This originally appeared on MIT Sloan Management Review
We are in the middle of a historic rupture in the economic fabric of our society. The COVID-19 pandemic has already had a pervasive impact on the United States, and economic and financial market experts are hotly debating how quickly the economy will recover once we get “on the other side” of the contagion and the enormous pressures it has placed on our health care system. Although it is too early to estimate the exact economic impact, it is likely that full recovery of economic activity, including GDP growth, jobs, and unemployment, will take at least a year, and likely much longer.
One group of economic commentators, including the president, argue that once we get to the point of health care stabilization, the economy will take off very rapidly, and we will be able to quickly recover the lost economic activity and growth rates.
But individuals and organizations must keep in mind that this view, as optimistic as it seems in the short term, is a potentially dangerous one when it comes to long-term planning, for four reasons. The first is that it overlooks the negative impacts on consumer sentiment and spending, which are likely to persist for many months, if not years. Second, the recent trend of governments trying to tilt the scales of the gig economy more toward worker rights is likely to continue in the coming months and years. Third, large segments of the economy are likely to be permanently disrupted as a result of the coronavirus’s impact on the travel, retail, and entertainment industries, among many others, requiring capital and labor to shift into new areas of economic activity on a massive scale. Finally, the industries that survive the downturn, including those that are vital to our economic system, will face a long period of adjustment to working and interacting virtually rather than face to face. In addition, industries and companies will have to prepare for future pandemics by building redundancies into their operations and supply chains — initiatives that will take years to develop and optimize.
Consumer Sentiment: Spending and Savings
It has been less than four months since the COVID-19 pandemic started in China, and only weeks since the virus began spreading rapidly in other countries across the globe. Although this has occurred in a much more compressed time frame than other historic events that have become major economic reference points, it’s likely that we will see changes in consumer spending and behaviors similar to those that resulted from the Great Depression of the 1930s and the Great Recession of the late 2000s.
Why? Currently, entire economies in the United States and Western Europe have already ground to a complete halt in ways that no one ever saw coming, especially government and corporate leaders. Epidemiologists had been warning about the risks of a pandemic, and there is certainly much more that could have been done to better prepare our health care systems, but no one anticipated this scale and breadth of economic disruption globally. What we see now is that both governments and businesses need to prepare for future pandemics like they never have before. The question now is not whether there will be another global pandemic; it’s whether the next one will be as severe as, less severe than, or — heaven forbid — even more severe than COVID-19. To properly prepare for the next pandemic, we need to better understand the impacts that are happening and likely to result from COVID-19.
Even before this crisis, there were a number of troubling trends in the labor, housing, and financial markets that had decreased economic security. The explosion in gig, temporary, and independent contracting work has created myriad opportunities for people to work in ways never before possible — but at the cost of job and income stability. That instability has been growing steadily over time as companies have perfected the substitution of employment on demand for regular, full-time hires. Additional instability has been introduced by companies adopting labor-on-demand models for shift work. Under these models, employees of businesses susceptible to rapid fluctuations in demand and activity — such as retailers, restaurants, call centers, and distribution centers — are given very little advance notice about when they need to show up for work.
Add in rising housing costs and growing levels of consumer debt, and a clear picture emerges: Most Americans were economically on the edge well before COVID-19. Now the virus has the potential to be the straw that breaks the camel’s back. At best, I expect it will take a full year for COVID-19’s negative impacts on consumer behavior to fully fade — contrary to the rapid recovery that some have argued is inevitable. This puts me in the camp of the more pessimistic, but with each passing day, that unfortunate scenario is becoming more likely.
Labor Market Regulation
Most of the labor market protections for workers in the United States, including rules on overtime pay, the minimum wage, health benefits, and retirement benefits, are built on an assumption of “regular” employment. Many of the major innovations in employment types in recent decades — first temp work and independent contracting, and now gig economy roles — evolved as a means for companies to get around the added costs of regular employment. Before COVID-19, though, we were already starting to see a legislative backlash against increased job insecurity. The most prominent recent example is California’s Assembly Bill 5 (AB5), a law that reclassified many gig economy workers, previously considered independent contractors, as employees.
Efficient economic solutions for workers involve better social safety net programs, such as the Affordable Care Act, which expanded health care coverage independent of employment. Similar schemes could be implemented for sick leave, workers’ compensation, unemployment insurance, and retirement benefits — all of which would be funded by direct taxation of gig work, temp jobs, and independent contracting. The less economically efficient solutions — such as California’s AB5 — directly disrupt the market for nonregular workers, including ride-share drivers, freelance writers, and musicians and performers. Yet such solutions are easier to implement because they put the burden of adjustment on workers and companies rather than on the government to design and run new aspects of the social safety net.
The push for increased worker protections was just starting to pick up steam before COVID-19. Now, with nationwide labor market disruptions and huge swaths of the population more financially exposed to the whims of the economy, I expect the push for greater government intervention to accelerate. Case in point: The recently passed $2 trillion federal rescue bill to counter the effects of COVID-19 includes an expansion of unemployment benefits to gig and self-employed workers for the first time. Further expansions of the social safety net for people working outside of regular employment almost certainly would be better for society — but at a cost to businesses, which would have to reconfigure how they use gig workers, temps, and independent contractors. Those adjustments will take time to work out and will play out in the next year and beyond.
The Destruction of Old Business Models and Rise of the New Ones
This point is one that is made every time there is a major recession: The bigger the economic decline, the greater the acceleration of what economist Joseph Schumpeter called creative destruction. This is the cycle where a recession causes declining industries and marginally successful business models to disappear faster than they would have if the national economy had continued to grow.
COVID-19 is going to cause an economic recession. The only question is how deep and how long it will be — and which industries will have a hard time recovering to their previous levels of economic activity without major disruptions and which businesses will survive and thrive.
The total cessation of activity in industries across the economy as a result of COVID-19 is similar to the impact of a major earthquake or snowstorm, where the vast majority of economic activity comes to a complete and unexpected halt. The difference with COVID-19 is that the standstill is not localized to one part of the country — natural disasters, while often devastating, typically have only small impacts on the national economy.
With COVID-19, as people have been forced to work from home, avoid travel, refrain from shopping in retail stores, and stop eating at restaurants, huge swaths of the economy have ceased to be financially viable. The disruptions from coronavirus are on track to continue for months. For many people who have been furloughed or laid off, this will mean not regaining their jobs. Many businesses that have temporarily closed will experience business model failure. The high levels of financial debt in the economy, especially in the business community, will ensure that marginally viable business models will be destroyed even quicker than would have happened otherwise. Eventually, the economy will recover as the new and growing business models take on greater shares of investment capital and people. But the adjustment process will slow the recovery of consumer demand and overall economic growth.
Face-to-Face Work Disrupted
As I write this, the number of people working under “stay at home” orders in the U.S. and across the globe continues to climb at a rapid pace. Companies in all industries are implementing new virtual work models, heeding the advice of leading medical professionals to practice social distancing. The sudden shift to distributed, remote work has enabled business continuity while creating huge challenges and inefficiencies in how business is conducted. And for some industries and jobs, moving from a face-to-face model to a virtual model is not an option or would create an enormous opportunity loss.
Most people’s workdays are filled with face-to-face interactions that are essential for effective communication and collaboration. Meetings are much more effective when conducted in person because you can read people’s body language, do more-effective brainstorming, and come to the right decisions quicker. Getting together with coworkers, customers, and suppliers over food and drinks outside of work builds camaraderie and trust: Meeting people in person often is the best way to get them to follow through on their commitments. Suddenly moving all those face-to-face interactions to virtual environments creates enormous friction in how the work is conducted.
That friction is not going to suddenly disappear if the stay-at-home orders are all lifted within the next few months. Because of the risk of repeat waves of infection, which are likely to hit in the second half of 2020 and beyond as we wait on a vaccine for COVID-19, businesses are already doing contingency planning. This includes potentially canceling large group meetings, conferences, and other in-person events through the end of the year. With each new wave of infection that threatens, businesses will proactively pull back on meetings and onsite work to avoid the bigger disruptions to ongoing operations that will occur when people get exposed to the virus and must self-quarantine.
This will happen even if there are no more government-imposed stay-at-home orders. Business leaders’ fears of larger disruptions to operations will lead them to be conservative in planning for a return to “business as usual” for face-to-face work arrangements. And that will significantly dampen economic productivity and growth through the end of 2020 and beyond.
Building Resilience Ahead of the Next Pandemic
Over time, companies have learned how to deal with unexpected adversity. Each recession is unique, presenting its own challenges that are difficult to forecast and overcome. And corporate scenario planning is full of examples of past events — such as the Johnson & Johnson Tylenol product-tampering event of the 1980s and the 9/11 terrorist attacks in the U.S. — that introduced substantial unexpected risks to companies’ business models. Companies had not anticipated these types of business disruption, so they were caught unawares and unprepared.
At first blush, it might seem like incorporating scenario planning for pandemics should fit into already well-defined frameworks for strategy formulation and capability building. The unfortunate truth is that the COVID-19 pandemic has caught virtually all industries and companies by surprise. The stresses on entire industries, nations, and the global economy extend way beyond the boundaries of standard corporate scenario planning, which is why so many segments of the economy are at risk of long-term retrenchment. As a consequence, we face many years of companies reevaluating and reorienting their operations and investments to be prepared for the next pandemic. Doing so will increase their resiliency, but at the cost of reduced sales and margins. As with an insurance policy, the ROI from shifting spending and resources will only be reflected in the bottom line when the next pandemic hits.
The recent growth in trade wars and escalating tariffs already had many corporate leaders rethinking the wisdom of highly interdependent global supply chains. The COVID-19 outbreak has emphasized these risks and brought them into sharper focus. Moving forward, true corporate resiliency will require businesses to consider challenges such as building redundant capacity in physical operations and human capital.
The specifics will vary across industries and business processes but are likely to include building the capacity to deal with sudden spikes in demand. For example, following the 2002-03 SARS epidemic, 3M began to prepare for the next surge in demand for N95 masks. It started cross-training workers to step in for colleagues absent due to illness and reconfiguring operations and supply chains with more manufacturing sites, approved vendors, distribution channels, and sales offices so operations could be shifted nimbly when one area couldn’t deliver its part of the business plan.
The steps needed to identify the most viable options, test them, and then build the capacity across end-to-end business processes are highly complex, and it will take years before a new equilibrium is reached. The process is certain to feature many battles between corporate leaders who want to look out for the interest of long-term investors, and the short-term-focused investors who will claim that the incremental investments are wasteful. The impending duel will not be pleasant to watch.
The New Economic Normal Is a Long Way Off
It takes time for business and society to settle into a new normal following a large-scale economic disruption. Even if the health care challenges from COVID-19 are solved before the end of this year, which seems highly unlikely, businesses will face many more months, and likely years, beyond the anticipated adjustment periods budgeted in their scenario planning and operations.
The shifts in consumer demand will require expansion in some industries and contraction in others. Future growth in consumer spending is likely to be slower than it has been for many years. Increased government regulation of gig and other nonregular work will require adaptation and changes in work practices. The disruptions in face-to-face work will be a drag on economic efficiency, leading to slower growth in revenues, lower profit margins, and reduced cash flow. And reconfiguring business models for greater resiliency will require significant investments of working capital into operations in ways that will not show any ROI until the next pandemic hits.
We will get to the new normal eventually. The corporate leaders who recognize these new challenges now and move quickly to adapt to them will put their companies in the best position to thrive throughout the 2020s.