policy, the better it will be for the economy (ceteris paribus).  Finally, the school-year starting virtually in most jurisdictions will put continued pressure on parents, especially mothers, and will likely reduce hours worked (not to mention induce further mental and emotional stress).

We are also watching how traditional seasonal patterns in spending (e.g., back to school buying) will be affected by the pandemic.  We expect much lower spending on children’s apparel and traditional school supplies in July and August.  In contrast, the largely virtual/hybrid school model will drive higher than usual technology spending as parents try to prepare home spaces for a better educational experience.   The mix-shift of consumption titling away from traditional goods toward electronics will likely be a further hit to brick-and-mortar retailers in North Carolina since technology goods are more often purchased online.  However, we also wonder if the summer tourism season may extend into September; with many schools opening in virtual-only mode, some families may sneak in an additional week in the mountains or beach.   Expect more on this in future commentaries.

New Insights on Undetected Cases

We have been wondering for some time how effective testing has been in identifying infections in North Carolina.  While we are working on a statistical model for undetected cases, a new study released last week has provided additional insights on how deaths from COVID-19 can shed light on testing in North Carolina.  The study was a meta-analysis by Meyerowitz and Merone of 26 case-fatality rates from other studies and was able to provide a more precise estimate than previous research.   Case-fatality rates, also known as infection-fatality rates, measure the likelihood of dying from the disease after becoming infected.  The values from previous studies examined by the analysis ranged widely from as low as 0.09% to as high as 1.60%.  By combining the results of prior studies, the authors were able to generate a point estimate of the infection-fatality rate of 0.68% with a 95% confidence interval of 0.53-0.82%.     

Why is this important for understanding testing in North Carolina?  We had been using the number of deaths and the infection-fatality rate to infer the total number of cases in North Carolina.  Given the uncertainty, we decided to use a conservative estimate of 1.4% estimated from New York data. However, we had little confidence in the results because they suggested the number of daily new infections in North Carolina were averaging about 1,400 (i.e., about 20 deaths per day divided by 0.014) and the actual number of reported new cases is now consistently higher than that.  The updated point estimate of 0.68% suggests new infections in North Carolina are closer to 2,900 (with a confidence interval of about 2,400 to 3,700) which is not too much higher than the current average of reported new cases of about 2,000.  Taken at face value this suggests that North Carolina is now identifying somewhere between roughly 55% and 85% of new cases which is likely a much higher percentage than even a month ago. We have added to the dashboard the updated calculations for death-implied new cases and confidence intervals based on a two-week lag of seven-day average daily deaths.

All in, we see much to worry about on the economic front even as the healthcare front appears to be stabilizing some. As always, we encourage individuals to do their part to reduce the risks of new infections through social distancing, use of masks and diligent hand-washing and personal hygiene.  Economic conditions are likely to only improve subsequently as perceived risks of infection go down, and we must take our shared responsibility seriously.

Up Next

Next week, we hope to have more insight into how the new federal stimulus package is evolving with a close eye on support for small businesses and the unemployed; the potential for NC to transition to Phase Three reopening; and nonstandard seasonal trends in consumer spending.   

The recent spike in COVID-19 cases nationally, including a large bump in North Carolina, has us worried on a number of fronts—including its potential impact on the budding economic recovery. The $64,000 question has become, “Will we see a double-dip recession?” After the substantial rebound in consumer spending in May and early June, the most recent data suggests a stall in activity over the last month. Combined with an out-of-control worsening of the pandemic in several states, this trend is worrisome. Yet current conditions do not guarantee another plunge in the economy like the one we experienced in April. In this commentary, we look at the situation from our preferred three angles: health statistics, economic data, and individual behavior and welfare assessment.

Rising health uncertainty

First, let’s recap current conditions with the pandemic itself. (We remind readers that we are not doctors or epidemiologists; we are simply providing our take on publicly available health statistics through the lens of their broader socioeconomic impact. No one should consider this column advice on public health matters.) While new cases are soaring in many states, the severity is quite varied. Some states are handling the situation just fine, while others are increasingly overwhelmed. Looking specifically at North Carolina, the state remains somewhere in the middle, as it has for much of the pandemic. Fortunately, the situation appears to remain under control for now.

While North Carolina has been consistently setting daily records for new cases, the associated numbers of hospitalizations and deaths continue to lag in terms of growth rates. To be clear, hospitalizations are growing and deaths have ticked up in the last few weeks, but the magnitudes are very different. For example, data from the week ending July 16 show the number of new cases in North Carolina over the previous month to be up about 84 percent, whereas the number of hospitalizations is up 37 percent and the number of deaths has remained basically flat (with the caveat that reporting delays for deaths appear longer than for new cases or hospitalizations). The most likely explanations for these trends are:

• More hospitalizations and deaths are coming, owing to the lag between infection and serious illness and death for many patients.
• Improved testing is identifying more cases that will not end up in hospitalization or death (we are working on a model for unidentified cases and hope to share that in the coming weeks).
• Better treatments are reducing deaths and time spent in the hospital.
• The demographics of infections are changing, with an increased number of younger and healthier people becoming infected.
• Hospitals are admitting marginal patients more often because they are less concerned about being overwhelmed with severe cases.

Any and all of these explanations could support the observed trends, but they also beg the question of how economic policymakers should respond. At its essence, this is a very challenging forecasting question. While the state’s hospital system currently has sufficient capacity to handle new cases, a rapid acceleration in demand from increased new cases or an increase in the severity of cases could result in some facilities (or broader geographies) getting overwhelmed. In our view of how broader economic conditions should be metered, this is the critical constraint. North Carolina must avoid what happened previously in New York and New Jersey and is now happening in other parts of the country. Yet with the uncertainty about what is causing the divergence in healthcare statistics, it is very difficult to determine appropriate “openness” policies. We were glad to see the that N.C. Department of Health and Human Services is now providing regional data on hospitalizations, but we would also like to have additional data that could shed light on the details of the problem (e.g., the age of patients who are sick, hospitalized or who have died).

Where does this leave the economy?

The reality is that short of a return to Phase 1 closures (which we do not support at this time), there is not an effective way for policy to meter new cases (besides advocating for the obvious and essential precautions of social distancing, handwashing and wearing of masks in public—all of which we strongly support). So, with most businesses and consumers currently left to make their own decisions, what are we seeing?

• Aggregate spending growth has stalled nationally and in North Carolina. We are observing this in the most sensitive sectors, such as entertainment, apparel, healthcare and restaurants. Interestingly, transportation has continued to grow at a steady rate, suggesting that more businesses are operating, but likely at lower average output levels (summer recreation travel is also a contributor).
• We continue to be surprised at how tightly the state economy tracks the national economy in almost all spending categories. This is potentially troubling, because it suggests that even if North Carolina can remain on top of the pandemic while other states struggle, our economy will be impeded by the national trend. However, unemployment trends have started to diverge a bit, with unemployment in North Carolina continuing to trend down, even as the U.S. rate flattens out. The current difference of almost three percent is the largest in more than a decade.
• Small business activity (which leveled off sooner than overall spending) had been another relative bright spot for North Carolina, with activity almost returning to pre-pandemic levels by late May. But the most recent readings suggest another decline over the last few weeks. (Recent data are slightly confounded by the Independence Day holiday; coming weeks will provide clearer evidence on the current trend.)

Overall, we are seeing clear indications of a stall in activity, but fortunately there is not yet an outright double-dip. Our concern, though, is that it may be coming. As conditions continue to worsen in many states, we will see some new policy lock-downs, which will mechanically reduce activity (and spillover to North Carolina as we mentioned above), but these will also affect broad consumer willingness to engage in nonessential activities.

The consumer is number one

Our mantra for months has been that there is no way to have a robust and sustainable economic recovery without consumers both being safe and feeling safe as they undertake nonessential activities away from home. (See, for example, this Goldman Sachs white paper.) Again, we acknowledge the massive public health component to the pandemic, but the negative impacts on society are much broader than even the (admittedly severe) healthcare outcomes.

This was the logic behind constructing our Consumer Consternation Index, as well as our desire to understand how different demographic groups are being affected by the pandemic. What we have been seeing over the last few weeks is concerning in that respect as well. After peaking in April, consumer concern over undertaking nonessential activities away from home was diminishing consistently until June. During the last month, consternation in North Carolina has leveled off, and even ticked up slightly in late June. Nationally, we see a similar flattening trend, but consternation has actually fallen to a slightly lower level overall than in North Carolina (though this difference may not be statistically significant). In short, and as we would expect, the consternation trends are mirroring trends in employment and aggregate spending (though some of this is mechanical, since the index includes spending data on some nonessential items). We reiterate that, while “openness” policies can influence the consternation index, we observed significant changes in the index before policy changes were made. Consumers make their own decisions, and without consumers on board, openness policies will not return the economy to pre-pandemic conditions.

Finally, we examine trends for specific socioeconomic and demographic groups. Looking at our Index of Socioeconomic Adversity, we see a notable uptick in July both for the U.S. and North Carolina. Clearly the broader impact of the pandemic is intensifying, and this is bad news for those individuals most under pressure as well as for society as a whole. In particular, we note:

• Those older than age 59 were less affected than other age groups initially, but recent data for North Carolina shows a spike in their adversity levels (the national index has also increased, but not as sharply). Older individuals are likely concerned that the risks of the pandemic to them in particular are increasing disproportionately, and are undoubtedly worried about how long they will have to stay home to be safe.
• Non-white households continue to face higher adversity than white households, though on the national level, all have seen an increase in adversity in recent weeks. The North Carolina data is too noisy to infer current trends.
• Households with children have been facing relatively more adversity during the last month.
• Married households, which had been faring better than single households, have experienced an uptick in adversity in recent weeks.
• Low-income households continue to face severe levels of adversity, but recently middle-income and high-income households have also started to tick up.

Taken together, these indicators suggest a negative trend in terms of the financial and social conditions facing individuals. At a minimum, this poses a risk to continued economic growth on both the state and national level. The immediate policy response is not obvious for North Carolina, where health conditions are worsening but seem under control. To a large extent, the path of economic activity in North Carolina will be driven by individual and business decisions, not government decisions. For this reason, we reiterate our simple advice that the responsible individual behaviors of social distancing, hand washing and public mask-wearing are crucial components of the economic recovery.