The K shaped Recovery — This time is different. Are policy-makers ready for it?

In Europe and the US, the economy slumped massively across all sectors in March and April 2020. After that, a rapid recovery set in, suggesting a v-shaped economic cycle.

K shaped recovery: There was another economic slump with the onset of a second wave of infection starting in October 2020. This time, however, it hit different sectors with varying degrees of severity. Using Germany as an example, we describe the resulting K shaped recovery.

The service sector in the corona crisis — this time, it’s different

In previous major economic crises, the service sector came through the economic downturn relatively unhurt. This was also true in the financial and economic crisis of 2008/09. However, with the Corona pandemic outbreak in spring 2020, parts of the service sector also collapsed.

The hospitality sector exemplifies this in Germany — a sector that includes a wide range of businesses and goes from hotels and restaurants to dance clubs and bars and caterers and campsites. The restrictions on public life are hitting this sector with full force.

Real, or inflation-adjusted, sales in the hospitality industry were about 75 percent lower in April 2020 than in April 2019. From May through August 2020, sales began a sharp increase. November and December (more recent data is not available) saw another massive drop in sales.

Monthly real turnover in the hospitality sector in Germany since 2005, calendar- and seasonally adjusted, data as index value (2015 = 100).

Source: Federal Statistical Office (Destatis), data downloaded on February 20, 2021.

K shaped recovery in Germany

In the manufacturing sector, the second lockdown in Germany — in contrast to the first -has not yet led to a decline in sales. On the contrary, sales still increased slightly in the final months of 2020. With a little imagination, the composite course of these two sectors is similar to a K.

Monthly real turnover in the manufacturing and hospitality sector in Germany since 2019, calendar- and seasonally adjusted, data as index value (2015 = 100).

Source: Federal Statistical Office (Destatis), data downloaded on February 20, 2021.

Manufacturing industry versus service sector

Why do these different sectoral developments exist? The answer to this question is largely related to the specific characteristics of services. For many services, the time and place of production are identical to the time and place of consumption.

A haircut can only be performed when the customer is on site. The same applies to concert visits, hotel stays, commercial parties, and much more.

On the other hand, in the case of physical goods, production and consumption diverge — both in terms of time and space. This has three major consequences:

  • Manufacturers can sell their goods during a lockdown, even if all stores are closed. Online retailing, pick-up and delivery services offer ways out.
  • Manufacturing companies can export their products to countries with little or no restrictions on economic activity due to low infection rates. For example, German companies have benefited from the rapid economic recovery in China and sell their products there.
  • Companies in the manufacturing sector can stockpile their products and then sell them during the upswing when consumer demand picks up again.

Saving in the crisis

Declining consumption opportunities result in higher savings: If numerous service options are no longer available due to the pandemic, people cannot spend money on them. They, therefore, save more of their income. For example, in Germany:

  • Over the past 25 years, private households in Germany have saved around 9 to 11 percent of their disposable income each year. There was no noticeable increase in this savings rate during the financial and economic crisis of 2008/09.
  • In 2020, savers reacted differently: the overall economic savings rate rose from around 11 percent in 2019 to just over 16 percent — by far the highest figure in reunified Germany.

Savings of private households in Germany, given as a percentage of disposable income.

Source: Statistisches Bundesamt, Volkswirtschaftliche Gesamtrechnungen, Inlandsproduktberechnung. Erste Jahresergebnisse (2020), Fachserie 18 Reihe 1.1, Wiesbaden 2021, Tabelle 1.7.

Where do we go from here?

As long as social life restrictions are necessary to contain the number of infections, the sectoral differences outlined will remain. Sales losses will affect not only the hospitality industry but also many other sectors of the service industry: tourism, many areas of cultural life, major sporting events, the fitness, wellness, and leisure sectors, to name just the most important.

If, after a sufficiently large number of vaccinations, social life loosens up again and the supply side recovers, consumer demand can also be expected to rise. I expect that many people will liquidate the savings built up during the pandemic and use them for consumption purposes.

However, the problem for large parts of the service sector is that it will be difficult to make up for lost consumption due to the crisis. The purchase of a car, which did not occur in the spring of 2020 due to the corona, can be made up in 2021. However, a canceled vacation season is definitely over.

This means that sales shortfalls in some parts of the service sector cannot be compensated by volume expansion. After all, it is conceivable that consumers will be willing to pay higher prices for vacations, visits to restaurants and concerts, etc., after a long period of consumption shortfall. However, this will most likely not be enough to offset the losses from the Corona pandemic.

Not all service companies will survive the current crisis economically. It will be the task of economic policy to cushion the resulting job losses with social policy measures. It will also be necessary to observe who buys up the physical assets of the insolvent companies.

Here, the antitrust authorities must ensure that no dominant market situations arise when companies that have come through the crisis well take over insolvent companies.

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