Morningstar - Q4 2020 - 51

Spotlight: World After COVID-19

History's Lessons for Navigating
the Postpandemic World
How habits, fear, and sunk costs can
reshape the economy after shocks.

HISTORY

Preston Caldwell

As we showed in "Staying Home" (Page 41),
the market is pricing in a major reshaping
of the economy compared with life before the
COVID-19 pandemic. The severe hit to energy,
for example, implies that people will be
permanently driving and flying less, and the hit
to real estate suggests large shifts to working
from home and away from shopping at brickand-mortar stores.
But what are the means by which these shifts
could happen and what is the likelihood that they
actually will? There are three ways the virus
could continue to shape the economy long after
the pandemic has subsided:
gHabits could change during the pandemic, causing
lasting change in consumer behavior.
gFear of the next pandemic, including a COVID-19
resurgence, could make consumers reluctant to
engage in activities with social contact.
gSunk costs incurred during the pandemic
could change the long-term economic calculus
of consumers and firms.
These factors can help us understand what
the world after COVID-19 will be like. To see how
habits, fear, and sunk costs could have lasting
effects on areas of the economy, we studied
five past events that we believe are comparable
to the pandemic: World War II and rationing,
WWII and female labor force participation,
the oil price shock of the 1970s, 9/11 and air travel,
and pandemics of recent history.

For each event, we analyzed the overall impact of
the temporary shock on long-term economic
behavior and gauged whether habits, fear, and
sunk costs fundamentally changed the way
people and businesses acted.
Sunk Costs Underappreciated
In "Staying Home," we identified three key themes
that could affect the postpandemic world: the
increase in working from home; the future of
industries that were severely hit by social
distancing concerns during the pandemic; and
increased adoption of e-commerce and other
digital services. EXHIB IT 1 maps out how we think
each of these themes will be influenced by
changed habits, fear, and sunk costs.

Habits are a key factor to consider. People have
cut back on many normal activities because
of social distancing concerns, including eating at
restaurants, flying, attending large events, and
shopping at physical stores. Will this short-term
deprivation lead to long-term changes in consumer
habits? The share prices of companies in affected
industries and companies imply that investors
think it will. Companies experiencing less demand
for their products and services because of social
distancing have underperformed, suggesting
the market believes there will be a lasting impact
on demand after the pandemic.
Fear of the next pandemic or a COVID-19
resurgence is another psychological factor that
could affect many of the same industries as
changes in habits. Conditional on the development
of a vaccine, the risk of catching a severe
infectious disease after the pandemic won't be
materially higher than it was before. Nevertheless,

people are vividly aware of the risk, and it's
difficult to predict exactly how fear will shape
consumer behavior. It seems dubious that
anyone will avoid eating in a restaurant over fear
of being exposed to a rare infectious disease.
However, perhaps the largest and densest kinds of
social gatherings (such as public transit or air
travel) will inspire lingering anxiety.
Sunk costs are probably the least intuitive of
the three concepts, and we've seen little
discussion of them. In finance, sunk costs are costs
that an entity already has incurred. The pandemic
has forced consumers and firms to incur costs
they otherwise would not have. A simple example
is firms purchasing office equipment for their
employees working from home. Companies
would not have bought this equipment without
the pandemic. Once the pandemic is over, with
equipment already purchased and in place,
working from home will be marginally more
attractive for employers, even though the impetus
for the purchase decision has disappeared.
Sunk costs are even more important if we
consider not only monetary costs but
also the expenditure of other scarce resources
by consumers and firms-namely, time.
The surge in working from home necessitated
a large expenditure of managerial time
to craft work-from-home capabilities, such as
drawing up policies and learning the best
ways to communicate with remote workers.
Likewise, allowing employees to work remotely
is a gamble of firm resources, as the effect
on productivity is unknown. For many firms,
experimenting with working from home
was deemed too costly before the pandemic.
Now that the experiment has been
carried out, that component of firms' cost
is no longer relevant.
Consumers, too, have limited amounts of
time. When shopping at physical stores
became impossible or discouraged because of
social distancing and safety measures,
previously reluctant consumers had to spend the
time acclimating themselves to shopping
online out of necessity. Now that consumers
have incurred that cost, they might continue to

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Morningstar - Q4 2020

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