Aftershock: The long-term prognosis for a tech economy in trauma

We may never see the levels of steady, robust growth in the global economy, nor in the information technology sector specifically, unless and until we resolve some of the fundamental, and potentially terminal, economic illnesses that have been ruminating under the surface. In the midst of the climate crisis, the cultural cataclysm, and the political plagues afflicting countries everywhere, including our own, there is now the economic malaise. The information technology economy has, up to now, been reliant upon a virtuous cycle of positive influences, the support systems for which have been kicked out from under them by the novel coronavirus.

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With the bottom dropping out of unemployment levels, and the last decade of recovery having been summarily squashed, it looks less and less likely that the IT economy will regain its familiar growth patterns at any time within the next five years. And as economics experts are now telling us, the formula for that growth, once tech producers regain their footing, may never be the same again .

“At the moment, the recession — especially given the way it’s being managed now — is going to be bimodal,” remarked Dr. Sherman Robinson, senior fellow at the Peterson Institute for International Economics, and a driving force behind the evolution of macroeconomics for over 43 years. “The top end of the labor market, top end of production, top end of services are already recovering, and doing pretty well. The bottom end is going to get worse.”

In a recession, the entire landscape can tip over, and the emphasis in manufacturing shifts to value, price point, and market sustainability. In this World Trade Organization chart, the “netbook recession” of 2008 — when IT producers tightened and digitized their supply chains, and constructed lower-cost products around them — is depicted by the pothole on the left. The Y-axis value is an index, where 100 is the relative value of global trade volume for Q1 2015. In terms of the size of the chasm, the coronavirus recession is already worse, even by the most generous estimates.

This is the raw speed of the economy — not just the output of manufacturing and services, but the extent to which they were involved in commercial transactions. We can prepare for numbers that indicate an 18.5% drop in trade volume over the previous half-year. In an absolutely worst-case scenario, that plummet could be as much as 45 percent.

Intertemporal elasticity

It’s a phenomenon first postulated last April by Prof. Veronica Guerrieri and her colleagues at the University of Chicago Booth School of Business, in a paper investigating the link between negative supply shocks and demand shortages. Accompanied by the diagram below, the Chicago Booth team writes:

When shocks are concentrated in certain sectors, as they are during a shutdown in response to an epidemic, there is greater scope for total spending to contract. The fact that some goods are no longer available makes it less attractive to spend overall. An interpretation is that the shutdown increases the shadow price [what people are likely to actually pay, as opposed to market price] of the goods in the affected sectors, making total current consumption more expensive and thus discouraging it. On the other hand, the unavailability of some sectors’ goods can shift spending towards the other sectors, through a substitution channel. Whether or not full employment is maintained in the sectors not directly affected by the shutdown depends on the relative strength of these two effects.

The tantalizing part of this paragraph is the phrase substitution channel. It’s not an easy phrase to explain, so bear with me: When efficiencies, such as the kinds made possible through technology, make feasible the replacement of one source with another (for better or worse), that alternative course is the substitution channel.

Prof. Guerrieri suggests here that, when a shock event causes spending to drop (“to contract”), some of that spending has to go somewhere. For decades, economists had advanced an observed phenomenon they called intertemporal substitution. It sounds like something LeVar Burton’s character in Star Trek: TNG would use to contain some temporal anomaly threatening the ship. In the general sense, this phrase actually refers to the willingness of consumers to make spending decisions now, or hold off until some later time — effectively trading present value for future value. When a purchaser or a consumer makes a choice to invest or transact later rather than now, that choice is said to be intertemporal. In terms of how that choice changes the value of business, an accountant would be substituting future value for present value.

What the Guerrieri team is suggesting is that interdependent sectors of a global economy can damage one another collaterally, during an event as calamitous as the pandemic. As their diagram suggests, an indirectly affected sector of the economy could experience a demand “bust” on account of one sector experiencing a shutdown.

For now, the increase in demand for cloud and data center services is being perceived as a sign of health and hope for the technology economy. But much of that increase is, as we’ve seen, a factor of demand transference:

  • Individuals shifting to working from home-based offices are utilizing Internet and cloud connectivity to a much higher degree, triggering some service outages as service providers ramp up availability.
  • Students of all ages are shifting to home-based learning regimens, triggering more worldwide service outages as the fall season commenced.
  • With less work being conducted in offices and schools, and more of it online, demand for writing and printing paper is said to be in sharp decline.
  • In the absence of consumer spending, including on IT devices and services, advertising expenditures have dropped, and investment in the creation of content around advertising and promotion has dropped in turn.
  • With an estimated 90% of the world’s currently open and operational cinemas located outside the US, many producers and content creators are shifting their media production strategies away from theaters and towards streaming delivery.

Where there’s an available substitution channel, demand can shift fluidly from one sector to another. Where there isn’t one, as may be the case with advertising, some of the value of the markets that depend on that main revenue channel, is lost.

To stimulate the near-term health of a country’s economy, its monetary policymakers may advise lowering their interest rates. The goal there is to encourage spending and investment rather than saving — for making decisions with present value rather than future. The sensitivity of an economy to this type of stimulus (as opposed to lowering taxes, which is considered fiscal stimulus) is called the elasticity of intertemporal substitution. Put another way, it’s the susceptibility of an ailing economy to the types of corrections that can get it back to full production after a downturn, as well as to emergency measures that could save it from a crippling shock to the system.

It’s hard enough for the US to consider the efficacy of fiscal policy when its fed funds rate was already 0.25%. What Guerrieri and her colleagues are investigating is whether a Keynesian supply shock with the magnitude of the pandemic shutdown event in Q1 2020, can trigger impacts on such factors as employment and GDP levels beyond the ability of a substitution channel to ameliorate it. A healthy economy has efficiencies that enable it to weather the storm, and even limited recessions are considered efficient responses. But in the absence of these efficiencies, are we faced with an anemic recovery?

Furthermore, can the positive trends in the tech services sector be dampened, or even nullified, by negative trends in another sector? Does a bimodal recession pattern remain bimodal for very long, when the impact is this severe?

There’s a “D” word here that no one’s saying yet. In the meantime, though, economic policy advisors are keeping their chins up, even when they have to be masked.

“Policy decisions have been critical in softening the ongoing blow to output and trade, and they will continue to play an important role in determining the pace of economic recovery,” reads a statement last June from WTO Director-General Roberto Azavêdo, evidently referring to countries where leaders are in place capable of making policy decisions. “For output and trade to rebound strongly in 2021, fiscal, monetary, and trade policies will all need to keep pulling in the same direction.”

Hysteresis

Recently, macroeconomist firm Consensus Economics surveyed its expert members as to their projections for international GDP. An August 25 assessment of this survey by Cannes-based asset manager Thierry Pujol, succinctly backs up Dr. Robinson’s projection. “Forecasters currently anticipate an incomplete recovery from the pandemic,” wrote Pujol. “While GDP growth is expected to revert back to its previous pace by 2022 or 2023, GDP levels would remain below their pre-pandemic expected trajectory. For the countries under review, the average cumulative loss between 2020 to 2025 amounts to almost 4% per annum.”

Once a country’s GDP returns to its pre-pandemic numbers, you may hear one or more of its leaders (or people pretending to be such) saying their country has “come back.” But as Pujol depicts in this graph, the lockdown event leads to a precipitous, perhaps catastrophic, drop. After that drop, GDP begins its “V-shaped recovery” rise, but assuming a shape Pujol likens to a bent square-root radical. The growth rate it’s aiming for never approaches where the original growth pattern would have taken GDP, had the pandemic never happened or if it had been managed the way H1N1 was managed.

The observation that any economy, once so severely impacted, cannot regain the shape it had, points to a phenomenon that Pujol ingeniously termed hysteresis. In physics, this term refers to the long-term, perhaps permanent, effects of the state of a system once it has been changed or impacted by another system. Imagine how a water balloon and a pillow would respond to being poked by a stick. Succinctly put, hysteresis is the impact of history on the future — the relative inability of a system to overcome its own past.

The role of technology in an economic system is to serve as a shock absorber for the effects of declining labor. GDP can plummet as a result of sudden unemployment, which a pandemic may certainly trigger. At its best, technology creates efficiencies where there were none before. (Any true permanent record of technology should be the unabridged story of efficiency.)

“Manufacturing jobs have gone down over the last 30 years,” noted Dr. Robinson. “But manufacturing output has not. We [the US] are a major manufacturing country. We’re just doing it more efficiently. What you don’t want to do is be less efficient, because then you’ll be losing more jobs.”

Not only has the data center sector of the tech economy weathered the pandemic, it has actually thrived. Workers being sent home and applications suddenly becoming more distributed, led to a spike in demand to which data centers — including the smaller Tier-3 and Tier-4 variety throughout the country — responded brilliantly. The reasons behind this positive response are all directly tied to efficiencies, in every aspect of data center operation: the way they’re sited, sourced, constructed, launched, powered, and administered. More than most any other sector of the global economy, data centers have answered the call.

But communications infrastructure is a far less nimble industry, relying far more on manual labor for construction and maintenance. It’s an area of the economy that is more sensitive to the impact of an employment drop. What’s more, data centers rely more and more upon the health of communications to establish network connectivity, especially with hyperscale and public cloud facilities. Communications may withstand one shock, but its recovery period is slower and its ability to withstand a second shock may be diminished. Hysteresis affects communications more.

As a result, we could expect the post-pandemic recovery path to be more of a dichotomy over time. What’s more, the extent of the rift may vary depending on where in the world you’re measuring it.

Pitfall

For his report, Pujol computed GDP recovery trajectories for 12 regions of the world, for each case using 100 as a relative index value representing 2019 production levels. As his model indicates, the total cost to some regions’ economies will be greater than for others. Wider gaps for a region indicate, among other factors, greater investments in pandemic containment measures. The US will have lost at least two years of regular GDP growth, Pujol projects, compared to Japan losing 3.5 years and Italy losing nearly 8.

Infrastructure and support services are typically omitted from GDP estimates. They’re the transactions and processes that lead to those final sales and consumptions. But as such, they are also the principal underpinnings of value. To the extent that they drag down the end products of technology, they point to inefficiencies that other technology segments — at least so far — have managed to avoid or overcome. This is what Robinson is referring to when he says the recovery may be bimodal. In such a case, the rebound of services is dragged down by the sluggishness of general labor.

Pujol’s global GDP growth chart points to the factors which cumulatively contribute to total economic loss over time — the blue zone at the top. The initial effects of a dual supply/demand shock, brought on by the pandemic, may be different for separate sectors of the economy. What distinguishes those sectors may be the length and breadth of their respective supply chains, and how much each link’s sensitivity to service disruptions translate to the final growth index, GDP. However, the ripple effects of each of these disruptions may have a kind of cumulative, aggregate drag effect. 

Put another way, hysteresis may be contagious.

“The basic intuition is simple,” wrote the Guerrieri team. “When workers lose their income, due to the shock, they reduce their spending, causing a contraction in demand. However, the question is whether this mechanism is strong enough to cause an overall shortfall in demand.”

That shortfall may change the profile of the recovery from “V-shaped” — or, as the President suggested earlier this month, “super-V-shaped” — to something that looks more like a barely tilted “L.”

“A V-shaped recovery is not gonna happen,” declared Dr. Robinson, who co-created the Computable General Equilibrium (CGE) model now commonly used in macroeconomics. “What you’re seeing is a crash. What we’re observing is absolutely unheard of in economics. This thing crashed down in weeks. Usually these recessions start somehow with a financial crisis, and the mortgage market goes, or banks go bad. And then it trickles down to the real markets, usually because investment collapses, and people’s confidence collapses. This thing started at the bottom. It’s a bottom-up recession. We had to close down a big hunk of the contact-intensive sectors in the economy, because of COVID. And we did it in weeks.”

Undocumented

Robinson believes the pandemic has exposed a vast chain of fault lines in the American economic and political system, none more important than the disparity between the value of goods and services and the value of the people responsible for ensuring their availability. , published by UCLA’s Latino Policy & Politics Initiative, reveals using US Government data that greater than 76% of the nation’s essential workforce, including IT and communications workers, as classified by the Dept. of Homeland Security, is comprised of undocumented laborers.

What’s more, those presumably essential jobs are among the lowest paying jobs in the American economy. Greater than 28% of undocumented laborers are earning at or below national poverty levels.

“We’ve been wildly under-invested in infrastructure, which has elements of public good. And we’re in trouble,” remarked Robinson. Laborers in all sectors, including the undocumented ones, must be paid more and afforded benefits — especially, as the DHS insists, essential laborers are critical to national security. “It is not good for the rest of us that we don’t provide medical care to 14 million non-citizen workers. That makes no sense at all. Something like universal health care, something like mobile pensions, would be necessary. Those are things Europe has. They would help a lot, to get this labor market working again.”

It is now an unescapable reality, like the orange smoke descending on the Western US: The workers responsible for keeping America well and functional, are the ones most susceptible to both infection by the virus and affliction by the economic malaise the virus has brought on. As Prof. Guerrieri’s models demonstrated, in a high-magnitude event such as the pandemic, the impact on some economic sectors can transfer onto others. While only small percentages of IT and communications workers are undocumented, large percentages of healthcare and vital services workers are seeking something approaching equity.

We’ve gotten by up to now without addressing this disparity, even indirectly. And now we’ve crashed. The only way up and forward will be for us to address the injustices uncovered by the pandemic, and then rather than bury them again, rectify them.

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