The Economic Bottleneck is Upon Us

In biology, abrupt environmental changes can create evolutionary bottlenecks that force species to adapt or die. This dynamic has occurred many times during the history of life on earth, and genetic analysis suggests that humans nearly went extinct in our own bottleneck around 70,000 years ago.

Our economy is now at a similar crossroads. And, as in nature, economic bottlenecks are a regular part of business cycles. They occur each recession as businesses are forced to adjust to rapidly changing demand for goods and services. These shifts in the kind, quantity, and quality of products that customers desire spur businesses to adopt new production technologies (changing their inputs or processes) as they streamline their operations to survive. In general, businesses that are better able to adapt to the changes in the economic environment expand, while less-capable companies shrink, merge with more successful companies, or go out of business. The recession caused by the COVID-19 pandemic is no different, and we’ll be experiencing the growing pains from these sudden shifts for years to come.

Temporary Furloughs Transitioning to Permanent Layoffs

The past months have been filled with reports of corporate bankruptcies and firms announcing that temporary worker furloughs would become permanent layoffs. This is the exact outcome that economists have worried about since the beginning of the pandemic-related recession. Economists (and everyone else) have been closely watching to see whether the economy would experience a fast, “V-shaped” rebound—one where most furloughed workers would be able to quickly return to their jobs (an unlikely outcome).

The most obvious alternative is a longer, “swoosh-shaped” recovery, which would involve a quick rebound by some sectors of the economy followed by slowing growth as furloughs become permanent layoffs for more-affected companies and industries. Recent news seems to be signaling that it will indeed be the latter.

The Bureau of Labor Statistics monthly jobs report from August supports the swoosh: workers are returning to their jobs in substantial numbers, but the employment gains are trailing off. Between May and June, 4.8 million jobs were added back to the economy, but the growth from June to July fell to 1.7 million. The growth from July to August dropped further to 1.4 million, and 240,000 of those jobs are temporary Census workers. All in all, the economy has recovered 10.6 million jobs since bottoming out in April. That’s nothing to sneeze at, but it’s not even half of the over 22 million jobs lost since February.

A steady stream of corporate bankruptcies were being announced even as the recovery began in May. Among the better-known businesses were Hertz car rental company, retailers J.C. Penney and Neiman Marcus, fitness center Gold’s Gym, and a number of midsize oil and gas companies, including Chesapeake Energy. In addition, an analysis by Yelp shows that by July 10 nearly 73,000 businesses had permanently closed, including over 18,000 restaurants and bars and over 12,500 retail stores. And, the small business services company Homebase finds over 20 percent of small businesses remained closed during August, an ominous sign for the future.

A bankruptcy doesn’t mean that the business is going to close its doors for good—often businesses emerge from bankruptcy leaner and better able to compete for customers. But bankruptcies are almost inevitably followed by staffing cuts, and layoffs have also been accelerating at companies that are still struggling along. American Airlines and United Airlines, for example, recently announced plans to lay off a combined 53,000 employees, with MGM Resorts accounting for 18,000 more.

Some of these layoffs are relatively temporary, in an economic sense. When the ability to travel safely eventually returns, we should expect to see airlines and hotels increase staffing to respond to returning customer demand (although that’s likely small consolation for the workers currently facing unemployment). But other layoffs reflect permanent reductions in the demand for labor as companies update their production technologies to maximize efficiency. For example, toolmaker Stanley Black and Decker and business software company Salesforce.com are both cutting around 1,000 workers as they restructure their operations.

A third class of layoffs is the result of businesses not adapting to new economic conditions. Sears & Co., once America’s largest retailer, is probably the best example. 130 years ago the Sears mail-order catalog was the Amazon.com of its day, and the company grew even larger with physical stores during the shopping mall era. But as Ball State University economics professor Steven Horwitz points out, “Sadly, the company that made its name on mail orders couldn’t quite figure out what to do in a world of email orders.” After bankruptcy last year the company has been continually closing stores, and it’s uncertain whether it will even make it to Christmas.

A Recession is a Time Machine, Accelerating the Future to Today 

Sears provides a useful example of how a recession-induced economic bottleneck can accelerate changes that were already occurring. The pandemic didn’t cause Sears’ fundamental problems—business decisions in previous decades did that. COVID-19 is just kicking out the last supports at a faster rate than would have otherwise occurred.

In a V-shaped recovery—assuming that a miraculous amount of social cooperation and good fortune had been able stop the pandemic in its tracks—the economy likely would have quickly re-adjusted back to its previous track. In this case the evolution-related layoffs would have been spread out over multiple years as those companies gradually updated their operations (or slowly declined). But, as the recovery slows, we’re seeing the initial signs of more companies struggling to avoid the same fate as Sears—and the pandemic recession may be the straw that breaks their back.

Recessionary job losses are more difficult to recover from, partly because of the size of the problem. During later stages of the business cycle, it’s easier for successful businesses to reorganize and reemploy a steady trickle of laid-off workers from failing businesses and direct them to new, more productive activities. Dealing with a surge during a downturn is more difficult because there are more unemployed workers available than opportunities to expand production. This is especially true because demand for goods and services declines as the recession makes consumers cautious.

Economic Evolution is Initially Painful, but Ultimately Beneficial Over the Long Run

Over time, continuous evolution is generally good for the economy and society. It’s the process by which the competition to provide goods and services organically discovers what customers want and finds ways to provide it. After all, that’s what a well-functioning market economy does.

Economists call this process “creative destruction.” Since customers are king in a market economy, businesses compete to satisfy them and entrepreneurs experiment to find new goods and services they will value. The result over the last 200 years has been a “great enrichment” of those societies that have adopted market economies. Across the globe, average human income has increased by a factor of 10 over that time period and is 30 times greater in countries that have embraced trade and the private property rights that make market economies work.

But that isn’t to say that economic evolution isn’t painful, especially for the individual workers affected. Economist Joseph Schumpeter, who coined the term creative destruction, called it a “perennial gale”—implying that the storm is difficult to weather for those experiencing it. But it’s inescapably the best method we’ve found to produce rapid “betterment” in the general quality of life.

Amazon CEO Jeff Bezos seems to have taken Schumpeter’s insights and the lesson from Sears’ failure to heart. He advises Amazon employees to always have a “Day 1” mindset. As he is fond of saying: “Day 2 is stasis. Followed by irrelevance. Followed by excruciating, painful decline. Followed by death.” He acknowledges that Amazon will inevitably be eclipsed by other competitors but maintains that Amazon employees can forestall that day if they are guided by “customer obsession.” That’s an example of a corporate culture poised to ride recessionary storms and survive economic bottlenecks.

In short, the slowing economic recovery signals that we’re approaching an inflection point where the quick rebound from mandated business closures ends and the slower long-term recovery begins. The pandemic recession is going to be painful for those directly affected, and that pain will be more severe due to the enormous amount of economic change happening all at once. However, the evolution-related change that the pandemic has accelerated was nearly inevitable. From an economic perspective, this change is the process by which businesses become more efficient, freeing up workers to be more constructively employed. In other words, this kind of economic evolution is indispensable to economic growth, which enhances the future quality of life for everyone. But it’s hard to remember that when you’re in the middle of the storm.