(Ed. Note: The “Innovation Fact of the Week” appears as a regular feature in each edition of ITIF’s weekly email newsletter. Sign up today.)
With surging COVID-19 cases in many parts of the country and a widely available vaccine months away—and with consumer and investor confidence and spending likely to be weak even with a vaccine—the odds are quite high that economic recovery will be long, drawn-out, and weak. As such, Congress is rightly debating a fifth economic recovery package.
Other than the size of the package, the most important issue for debate is whether it should be designed to support a weakened economy in the way that hopes most existing businesses will come back to full strength, or should recognize that significant industrial and occupational reallocation is likely and that policy should accelerate, not retard this. Making the former choice might result in somewhat less short-term pain, but it would also result in a much more drawn-out recovery with slower rates of overall GDP growth for many years.
Lawmakers should address both challenges by structuring a recovery package that addresses the short-term economic contraction while also effectively laying the groundwork for more robust long-term recovery, growth, and competitiveness.
After the 2008 downturn, China emerged much stronger because it structured its economic response in a way to boost productivity and competitiveness. In contrast, in large part because of the way the American Recovery and Reinvestment Act was structured, the U.S. economy emerged weaker with a long, drawn-out recovery, 12 years of anemic productivity growth rates and a less competitiveness. The United States cannot afford to make that mistake again.
The Uneven Recession and Industrial and Occupational Reallocation
The United States is not in a typical recession where demand is down somewhat evenly across all sectors and occupations. This is a recession where some sectors and occupations are extremely hard hit while others actually are growing. And for a number of reasons, at least some of these changes are likely to be long-lasting, with some sectors not coming back to normal for many years, if ever.
For example, between June 2019 and June 2020, employment in personal care and service occupations was down by 50 percent, while food preparation and serving-related jobs were down by one-third. In contrast, computer and mathematical jobs were up 10 percent, and health care support jobs were up 14 percent.
We see the same stark patterns for other industries. Employment in the motion picture and sound recording industries was down 53 percent, and jobs in transit and ground passenger transportation and accommodation occupations both were down 38 percent. In an article titled “COVID-19 is Also a Reallocation Shock,” economists Jose Maria Barrero, Nicholas Bloom, and Steven J. Davis reported that by April 1, 2020, consumer spending on airlines, hotels, rental cars, taxis, ride sharing, and movie theaters was down 75-95 percent relative to spending in 2019.
In contrast, some industries have actually grown in the last year. Jobs in data processing, hosting, and related services are up 3 percent, as many Americans do more activity online. Similarly, employment in the computer and peripheral equipment industry is up 6 percent. Jobs in general merchandise stores, including warehouse clubs and supercenters, are up 10 percent as more Americans shift to online shopping. Amazon hired 100,000 new employees and Walmart added 150,000. In an informal ITIF analysis ranking 134 industries by average degree of face-to-face contact involved (with, for example, spectator sports ranked 5, and truck transportation ranked 1), there is a -0.72 correlation between job loss from June 2019 to June 2020 and face-to-face rank. In other words, the more face-to-face activity in the industry, the greater share of job loss.
Many of these changes are likely to be long-lasting, even if an effective vaccine is available for all Americans within the next year. Millions of households have started buying a wide array of goods online, and it is likely that many will stick with that habit. Businesses now realize that at least a significant share of activity that they thought required face-to-face activity, including that requiring air travel, is no longer required. Many companies and workers realize that at least part-time telework is feasible and desirable. Certainly, some of this shift in spending patterns and business practices will persist.
Moreover, the shift to the “isolation economy” is accelerating technological changes that will also spur occupational and industrial reallocation. For example, it is likely that driverless taxis will be accelerated because of COVID. And companies are investing in automation, including new software systems like robotic process automation.
In other words, many of these current changes will become permanent. Barrero, Bloom, and Davis and find similar patterns when they look at economy-wide hiring. They find that for every 10 layoffs there have been 3 new hires, reflecting the fact that while many sectors and firms are shedding workers and contracting, some are growing. Importantly, they estimate that 42 percent of the layoffs will be permanent. In other words, the economy will be reallocating capital and labor from declining firms and sectors to growing ones. As they argue, “Even if medical advances or natural forces bring an early resource to the crisis, many pandemic-induced shifts in consumer demand and business practices will persist. Thus, much of the near-term reallocative impact of the pandemic will also persist, as indicated by our forward-looking reallocation measures.”
Two Kinds of Reallocation
There are two major kinds of reallocation of labor and capital. The first is within industry. In any particular industry, the response to the COVID economic collapse will mean that some firms will grow, and others will decline or go out of business. Normally, in periods of economic downturn economically weaker and less productive firms are more likely to go out of business. This means that unless government shelters firms from this natural selection process, when the recovery comes the economy will be stronger, because there will be a greater share of firms with higher productivity. Sometimes this reallocation is related to firm size, as small firms on average are less productive than large firms and are in a weaker position to weather the economic storm. Sometimes its related to business models. For example, it is likely that after the recovery a greater share of retail jobs will be in e-commerce firms rather than bricks-and-mortar firms. Fewer malls, more e-commerce warehouses.
The second kind of reallocation is between industries. For example, it may be a decade before air travel demand is back to pre-COVID levels, but demand for cloud computing and video conferencing services is likely to grow significantly. If telework grows as is expected, the commercial office real estate industry is likely to shrink, while the telecom (broadband) and cloud computing industries could grow.
This kind of reallocation does not happen immediately. Some weak firms hang on a relatively long time before going bankrupt, especially if supported by the government. Moreover, even if firms go out of business it is often hard for workers in declining occupations to shift to growing occupations requiring different skills. As Barrero, Bloom, and Davis write, “Historically, creation responses to major reallocation shocks lag the destruction responses by a year or more. Partly for this reason, we anticipate a drawn-out economic recovery from the COVID-19 shock, even if the pandemic is largely controlled within a few months.”
Overall, while this kind of economic pressure that weeds out weaker firms can in the long run be healthy, there is one way it is not the case, and that is with potentially high-growth, entrepreneurial start-ups. The vast majority of small businesses and start-ups are not high growth; most are what are termed lifestyle businesses whose owners want to work for themselves and not grow the business beyond a certain small size. However, some start-ups are growth companies, intending to grow to become at least mid-sized, if not large companies. And these firms are critical not only to future job growth, but to revitalizing the economy by injecting new innovation into the economy’s sinews. Deep recessions like the current one can be extremely destructive for these kinds of firms, killing off or seriously weakening many in the current generation so that over the next decade or two, the economy is has a much weaker cohort of high-growth firms, many of which would have competed in tough international competition.
Weaknesses of Recovery Packages to Date
To date, Congress has largely ignored the issue of reallocation in its prior economic recovery packages. In fact, the major policies enacted have deterred needed reallocation. As Barrero, Bloom, and Davis write, “Unemployment benefit levels that exceed earnings for many American workers under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, policies that subsidize employee retention irrespective of the employer’s longer-term outlook… inhibit business formation and expansion.” They add, “policy efforts to preserve all pre-COVID jobs and employment relationships could prove quite costly, if pursued. They are analogous to policies that prop up dying industries and failing firms. These policies are feasible, but the cost is high in terms of resource misallocation and taxpayer burden.”
Providing unemployed workers with a $600 dollar unemployment insurance payment bonus has slowed worker reallocation because many workers are making more unemployed than they were employed. Barrero, Bloom, and Davis cite an analysis which found that, with this bonus, “the average replacement rate across states would increase to roughly 116 percent…. The expanded benefits exceed 90 percent of the average weekly wages in all states; they exceed 120 percent of average wages in 21 states and 130 percent in six states.”
The Paycheck Protection Program that provided forgivable small business loans also slowed reallocation in two ways. First, by only supporting small firms, the program meant that larger firms that are more productive will now be more likely to close than smaller, less efficient firms, which will be more likely to survive, locking capital and labor in less productive enterprises. Many policymakers seemed to believe that protecting small business owners was the main purpose of the program, rather than helping workers. If they had believed the latter, the program would have focused on all business, not just small ones. But populist outrage, particularly from anti-big business progressives, demonized any help for big companies, as if their workers didn’t matter.
In addition, the PPP meant that within some industries that will see long-term declines in sales, the program made it harder for firms to survive, because the government propped up weaker ones, enabling excess competition, with too many firms now competing for too little business. Take restaurants, for example. It would have been better to allow more restaurants to go out of business so that the remaining ones could operate closer to full capacity, even if that capacity was to prepare meals for delivery or takeout. If in fact there is likely to be little post-COVID reallocation between sectors, then this might be good policy. The lion’s share of firms in an industry would stay in business and come back healthy. But for a number of industries, that is not likely to be the case, and the PPP program simply keeps some firms going for a while until government aid ends and they go under, hurting stronger firms in the process. As Barrero, Bloom, and Davis write, “In other words, the PPP creates financial incentives to keep workers engaged in businesses that cannot succeed beyond the duration of government subsidies, and to postpone their redeployment to viable businesses.”
What Should Congress Do?
Policymakers rightly want to reduce the economic pain on workers from this unprecedented economic crisis. So what should they do? It is possible to support laid-off workers and spur economy-wide demand to speed recovery while also being neutral or even supportive of economic reallocation that will lead to a stronger U.S. economy. As Barrero, Bloom, and Davis:
There are potentially large benefits of policies and policy reforms that facilitate a speedy reallocation of jobs, workers, and capital to newly productive uses in the wake of the pandemic. Policies that deter or slow factor reallocation are likely to further lengthen the lag of creation behind destruction, slowing the overall recovery from the pandemic, the lockdown, and the pandemic-induced reallocation.”
There are five key areas the next recovery package should focus on.
1. Unemployment Insurance
Rather than provide a waiver of payroll taxes or send checks to most American workers, the federal government should instead use those dollars to help states expand unemployment insurance (UI) payments. But lump sum weekly UI payments are not the right answer, especially because it means that some workers have a strong incentive not to return to work. Rather, the federal government should mandate that all states provide wage replacement rates of 75 percent up to an annual salary of $100,000. This will mean that most unemployed workers will receive needed income support to help them and their families weather this storm, while also shoring up needed consumer spending. And automatic stabilizers should be built is so that as local unemployment rates fall, this amount should decline to around 50 percent to preserve incentives for workers to actively get back in the labor market. Moreover, workers should be allowed to collect benefits indefinitely, as long as the local unemployment rates are above a certain level. The federal government would be responsible for all the costs of this program. Some argue that Congress should keep any changes simple due to the antiquated nature of state UI computer systems. But this change would be very easy to implement, requiring the systems to calculate 75 percent of the weekly wage or salary, subtract current payments from that, and submit a regular invoice to the federal government for payment of the difference between original payment (if under 75 percent) and the 75 percent payment.
2. Financial Assistance for Firms
Rather than provide forgivable loans only for small firms, Congress should provide very low-interest loans for all firms, regardless of size. It is illogical, to say the least, that a firm with 499 workers would be eligible for government help while a firm with 501 workers would not. Any firm, regardless of size, should be eligible for a low-interest loan with no loan repayments required for at least a year, and an ability to pay off the loan over a period of approximately five years. As Barrero, Bloom, and Davis write, “Assistance in the form of low interest loans without forgiveness provisions would discourage firms with poor economic outlooks from applying for assistance.” Some will argue that aid should be targeted to small firms because they are the “job generators.” But this isn’t true. On net, while new small business create jobs in year one, they proceed collectively to lose jobs every year for the next twenty years.
3. Incentives for Investment
Investment in R&D, new capital equipment and human capital (e.g., education and training) are the key drivers of long-term growth, innovation, and competitiveness. It is likely that there will be significant cuts in all three kinds of investment because of the crisis. For example, from 2008 to 2009, business R&D fell by 5.5 percent. As one study argues, “Given the extraordinarily high levels of economic uncertainty in the wake of the COVID-19 shock investment rates in these intangibles are likely to be at least temporarily depressed.” Not only does this reduce long-term growth, competitiveness and innovation, it also exacerbates the crisis by reduced demand in the short-term.
As a result, Congress should enact temporary incentives for investment in capital goods, research, and skills. Congress should provide a temporary bump-up of the R&D tax credit—to 40 percent for the Alternative Simplified Credit, and to 60 percent for the regular incremental credit—for all R&D expenditures made in 2020 and 2021. Importantly, any increase in investment should not count against a firm’s base period expenditures so that any increases do not reduce future year tax credits. Congress should also provide a temporary tax credit of 20 percent for investment in capital equipment, including software.
In addition, the best time for workers to obtain retraining is while they are unemployed and have time to attend classes. Yet many workers, even with unemployment insurance, will not be able to afford community college tuition, and many states are likely to cut funding for community colleges. As such, Congress should take advantage of this opportunity by providing funding to create community college tuition vouchers for any American who wants to enroll in classes for up to six months related to growing occupations between now and the end of 2021. This would help workers who are now in declining occupations get the skills they need to move into growing occupations.
4. Help for High-Growth Startups
As noted above, if even a modest share of current high-growth startups fails because of the current economic crisis, it will have long-term negative implications for U.S. growth and competitiveness. There are several steps Congress should take. First, lawmakers should make the temporary expanded R&D credits refundable until the end of 2021 while also passing S.2207, the Research and Development Tax Credit Expansion Act of 2019, which would make it easier for startups to take a credit against R&D expenditures.
Many startups are research-intensive and yet do not yet generate profits to take a credit against for R&D. Under current law the credits can offset some payroll taxes for early stage companies, but the amount is generally low. And while they can carry forward the credits, that doesn’t help the firms now. Moreover, the credit carry-forward provisions are revoked if the firm engages in an equity financing round or other type of “ownership change.” Congress should make R&D credits refundable for all companies, regardless of size for 2020 and 2021 in order to support research that could otherwise go dormant during the economic downturn.
In addition, Congress should allow startups and growth companies to monetize eligible net operating losses (NOLs). If startups, which generally don’t make a profit for many years, become profitable, these NOLs can be applied against future business taxes. Allowing startups to bring the value of these losses forward and monetize at least a portion of them through tax credits will help more survive the crisis.
5. Support for IT and Broadband
Unlike some sectors, it doesn’t appear likely that there will be much reallocation to or away from state and local governments. They will still need to perform critical functions after the economic recession, including providing police, fire, education, and social services. As such, any recovery plan should include support for state and local government, so they do not have to cut personnel, thus further prolonging the recession. However, that doesn’t mean that Congress should not try to speed up IT-based transformation of government. As we saw with the dismal response of the state unemployment insurance system, most state and local governments are using 20th century technologies to cope with 21st century challenges. And while COVID provided a badly needed wakeup call for just how antiquated state and local IT systems are, the economic crisis and collapse in tax revenues will mean less, not more IT investment. Collectively states invest about $50 billion per year in information technology. Congress should provide one-time funding allocation of $25 billion for a state and local IT modernization grant fund, to a be managed by the General Services Administration.
State governments should be allowed to submit proposals in rounds, with the first round of funding going to states that commit to the highest rate of matching funds. For example, if 14 states agree to spend 75 cents of their own budgets for every 25 cents in federal aid, and all other states are below this level, these states would be awarded funds in the first round. If funding is still available after the first round, then subsequent rounds of bidding would occur. Cities and counties would follow the same process, but with priority given for lower-income cities and counties.
Finally, it is clear that the economy and society are moving toward more digital, remote functions, both must improve efficiency but also resilience, especially in the face of the pandemic. Yet the United States still does not have adequate broadband in many high-cost rural areas and too many low-income Americans do not subscribe to broadband. Congress should provide funding for deployment of broadband to rural areas. At the same time it should provide stimulus funds to expand the Lifeline program, which subsidizes connectivity for eligible low-income Americans. Ideally the program would be a flexible voucher given directly to end-users to spend on two communications services or devices of their choosing. Currently, a qualifying household is eligible for only one service. But most families, especially those who hope to have systems to let kids do homework at home, need both a mobile and fixed broadband connection.
The economic crisis created by COVID-19 will likely be the worst since the Great Depression, especially if Congress does not act forcefully once again with a strong recovery package. However, such a package can and should be designed to keep overall economy-wide demand up, while not hindering, and even actively encouraging inevitable and positive occupational and industrial relocation.