We Want Fiscal Stimulus!

The call for a substantial and long-running fiscal stimulus bill is getting louder and louder. The reason is that economic growth is beginning to stall out. Back in Spring, most businesses and investors were expecting that the economic downturn would be reversed very quickly. There was great confidence that just as easily as we shut down the economy, we could “turn on” the economy and instantly bring it back to its normal state. That confidence is starting to quickly disappear as the economy loses steam. This stalling of economic growth in turn is causing spending to decrease across the economy. And this decrease in spending is causing the economy to slow down, thus completing the vicious spiral that the economy is going down.

When Covid-19 hit, virtually all businesses were forced to shut down temporarily, and they were faced with the question of what to do with their employees. Many unskilled (low wage) employees were laid off or the equivalent (e.g., the Paycheck Protection Program) — employees in restaurants, hotels, and retail, for example. Skilled (higher wage) workers were typically kept on payrolls because replacing their skills was expected to be more difficult — employees in tech, medicine, and finance, for example. Therefore, businesses retained skilled employees so that in case the economy quickly returned to its normal state, these businesses would be ready to produce and sell products and services immediately. As of the end of September, employment data indicated that there were about 34% fewer unskilled jobs than before the pandemic. However, the number of skilled jobs had decreased by only about 4%.

Looking at that same employment data, we see another trend becoming clear. Companies are starting to believe that the economy will not bounce back as quickly as they once thought. This can be seen in the data on skilled employment. While skilled jobs have so far held steadfast, the number of skilled jobs is now starting to decrease. The number of skilled jobs had actually stayed flat relative to their pre-pandemic levels as of August, but that number has decreased to -4% of the September. A decrease in the skilled workforce is the first sign of a long-lasting, substantial recession. Companies now believe that the economy will not bounce back quickly, so they are cutting their skilled, but more expensive, labor as they try to better match expenses with the reduced revenue outlook. In fact, the pace at which expectations are changing in the economy has been rapid. A recent poll of CFOs at companies shows that firms are reducing their 4th quarter growth estimates from 10% to 2.5% on average, and correspondingly cutting their labor costs, especially expensive skilled labor.

The problem with cutting skilled labor is that if we look at personal spending, skilled labor spends five times more than unskilled labor on things beyond basic necessities (food, etc.). The velocity of money through the economy is the biggest determinant of a healthy economy, and skilled labor is far and away the biggest driver of money flow in the economy. However, as businesses begin to make cuts in their skilled workforce, this introduces uncertainty into the lives of this workforce, even if most still retain their jobs. They start to wonder when the cuts will end?, will they be next?, etc. This causes spending by the skilled workforce to stall (spending growth in our economy has slowed for three consecutive months). Of course, because the skilled workforce drives the bulk of money flow, most businesses start to see a slowdown in revenues. This in turn prompts them to further decrease their expenses by letting go of yet more skilled labor. At this point, the economy is in a slow death spiral, i.e., a substantial recession.

The traditional way to turn this around has been to not just prompt companies to stop letting go of their skilled labor but to get them to start hiring back skilled labor. Of course, firms won’t do this unless they see a permanent uptick in revenues. That’s why a policy of substantial fiscal stimulus has traditionally been the solution. With the government increasing spending on high value-added products like defense systems, information technology, medical technology, etc., companies throughout global supply chains start to hire back their skilled workforce. Confidence in their jobs returns to the skilled workforce, who in turn start increasing their spending. This leads to greater revenue for companies, who then hire more skilled workers, as well as unskilled workers. This creates greater overall consumer confidence, greater spending, and higher revenues for businesses. The death spiral turns into a life spiral, i.e., a healthy economy.

While fiscal stimulus spending and running even larger budget deficits run counter to the principles of fiscal conservatives, it remains the only proven tool in the government’s tool chest to get businesses to hire workers back and in turn to get consumers to spend. That is why so many people, ranging from the Federal Reserve Chair and the Treasury Secretary to most business leaders are warning that without a fiscal stimulus bill from Congress, the country will likely slip back into a recession.