The Risks to a Robust Recovery

In this brief Q&A, Cam Harvey outlines seven risks that have the potential to derail the economic path forward. The risks themselves are interconnected and each risk has multiple dimensions. Interested readers can always find Cam’s latest views of the economic and financial implications of COVID-19 and related material in his media library. Also, follow Cam on LinkedIn and Twitter.

Question: Cam, you point out seven risks with the potential to threaten a robust economic recovery. Could you begin by describing the first three?

Harvey: Sure. Let me first state that I still believe in the possibility of a robust recovery although the damage the economy has sustained will prohibit an immediate reversion to pre-crisis levels. To be prudent, we should go through the exercise of listing the risks to the recovery and assessing their economic and financial implications.

The first risk is what I call rose-colored glasses. People often look at data and interpret it in ways that are far too optimistic. This tendency is related to the human bias of overconfidence. One example is that we become careless in following social distancing practices or wearing masks, causing a surge in new cases of coronavirus, which is exactly what we are seeing now.

Next, we face the risk of a biological setback. Biological uncertainty has multiple dimensions. For instance, we may face disappointing results in the vaccine trials, problems with pharmacological (treatment) solutions, lack of progress on antibody research, and an unfavorable mutation of the virus, all of which could unexpectedly reduce the viability of vaccines currently in progress. While I am confident we will have a widely deployed viable vaccine by early 2021, much uncertainty on the biological front remains. Both the cause and the antidote to this crisis are a function of biology, reinforcing just how fragile the economic path forward is.

The third risk is debt overhang. This risk can be toxic for economic growth, impacting companies, consumers, and government. Firms that have weathered the crisis, but taken on excessive debt in the process, are unlikely to get needed financing. Think of a company with a project expected to deliver 30% profit growth, exactly the type of innovative projects the economy needs, but the company is turned down by its bank because it has too much debt.

Excessive debt also affects consumer behavior (partially due to the rose-colored glasses phenomenon). The frugality needed to repay this debt can reduce consumer spending and slow economic growth. The same goes for governments. The US national debt is approaching $200,000 per taxpayer. Although government spending can lessen the blow of an economic downturn, it inevitably translates into lower future government spending as the debt comes due for payment. Often important projects for long-term value creation, such as infrastructure and basic research funding, are likely the first to be slashed. Debt overhang is a global phenomenon.