How Will Business Behave in the New Normal?

New research foresees long-term economic changes from belief scarring. 

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Based on research by Julian Kozlowski, Laura Veldkamp, and Venky Venkateswaran

When the US Bureau of Labor Statistics announced on May 8 that the unemployment rate, which was 3.5 percent in February, had shot to 14.7 percent in April, Professor Laura Veldkamp was not surprised. 

How long the economic downturn will last is a key aspect in Veldkamp’s latest working paper which examines how COVID-19 will affect the behavior of businesses, as well as consumers, in the coming months and years. 

“It’s not the immediate question,” Veldkamp, the Leon G. Cooperman Professor of Finance & Economics, says. “But it is large in magnitude: are we permanently changing society?” 

Veldkamp’s new paper, co-authored with Venky Venkateswaran of NYU and Julian Kozlowski of the Federal Reserve Board of St. Louis, puts the aftermath of the coronavirus in context of “belief scarring,” or the effect of a persistent change in a normal business environment due to a shock. To mitigate scarring, the research calls for policies detailing a substantial government intervention in the economy. 

Veldkamp and her colleagues found that the long-term losses due to the pandemic could range from one to four years of lost output. Veldkamp says  those large losses come from permanent changes in the decisions of consumers and businesses.

“Belief scarring means we won’t evaluate  risks the same way again,” Veldkamp says.

Veldkamp predicts that even that timeless symbol of business transactions, the handshake, won’t become as commonplace as it has before. 

“Shaking hands is economically irrelevant, but think about all the activities we do in close contact -- movie theaters, getting on an airplane, going to a big conference, dining at that cute, but very crowded restaurant,” she says. “I’m not saying that we’ll never do any of those things, but at the margin,  being aware of the health risks will change the calculus.” 

Veldkamp does not make value judgments on whether these changes are for better or worse, but emphasizes how that kind of scarring will inevitably alter consumer behavior, and lead to turbulence in the economy, notably in the pairing of labor and capital. 

“Maybe we have too much restaurant capital right now,” Veldkamp says. “Historically, life is different after we’ve had these transformative events. Shifts in preferences mean that people who were wait staff would need to move into different fields, such as healthcare or delivery services.”  

Veldkamp says that with most office-based work being done from home, the pandemic might lead to a rethinking of work environments, which could have negative implications for commercial real estate.

“If a worker prefers to work from home and they are every bit as productive, perhaps a supervisor lets them do it two days a week,” Veldkamp says. “They don’t demand as much office space, and then we’ve got a capital infrastructure that is maladapted to the new economy.” 

To stem belief scarring, Veldkamp says government actions, such as the CARES Act, are necessary, but recommends policies that assist workers in re-matching themselves with old or new employers. 

“Just because you pay a restaurant to keep their workers does not mean it will be a profitable business post-pandemic,” Veldkamp says.

In the economy at large, Veldkamp believes that the government will not allow widespread bankruptcies, nor will it allow banks to fail, to bolster confidence. 

“We’re going to throw as much money as needed and figure out the consequences later, “she says. “If confidence is shattered, if we don’t think this whole capitalist system works, then we’re going to have much larger problems than 18 months of pandemic.” “Our government is trying to make it clear that they’re ready to backstop to prevent the worst possible events.” 

While it is hard to find a bright spot in the economic gloom that has enveloped the country, Veldkamp has been encouraged that relief from the CARES Act shored out current equity valuations in firms. 

Still, the telltale sign of belief scarring is how people will behave as scientific progress is made on treatment and prevention of COVID-19. 

For guidance, Veldkamp thinks it is important to examine the lives of those who lived through the Great Depression, to which the current crisis has been compared. 

“People who lived through the Depression behaved systematically differently throughout the rest of their lives,” she says. “They saved more, they used less materials. Shocking events sear these memories and these persistent behaviors into us in ways that regular times do not.” 

About the researcher

Laura Veldkamp

Laura Veldkamp is a Professor of Finance at Columbia University's Graduate School of Business and a co-editor of the Journal of Economic Theory...

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