Mancur Olson’s The Rise and Decline of Nations tells us that in stable times special interest groups tend to slowly create increasingly rigid agreements to cement their income streams. Major wars, and other cataclysms of that size, occasionally sweep away those rigidities, creating conditions under which faster economic growth is possible.
COVID has been much less cataclysmic than what Olson talks about. Yet I see hints that the recent pandemic has had effects that weakly resemble war. I see stronger evidence that the pandemic was a useful trigger for overcoming the effects status quo bias. I’m writing this post to help clarify my thoughts about how significant these effects will be, and how they’ll affect stock markets.
Is the stock market’s impressive performance partly due to expectations that the pandemic caused a lasting increase in profits?
I’ll guess that it explains one quarter of the stock market’s rise. A fair amount of that guess reflects my intuitions about how much can’t be explained by other factors. That approach is at least as error-prone as estimating individual pandemic effects. So please interpret this post as mostly groping around in the dark.
The pandemic caused many changes that have unambiguous benefits, but which would otherwise have been delayed for who knows how long because the early adopters would have born most of the risk, while getting the same benefits as those who delayed.
Telemedicine is a prime example. It’s not quite a perfect replacement for in-person visits to a doctor. That means that risk-averse institutions who used to require in-person visits were reluctant to be the first to adopt telemedicine.
E.g. when I initially enrolled in CCFM, their malpractice insurance required me to visit them in person once a year. There are some serious (but hardly great) reasons for requiring regular doctor visits. Those reasons involve some worst-case scenarios where doctors get blamed for something unusual, which means that doctors need more than just evidence that an innovation helps the average patient before it’s safe for doctors to adopt it.
In-person doctor visits involved hassles that prevented some patients from getting medical help. Telemedicine has fixed some of that. Maybe it occasionally produces a faulty diagnosis that an in-person visit would have improved upon, but my guess is these are hard-to-diagnose cases where medicine is not very effective, and cases where workers can’t find time to travel to a doctor include more cases where medicine provides a simple, high value solution.
Also, the act of traveling to a doctor had costs that mostly got ignored when they seemed inevitable. Eliminating them likely enabled workers to work a wee bit longer with lower overall stress.
Remote work and reduced business travel are important examples. Employees risk having their boss be less aware that they’re working hard. Even worse, working remotely might signal (or cause?) reduced loyalty.
Remote work has potentially large benefits: less time wasted in commuting, sometimes greater ability to work without distractions, and more flexibility about who works for which company. These gains are often underestimated because they’re inconspicuous.
A majority of employees who switched to remote work during the pandemic will likely return to their offices, because the original reasons for office work still hold. But a large fraction will continue at least some remote work now that status quo bias favors it.
In the early stages of the pandemic, many industries stopped most of their advertising. Some did that because they had little hope of selling anything in the near future (gyms, cruises). Some expected their sales to be purely limited by their ability to deliver (toilet paper, furniture).
A good deal of that advertising will return to normal. But some of it was useless (maybe the company was misled into overspending by a convincing marketing department). Some companies will postpone a return to normal advertising, and find that they’re better off with less advertising.
Why wouldn’t they have tried this in the absence of a pandemic, I hear you ask? A variety of reasons: it’s riskier for an executive to cause an unusual change compared to postponing a change (status quo bias), cash flow problems will influence a few cases, product shortages will influence others.
Delivery services are more efficient because the pandemic convinced them to not wait at our doors, and instead provide decent electronic notification. Any one instance of this seems insignificant, but it affects a large number of transactions, and smooths the path to further automation of delivery.
There have been potentially important changes in the labor market. It’s hard to evaluate whether the net effect has been good or bad.
The unusual unemployment insurance has made workers more willing to search longer for jobs that better suit their comparative advantage.
The widespread patches of labor shortages have caused increased movement of workers to new jobs. That has likely caused a temporary decrease in productivity as workers struggle to learn new jobs, but will likely result in better fits between workers and jobs, causing in higher productivity in coming years.
Many workers retired earlier than they otherwise would have. This both cleared out a good deal of unproductive labor, and removed some valuable institutional knowledge and skill. I’m guessing that both employers and employees do a slightly better than random job of preserving productive relationships and discarding the bad ones. So I’ll guess this is a modestly positive effect that will last for at least a few years, and maybe have a slightly positive effect on corporate culture for a decade or so.
The pandemic likely had some effect on the rate at which people are willing to work for a disruptive startup versus an entrenched giant. Alas, I don’t know which direction that effect went. This is one effect where increased productivity (through better startups) likely reduces profits (due to more competition).
Relatively Temporary Effects
There are many industries where profit margins have soared since the start of the pandemic. Some of this is due to effects that are clearly temporary, and these effects mostly reduced productivity a bit.
Many industries postponed new capital spending at the start of the pandemic due to uncertainty, then had trouble making up for that delay due to labor shortages, supply chain disruptions, etc. That means those industries have less capacity now than they would have. The resulting shortages reduce the competitive pressures that usually limit prices. Or sometimes existing factories have run below capacity because companies underestimated demand due to pandemic-induced pessimism, and failed to order enough parts, and production was never flexible enough to readily make up for this kind of shortfall. I suspect these effects have been important in the chemical and semiconductor industries. I’m unsure whether they’re affecting the auto industry. This effect will gradually diminish over several years.
Grocery stores made more money due to demand shifting from restaurants to stores, and due to shoppers doing less comparison shopping in response to the increased risk associated with spending time in stores.
Homebuilders are prospering due to another wave of what Erdmann calls a refugee crisis. The migration away from expensive cities has likely dropped back to pre-pandemic levels by now, but homebuilders have large backlogs that will keep them busier than usual for another year or more.
The Paycheck Protection Program has increased profits of medium-sized companies more than most investors realize. I presume those effects will end soon.
Auto insurers are doing well due to fewer auto accidents (alas, that doesn’t mean fewer deaths – I guess people are driving faster, so the average accident is more dangerous).
Highly Speculative Effects
The pandemic has drawn more attention to the harm the FDA causes by delaying the availability of medicine. That doesn’t appear to have improved anything so far, but there’s a modest chance that it has set in motion political forces which will free up a bit of medical innovation.
The Fed did a better than normal job of stabilizing the economy. Markets may be interpreting this as evidence that future recessions will be smaller. That could cause an important shift of investment from bonds to stocks, since it would cause stocks to be safer than markets previously thought they were.
I’m concerned that the Fed’s actions were partly due to a longer-term trend of preferring to err in the direction of causing too much inflation. In that case, any market reaction to the Fed’s success that may have happened includes some component of delusionally overestimating the benefits.
There are lots of ways that the pandemic might have made the economy more productive. I’ve made little effort to quantify their importance, and if I tried to put numbers on any one effect, I’d often be wrong by a factor of ten. I’m hoping that those errors are uncorrelated enough that when I use intuition to add them up, I get a result with less error. But I don’t have a clear argument to that effect.
The inefficiencies that COVID swept away seem less like Mancur Olson’s rigid agreements than I’d expected when I started writing this post.
Don’t forget that the pandemic did a good deal of harm that won’t get reflected in profits of publicly traded companies.
Some of the market’s rise still looks irrational, but that mostly looks like a continuation of trends that preceded the pandemic.