K-shaped recoveries end well for everybody

There is a lot of chatter about which letter of the alphabet will represent the shape of the eventual recovery from the pandemic recession. Hopeful politicians predict a V, representing a rebound as robust as the downturn was calamitous. Pessimists forecast a U, in which the US economy would wallow in terrible shape for some time. A recovery followed by a second slump would look like a W.

K has emerged as a leading contender. The idea is that upper-income households will experience a rapid and strong recovery, while those with lower incomes keep losing ground.

The evidence suggests that this bifurcated recovery is already in progress, at least to some extent. But that is often the case in recessions and recoveries. And the first stages of economic expansions do not necessarily tell the full story. Lower-income households fare better as recoveries strengthen.

That is likely to happen this time, too. Unemployment spiked for workers in all education groups in the spring as the coronavirus and lockdown orders sent the labour market into a free fall. But it rose considerably more for workers with less education.

As the coronavirus started pounding the US economy in the two months between February and April, the unemployment rate for workers over the age of 25 who did not graduate from high school increased by 15.5 percentage points. The rate for workers of the same age but with advanced degrees increased by much less, 4.6 percentage points. The soaring productivity growth and rapidly rising wages seen this spring were driven by changes in the labour force, with lower-wage, less-productive workers bearing the brunt of layoffs.

This pattern is not unusual. The growth rate of average wages rose by around 70 basis points at its peak during the deep 2008-2009 downturn, in part reflecting the same dynamic the US is experiencing now. During that Great Recession, an additional eight out of every 100 workers without high school diplomas were added to the unemployment rolls, while only an additional three out of every 100 college graduates became unemployed.

But economic outcomes for different groups of workers and households tend to rebalance as the economy stops contracting and begins expanding. And as the slow and steady recovery from the Great Recession continued, lower-income and vulnerable workers saw their pace of improvement quicken.

The Great Recession officially ended in the summer of 2009, but it took four or five more years for unemployment rates to return to their pre-recession, longer-run averages. In the final years of that expansion, the job market for workers without a high school diploma was tighter than for college graduates. According to my calculations, in the three years preceding the pandemic, unemployment for dropouts was around two-thirds of its long-run average, compared to around 90% for college graduates.

In the first three years of the recovery following the Great Recession, from mid-2009 to mid-2012, weekly earnings for workers at the bottom tenth and at the top tenth grew by 2.1% and 3.3%, respectively. Workers at the bottom had the slower earnings growth by a wide margin. But in the final three years of the recovery, from mid-2016 to mid-2019, earnings growth at the bottom was the fastest, at 16% over those years. Earnings at the top grew by 8.5%, a little over half that amount.

Workers with disabilities saw their employment rates increase by 21% from their low in 2014 to the eve of this spring's pandemic. Anecdotes suggest that ex-felons had more job market opportunities as the expansion reached traditionally vulnerable populations of workers, and employers were less likely to conduct background checks on job applicants.

There is every reason to believe that the right combination of fiscal and monetary policy can create a similar situation as the recovery from the pandemic recession continues. The story from the K shape is that lower-income and more-vulnerable workers and households are more sensitive to the business cycle — they are hit harder in downturns, but if the economy gets hot enough, they can also benefit more as the expansion continues.

Taking an even longer view gives more reason for optimism about the prospects for lower-wage workers. In my new book, "The American Dream Is Not Dead: (But Populism Could Kill It)," I chart the economic success story of typical workers and households over the past several decades. Workers have faced serious challenges over that period, including the Great Recession.

But American workers are resilient and have overcome these challenges. Over the three-decade period ending in 2019, I calculated that inflation-adjusted wages for typical workers increased by one-third. Households in the bottom 20 percent saw their incomes (adjusting for taxes and government transfer payments) increase by around two-thirds. I found that 86% of people raised in the bottom 20% have higher inflation-adjusted household incomes than their parents did when they were of similar age.

Concern about the uneven recovery could lead to counterproductive policies. Raising taxes on corporations and well-off households — as Democratic presidential candidate Joe Biden has advocated — would make incomes more equal, but it would also slow the pace of economic improvement to the detriment of low-wage workers.

With the right fiscal and monetary policy, the benefits of the expansion will eventually reach lower-income households and vulnerable workers. But that is not an excuse for Congress to be complacent about its obligation to spend money now to support struggling workers, families and businesses.

Last week, House Speaker Nancy Pelosi and Treasury Secretary Steven Mnuchin expressed optimism about their negotiations on another round of economic-recovery legislation, though they remain far apart on key issues. On Saturday, while in the hospital being treated for Covid-19, President Donald Trump tweeted that the US needs "stimulus," instructing lawmakers and his administration to "work together and get it done."

It is needed. The sooner the economy tightens, the sooner its benefits will flow to lower-income workers and households. And when that happens, the "K" will become a check mark.

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement