COVID-19’s Creative Destruction

COVID-19’s Creative Destruction

“Creative destruction refers to the incessant product and process innovation mechanism by which new production units replace outdated ones. Over the long run, the process of creative destruction accounts for over 50 per cent of productivity growth.” – Joseph Schumpeter, 1942

There is nothing more depressing than dashed expectations. The vision of economic and social recovery we all had last June has been obscured by reality. The vaccine rollout was a failure. After months of effort there are only 60 – 70% inoculated (much lower in some places). This is well below the herd immunity level required for the latest Delta variant.

The labor market is in a strange whirlpool. Wages are up over 4% and there are 10.9 million open jobs or 1.4 jobs for every unemployed person. The tactical notion was that this would change once schools re-opened and the Federal unemployment benefits ended in September. It didn’t happen. Instead, 4.3 million people quit their jobs in August.

The hiring problem has CEOs depressed. The CEO Confidence Index dropped from a multi-year high in July to a 12-month low this month. Economists are cutting growth forecasts as fast as their models can recalculate.

According to the Bureau of Labor Statistics, labor force participation is 61.6% versus 63.3% in February 2020. That means about five million workers have dropped out since the start of the pandemic lock-downs.

What happened to them? Are five million workers on extended sabbaticals? Maybe they all went back to college – unlikely as enrollment dropped 603,000 this spring? Have people lost their mojo to work and create wealth or as John Maynard Keynes described it, their “animal spirits?”

Here is a thought. Millions of people were out of work yet they were not really financially troubled after a series of three stimulus payments, enhanced and extended unemployment benefits, rent deferrals, and child support payments. This is why, despite the massive layoffs and lockdowns, median household income dropped a mere 2.9% in 2020, and the savings rate jumped to 17%.

The chart nearby compares Labor Force Participation (from the FED) to New Business Formations (from the Census Bureau). It appears that not long after the lockdowns began workers realized this was not going to be “three weeks to flatten the curve” but a rather longer-term project. They launched new businesses at a ferocious pace. Beginning in June 2020, new business formations doubled. In the 15 months since June more than 7 million new entities have been formed.

What happened to the five million? They became entrepreneurs. Surprisingly, mixed into the trillions of dollars in the five COVID relief packages passed in 2020, was the seed capital for millions of new entrepreneurs.

It is, of course, impossible to assess the likely success of all these new companies. In development economics we might term these founders “forced entrepreneurs”, in that, their entrepreneurship is a result of negative life circumstances rather than some life-long ambition. Yet the fact that the pace of formation is continuing as the labor market rebounded is a strong counter to the “forced entrepreneur” explanation.

There are broader policy implications if these new business owners are not coming back to fill some of those millions of open positions.

  • First, hiring will remain slow and growth stifled from the labor constraint.
  • Second, the Federal Reserve Board seems to be waiting for a jump in employment before moving against inflation. This delay could be risky as inflationary expectations are increasingly imbedded in consumer and wage-earner psyche. High inflation is one of the reasons consumer confidence continues to decline
  • Third, the transportation bottlenecks at the ports and the shortage of truckers will continue for an extended period of time. Product shortages and the attendant price increases will persist.
  • Finally, there is no need for additional monetary or fiscal stimulus.

We were worried about some national angst taking hold – a Jimmy Carter type malaise. After months of bad news and ruined expectations and having faced and survived COVID, maybe people are re-thinking their priorities. Reassessing the value of work vs. the value of other things that matter and now matter much more.

Those worries were misplaced.

Starting a business is the ultimate expression of optimism. The animal spirits in the U.S. are as robust as ever.