Avoiding zombification after the COVID-19 consumption game-changer

Alexander Hodbod, Cars Hommes, Stefanie J. Huber, Isabelle Salle 21 December 2020

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From the outset of the COVID-19 crisis, there has been a rich debate on the appropriate fiscal response. Soon after the crisis began, analysts quickly diagnosed the huge consequences it would entail for the macroeconomy (e.g. McKibbin et al. 2020,  Gopinath 2020). Major negative impacts would arise from both the demand and supply side (Brinca et al. 2020). The economics profession strongly encouraged governments to swiftly pursue aggressive fiscal expansion to help keep employers afloat and to maintain household solvency (e.g. Gourinchas 2020, Goldberg 2020). Governments across the developed world have heeded this advice, introducing unprecedented broad-based support measures such as furlough schemes, loan moratoria, and outright subsidies for struggling firms. These economy-wide responses allowed those sectors of the economy impacted by social-distancing measures a chance to survive the initial COVID-19 shock.  However, as the duration and the extent of the crisis are becoming clear, governments must ask themselves how to hone their continuing support to the economy to transition to the post-COVID-19 equilibrium. 

In particular, the longer the crisis lasts and the more profound the experience of it is, the higher the chances that the post-COVID-19 economy will look fundamentally different from what preceded it. If consumer preferences have fundamentally shifted in response to the COVID-19 experience, some firms and potentially some entire sectors will become obsolete. Fiscally bailing out such obsolete firms on an ongoing basis will, in the long run, merely create unsustainable ‘zombies’ and mismatch unemployment. Concerns about zombification are also growing due to the current extreme liquidity that exists in debt markets and the associated corporate debt overhang that is building up (Jordá et al. 2020).

Our recent paper (Hodbod et al. 2020) seeks to provide insight into how different the post-COVID-19 equilibrium might be from what preceded it by using a cross-country survey of five European countries. In line with existing recent country-specific studies looking at France (Bounie et al. 2020), Spain (Carvalho et al. 2020), the US (Coibion et al. 2020), South Korea (Kim et al. 2020), and the Netherlands (Golec et al. 2020), we observe major consumption drops across sectors since the COVID-19 outbreak. We contribute to this related descriptive literature by analysing the data on households' self-reported reasons for their consumption shifts. Thus we provide initial evidence on the nature of the COVID-19 demand shock and on how durable the reported consumption shifts could turn out in the post-COVID-19 environment. 

Sector-specific shifts in consumer preferences 

A sample of 1,500 representative households per country was surveyed in France, Germany, Italy, the Netherlands, and Spain. We collected the data after the first lockdown experience in July 2020, at a point when those initial restrictions were completely lifted. The survey asked households how their current consumption compares to before the COVID-19 outbreak for five key sectors (tourism, hospitality, services, retail, and public transport).  We find that a substantial fraction of households decreased their consumption across all sectors, with the largest drops in Spain and Italy. Overall, tourism was the most negatively impacted sector (66%), followed by public transport (58%), hospitality (55%), retail (46%), and services (38%) (see Figure 1).

Households were specifically asked to state the primary reason for their consumption changes. We focused on five self-reported drivers of consumption changes: (1) financial constraints, (2) worry of infection risk, (3) a lack of confidence in the future that induces a rise in precautionary savings, (4) substitution to online alternatives, or (5) permanent shifts in taste and preferences arising from the lockdown experience. This design allows us to reveal the underlying drivers for reported consumption changes and thereby to shed light on the nature of the COVID-19 demand shock. Are we merely experiencing a transitory income shock? Or a shock to consumer confidence? Or is the COVID-19 experience a game-changer, creating permanent changes in consumer preferences?

Figure 1 Fraction of households that consume less compared to before the COVID-19 outbreak (selected sectors)

Signs of substantial long-term structural consumption preference changes 

Lockdowns and travel restrictions were lifted in the countries during the time of the survey. Figure 1 shows that, despite this, a large fraction of households report reducing their consumption compared to before the COVID-19 outbreak. Analysing respondents’ feedback on their underlying motivation for changing consumption habits shows that a substantial fraction of households report what seems to be a durable shift in preferences. In France, Germany, and the Netherlands, “the realisation of not missing it” is the second biggest explanatory factor that respondents cite to explain their reduced consumption.1

Households’ permanent preference shifts are particularly observed in the services sector (such as hairdressers) and the hospitality industry (i.e. restaurants). For example, the fraction of households that realized that they do not miss services such as hairdressers amounts to 23% in France, 19% in Germany and Italy, 14% in the Netherlands, and 10% in Spain. At the same time, the fraction of households that realised that they do not miss going to restaurants amounts to 19% in France, 21% in Germany, 18% in Italy, 15% in the Netherlands, and 9% in Spain (Figure 2).

Slightly behind the fraction of respondents that don’t miss consuming the products and services in question, another substantial fraction cite precautionary saving motives. This saving motive is the second most cited reason for reduced consumption in Italy and Spain, and the third most popular in France, Germany, and the Netherlands. Within this segment of respondents, one may speculate that underlying permanent preference shifts could be taking place. Amongst those having chosen to forego certain consumption goods and services for an elongated period, a proportion may end up shifting their consumption patterns permanently as they adapt to living without them.  

Beyond the question of how much households are consuming, one must also reflect upon how they are making their purchases. For instance, amongst respondents indicating a reduction in their shopping at malls and other stores, a significant number report that this was due to substitution into online alternatives.  The fraction of households reporting online substitution as the main reason for shopping less in malls and other stores is highest in France with 16% and lowest in Germany with 9%. As the crisis becomes prolonged, consumers may become accustomed to this new way of consumption, which could lead to a long-term shift in the retail sector away from high-street shops.

Figure 2 Reasons for consumption reduction (selected sectors)

The crucial factor: personal experience with COVID-19 infections and the severity of the health crisis

On an aggregate level, the fraction of households reporting to be reducing their consumption compared to before the COVID-19 outbreak is highly correlated with the number of deaths per million of the population and personal infection experience during the preceding lockdown. We exploit the heterogeneous severity of the health crisis across the five countries surveyed to investigate what drives households' reduced consumption in each sector. Using probit regression models, we find that gender is the only socioeconomic household characteristic that is consistently and significantly associated with consumption changes. Standard socioeconomic household characteristics such as income, age, employment status, and education play a negligible role. Instead, behavioural factors such as macroeconomic expectations (pessimism) and psychological factors (such as worries and fear) are powerful explanatory factors underlying households' consumption drops in all sectors.  These behavioural factors are highly correlated with the severity of the health crisis and with personal experiences of COVID-19 infections within respondents’ family and friend networks.

Honing fiscal policy to prepare for the post-COVID era

Despite the recent positive vaccine news, it remains clear that the risk of infection will unfortunately remain with us still for quite some time. Nonetheless, governments must begin to plot a policy pathway out of the crisis and towards a new post-COVID equilibrium. Our results suggest two conclusions that policymakers should keep in mind to ease this transition. 

First, our indicators of long-term shifts in consumer preferences should serve as a warning against maintaining broad-based horizontal fiscal support to firms for an extended period. Given the scale of the shock and the profundity of the experience, some fundamental changes to consumer preferences are likely. The shift to a post-COVID equilibrium will therefore require some obsolete firms to leave the market, allowing resources to be reallocated into new sectors that better reflect consumer demand.   

Second, until the health crisis is over, governments should avoid seeing their dual objectives of protecting citizens from virus risk and preserving economic prosperity as a trade-off. Our results instead suggest that governments should see controlling infection risk as a prerequisite to preserving economic prosperity.

Authors’ note: The views expressed here are our own and do not represent those of the ECB, the Eurosystem, or the Bank of Canada.

References

Bounie, D, Y Camara, E Fize, J Galbraith, C Landais, C Lavest, T Pazem, and B Savatier (2020), “Consumption dynamics in the COVID crisis: Real-time insights from French transaction and bank data”, Covid Economics 59: 1-39. 

Brinca, P, J B Duarte, and M Faria-e-Castro (2020), “Measuring Sectoral Supply and Demand Shocks during COVID-19”, Covid Economics 20: 158-182.

Carvalho, V, S Hansen, A Ortiz, J Ramón García, T Rodrigo, S Rodriguez Mora, and J Ruiz (2020): “Tracking the COVID-19 Crisis with High- Resolution Transaction Data”, London, Centre for Economic Policy Research. 

Coibion, O, Y Gorodnichenko, and M Weber (2020), “The Cost of the Covid-19 Crisis: Lockdowns, Macroeconomic Expectations, and Consumer Spending”, Covid Economics 20: 1-51. 

Goldberg, P (2020), “Policy in the time of coronavirus”, in R Baldwin and B Weder di Mauro (eds), Mitigating the COVID Crises: Act Fast and Do Whatever It Takes, CEPR Press.

Golec, P, G Kapetanios, N Neuteboom, F Ritsema, and A Ventouri (2020), “Disentangling the effect of government restrictions and consumers’ reaction function to the Covid-19 pandemic: Evidence from geo-located transactions data for the Netherlands”, Covid Economics 56: 60-105.

Gopinath, G (2020), “Limiting the economic fallout of the coronavirus with large targeted policies”, in R Baldwin and B Weder di Mauro (eds), Mitigating the COVID Crises: Act Fast and Do Whatever It Takes, CEPR Press.

Gourinchas, P-O (2020), “Flattening the pandemic and recession curves”, in R Baldwin and B Weder di Mauro (eds), Mitigating the COVID Crises: Act Fast and Do Whatever It Takes, CEPR Press.

Hodbod, A, C Hommes, S J. Huber, and I Salle (2020), “Is COVID-19 a consumption game changer? Evidence from a large-scale multi-country survey”, Covid Economics 59: 40-76, London: CEPR Press.

Jordá, O, M Kornejew, M Schularick, and A Taylor (2020), “Zombies at large? Corporate debt overhang and the macroeconomy”. London, Centre for Economic Policy Research.

Kim, C, E Santacreu-Vasut, and E K Shin (2020), “Trade-off between health and wealth? Insights from COVID-19 in South Korea”, Covid Economics 58: 57-84.

McKibbin, W and R Fernando (2020), “The economic impact of COVID-19”, in R Baldwin and B Weder di Mauro (eds), Mitigating the COVID Crises: Act Fast and Do Whatever It Takes, CEPR Press.

Endnotes

1 Unsurprisingly, the most often cited reason for consumption reduction is the infection risk, while financial constraints are the least often reported reason across all sectors and countries.

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Topics:  Covid-19

Tags:  COVID-19, zombie firms, zombification, household consumption, consumption preferences

Counsellor to ECB Representative to the Supervisory Board, ECB

Professor of Economic Dynamics at CeNDEF, Amsterdam School of Economics, University of Amsterdam; Research Fellow of the Tinbergen Institute; Senior Research Director, Bank of Canada

Assistant Professor, Amsterdam School of Economics, University of Amsterdam; Research Candidate Fellow, Tinbergen Institute

Principal Researcher, Bank of Canada; Research Fellow, Amsterdam School of Economics, University of Amsterdam; Research Fellow, Tinbergen Institute

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