How “belief scarring” could impede U.S. economic recovery

A new study by researchers at the Columbia Business School cites “belief scarring” as a potential impediment to full economic recover in the U.S.

“Belief scarring” is a kind of crisis of faith in the minds of consumers — and business owners — prompted by any traumatic, unprecedented historical event. The COVID-19 pandemic is exactly that: a “tail event” — one about which we have little data (many term such an event as a “black swan.”)

Business hiring/investment and consumer consumption is driven by certainty — at least within certain bounds. But the COVID-19 crisis is without precedent. Such a situation shocks — and “scars” — our belief systems about the way the world should properly work. We are struck dumb by the radical shift in expectations, and — planners that we intrinsically humans are — have no data to inform our present and future actions.

“Take the example of a restaurant,” the paper implores. “Its kitchen may still be in use, but its dining area is unproductive capital, on which it is earning zero return. A key question is then whether this capital is gone for good. Surely, the restaurant has not disappeared. It is physically still there. But it could go bankrupt, which means the value of firm-specific investments that they made to their structure will be lost permanently. Even if the restaurant survives, people’s habits could change so that dining out is in lower demand for years to come. This could also be a source of permanent impairment to the value of such capital.”

The researchers applaud the application of public funds to ease the erosion of U.S. economic infrastructure. “We know that immediate economic interventions (e.g. the recent stimulus package) are expensive,” writes Veldkamp. “But in the long-term, these kinds of interventions can be the difference between a progressive versus a sluggish recovery. Policies that help prevent capital depreciation or obsolescence, even if they have only modest immediate effects on output, can have substantial long-run benefits, mitigating the potentially catastrophic belief scarring effect.”

Which — in a nutshell — means that every dollar that we can spend to prevent more capital destruction is a dollar well spent.

You can read the complete research paper here: https://cepr.org/sites/default/files/news/CovidEconomics8.pdf