Measuring the Medium Run Productivity Costs of the Coronavirus Recessions

With some types of machines such as a coffee grinder, it works when you press the button and it doesn’t work when you don’t.   As aggregate demand for air travel, restaurants and just about everything declines due to virus self distancing efforts, will a short run recession trigger long run negative effects?

An optimist might posit that the coming recession will have little medium term impact because our human capital and physical capital will not change much.  Such an optimist would have to grapple with the wealth effect of the lost income due to a decline in real estate values and asset values.

A more pessimistic view points to the human capital dynamics of adult workers.

Labor economists have discussed duration dependence for decades.  Under this theory, a worker’s skills atrophy as she spends more time not working.  So, note that this is a treatment effect (causal) hypothesis. The more time you have not worked causes you to be less employable in the next moment. One micro mechanism is that you start drinking or become even more lazy.

The Coronavirus will provide a natural experiment for studying the duration dependence hypothesis.  Economists should note that the virus causes mass unemployment and thus concerns about selection bias (that losers are more likely to be fired) is a 2nd order concern here.

In an underappreciated AER paper from 20 years ago, Lanier Benkard explores a different theme. In this paper. Lanier argues that if a producer releases workers during bad times that these workers with firm specific and product specific production skills may not return to the same firm. Once product demand increases, this means that the firm will need to bear new training costs to produce the same products. A prediction of this model is that such firms should keep such “asset specific” workers on payroll during bad times to avoid organizational forgetting.

So, unemployment will increase more in firms and industries that feature less firm specific human capital and where worker training costs are lower.

The medium term economic loss, caused by reduced demand caused by the virus, will be larger if firms fire workers now have plenty of firm specific human capital.  If these fired people lose their ability to work  (duration dependence) , forget their skills (Benkhard) or find other jobs; then the productivity losses for the firms will be more persistent.