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Sun Liping on China's Post-Pandemic Economy
Sun Liping, "The Scarring Effect: Don't Think Everything Will Be Fine once the Pandemic is Over"[1]
Introduction and Translation by David Ownby
Sun Liping (b. 1953) is a well known Chinese sociologist who retired fairly recently from Tsinghua University. He is a frequent blogger with a large following, and I have translated many of his posts for this site. As noted, his general pose is as a "truth-teller," not someone who "speaks truth to power" necessarily (although his posts are occasionally taken down), but someone who says out loud what lots of people are thinking, on important contemporary issues like Russia, the war in Ukraine, the coronavirus, and China's impending demographic crisis.
The text translated here appeared on December 2, 2022, as China's zero-covid policy was being rolled back. Sun's theme is China's economy and the difficulty it may face trying to return to normal. What struck me was Sun's complete lack of discussion of recent history or recent policy. He has been saying for some time that China cannot afford the costs of zero-covid if the rest of the world has moved on, and he was surely tempted to crow a little, as the new policy seems to acknowledge that. But instead, Sun references a recent book by Princeton economist Markus Brunnermeier (The Resilient Society) which discusses the American (and more broadly, Western) economic recovery from the pandemic, seemingly as a way of saying "it's a competitive, capitalist world out there, and China's got to get back in the game. We can't be 'resilient' in lockdown!"
What will be the long-term impact of the epidemic on the economy? Will everything go back to the way it was once the epidemic is over, as one might be tempted to think? In The Resilient Society, Markus Brunnermeier, Professor of Economics at Princeton University, uses the figurative concept of the scarring effect to explore this question in depth.
According to Brunnermeier, the coronavirus epidemic is different from the 2008 financial crisis. On the surface, it does not appear that the epidemic was preceded by the kind of structural imbalances that led to the financial crisis, which can give the illusion that the economy will recover quickly once the epidemic passes. In reality, however, the severity of the recession caused by the coronavirus pandemic could have long-term scarring effects on workers and businesses.
Brunnermeier identifies three dimensions in which the pandemic could have such a scarring effect. First, it strikes at optimism and the willingness to take risks, leaving scars on the population's psyche. Second, human capital has been damaged by extended periods of unemployment, leaving scars on the labor market. And third, the debt backlog, especially if bankruptcy proceedings are prolonged, leaves scars on businesses. All of these can affect economic activity and depress long-term growth rates.
The first scar: the blow to optimism and the willingness to take risks. People always say that in the midst of a crisis, confidence and hope are very important. During the Great Depression of the 1930s, President Franklin D. Roosevelt said that confidence was more valuable than gold. That is, optimism, hope, and openness to risk are very important for economic activity. But hope and attitudes toward risk can change in a crisis. Brunnermeier points out in his book that historically, people who experienced the Great Depression were less likely to engage in risk-taking behavior later on. This suggests that even as the economy moves toward recovery, heightened sensitivity to risk and risk-averse attitudes may hold back demand. This means that attitudes and behavior change after an epidemic or a crisis, both in terms of investment and consumption.
There may even be a long-term scarring effect, or risk aversion, as Brunnermeier calls it. When survey respondents were asked, "To what extent will you return to your pre-epidemic life after the vaccine is available," only 27.5% reported that they would return completely to their pre-epidemic lives. So for years to come, people will likely still take fewer subways, cabs, elevators, or meals out, reshaping any number of daily behavior patterns and economic sectors. In the long run, more people will likely choose to "live for the sake of living," rather than living to work, just as the plague which ravaged Europe in the 14th century profoundly changed the attitudes of the survivors—some historians believe that these survivors appreciated life more and were more willing to enjoy it. This change in attitude perhaps even paved the way for the Renaissance.
The second scar: damage to human capital and thus to the labor market. Some studies have shown that in the recovery period following successive recessions, the employment situation recovers quickly. This has been largely true in the U.S. during the current pandemic. Unemployment soared while the epidemic was raging, but soon, as the epidemic was contained, employment conditions recovered quickly, and even to this day, demand for labor remains strong. But Brunnermeier argues that this picture is somewhat misleading and should not be interpreted as a sign of a truly resilient U.S. labor market. The unemployment strategy chosen by the U.S. in the midst of the epidemic, namely the dismissal of employees and the provision of generous unemployment benefits, severed job ties and may have led to a severe scarring effect in the labor market.
Brunnermeier compared the two different approaches of the United States and Europe. The U.S. approach was to terminate employees and provide generous unemployment benefits, while the European approach was to allow employees to keep their positions even while not working, with the government footing a large portion of the wage bill. Which of these two approaches is better? According to Brunnermeier, it depends on the nature of technological change at the time. If technological progress is surging forward, with new industries proliferating and old ones declining, the U.S. model is more conducive to promoting labor reallocation. Conversely, if the shock is only short-term in nature, maintaining the original job ties may be preferable.
An important concept here is work ties. If the epidemic lasts for only a short period, even the American approach will have little impact on work ties. But if the epidemic lasts longer, work ties can be weakened. It's easy to understand that if a restaurant closes down for a short period, getting the original cooks back is no problem, but if it remains closed for too long, then it's no longer so easy.
Here it is particularly important to note the impact of this scarring effect on recent college graduates. Obviously, a college graduate who does not find a job during the epidemic may be less advantaged in the labor market than a recent graduate. Brunnermeier's research suggests that graduating from college during a recession can leave a long-term scarring effect on workers, causing them to lag behind earlier entrants to the labor market for many years. Similarly, unemployment erodes human capital. The unemployed may suffer lasting scarring effects after losing their jobs if they lose skills or fail to catch up with new trends.
The third scar: the scarring effect on businesses. Brunnermeier notes that the coronavirus pandemic created an unprecedented cash flow shock for businesses, particularly for technology-intensive industries. In addition, after the initial shock of the epidemic on corporate financial decisions, a second round of dangers affecting practical decisions began to emerge, especially related to real investments. In this way, more leveraged firms will face long-term and sustained obstacles to growth after the epidemic, taking a toll on resilience. Accumulated debt would prompt firms to prioritize cash flow to reduce leverage rather than for investment purposes. And reduced investment will delay the onset of recovery, increasing the risk that the scarring effect will be prolonged.
Brunnermeier noted that impact of the scarring effects differs for small businesses and large corporations. Banks severely tightened their lending standards during the initial stages of the epidemic, which had a significant bearing on the cost of external financing for small businesses. Small businesses, especially those in hard-hit industries, can find themselves in a double bind, unable to get their business up and running while facing high funding costs from banks. Conversely, large businesses have benefitted far more than small businesses from the Federal Reserve's corporate bond buying program.
This scarring effect is more clearly seen in bankruptcies and corporate restructuring. Brunnermeier noted that, somewhat surprisingly, the number of corporate bankruptcies in many countries did not increase significantly in 2020. In places such as Germany, bankruptcies even decreased, as moratoriums relaxed the requirements that companies file for bankruptcy when they default on their debts. The problem, however, is that this phenomenon may benefit economic recovery or delay recession in the short run, but on the other hand, it can also have a weakening effect on creative destruction and thus be damaging to economic growth in the long run. Schumpeter of course argued that creative destruction is a major source driving long-term growth. In other words, renewing the lives of too many inefficient zombie firms can damage the economy's resilience.
Based on the analysis of these scarring effects, Brunnermeier argues that economies develop resilience by moving from risk management to resilience management. By resilience, he means the ability to respond and bounce back during a crisis, and the ability to recover in a dynamic way after a shock.
[1]孙立平, "疤痕效应:不要想疫情过后一切都会恢复," posted on Sun's WeChat feed on December 7, 2022.
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