The Effects of Pandemics on the Real Productive Structure: The Labor Market, the Process of Capital-Goods Stages, and the Impact of Uncertainty

The Labor Market

The emergence of a new, highly contagious illness which spreads throughout the world and has a high mortality rate constitutes, without a doubt, a catastrophic scenario capable of producing a number of serious economic consequences in the short, medium, and even long term. Among these is the cost in terms of human lives, many of them still actively productive and creative. Let us recall, for instance, that the so-called “Spanish flu” killed an estimated 40 to 50 million people worldwide beginning in 1918 (over three times the number of dead, including both combatants and civilians, in World War I). This flu pandemic attacked mainly men and women who were relatively young and strong; that is, people of prime working age.[1] In contrast, the current Covid-19 pandemic caused by the SARS-CoV-2 virus produces comparatively mild symptoms in 85 percent of those infected, though it hits the remaining 15 percent hard. It requires even hospitalization for one-third of these and leads to the death of close to one in five of those hospitalized with a severe case of the disease, the vast majority of whom are elderly, retired people and people with serious pre-existing conditions.

Thus, the current pandemic is not having a noticeable impact on the supply of labor and human talent in the labor market, since the increase in deaths among people of working age is relatively small. As I have already mentioned, this situation differs considerably from the one that arose with the “Spanish flu,” after which it is estimated that the aggregate supply of labor fell worldwide by over 2 percent. This figure takes into account fatalities from both the disease and World War I (40 or 50 million casualties from the disease and over 15 million from the war). This relative shortage of labor pushed up real wages during the Roaring Twenties, when the restructuring of the world economy was completed. It went from a wartime to a peacetime economy, and the whole process was accompanied by great credit expansion, which we cannot analyze in detail here, but which, at any rate, set the stage for the Great Depression that followed the severe 1929 financial crisis.[2]


Over the course of history, various pandemics have actually exerted a much stronger impact on the labor market. For instance, it is estimated that the Black Death, which ravaged Europe beginning in 1348, reduced the total population by at least one third. The acute, unexpected shortage of labor that resulted led to considerable real-wage growth, which took hold in subsequent decades. It is exasperating that monetarists and, particularly, Keynesians tiresomely go on about what they suppose to be the “beneficial” economic effects of wars and pandemics (for everyone except the millions who are killed or impoverished by them, I imagine). It is argued that these tragedies permit economies to overcome their lethargy and start on the road to a buoyant “prosperity.” At the same time, such calamities provide justification for economic policies of intense monetary and fiscal interventionism. With his customary insight, Mises refers to these economic theories and policies as pure “economic destructionism,” since they simply serve to increase the money supply per capita along with, and especially, government spending.[3]


The Productive Structure and Capital Goods

Aside from these effects on the population and the labor market, we should also consider the impact a pandemic exerts on the social rate of time preference and hence, on the interest rate and the productive structure of capital-goods stages. Perhaps the most catastrophic scenario conceivable is the one Boccaccio describes in his introduction to the Decameron when he writes of the bubonic plague that afflicted Europe in the fourteenth century. For if the belief becomes widespread that everyone is very likely to catch a disease and die in the short or medium term, it is quite understandable that subjective valuations become geared toward the present and immediate consumption. “Let us eat and drink, for tomorrow we die.” Or conversely, “Let us repent, do penance, pray, and get our spiritual lives in order.” These two opposing and yet perfectly comprehensible attitudes toward the pandemic have the same economic effect: What sense is there in saving and launching investment projects that could mature only in the distant future if neither we nor our children will be here to enjoy the fruits of them? The obvious result could be seen in fourteenth-century Florence, ravaged by the bubonic plague. En masse, people abandoned farms, livestock, fields, and workshops and, in general, they neglected and consumed capital goods without replacing them.[4] This phenomenon can be illustrated graphically in a simplified fashion as described in the section “The Case of an Economy in Regression” of my book Money, Bank Credit, and Economic Cycles.[5] There, I use the well-known Hayekian triangle, which represents the productive structure of a society. (For a detailed explanation of its meaning, see pages 291 and following of the book.)

As we see in Chart 1, in this case a sudden, dramatic increase in the social rate of time preference augments immediate monetary consumption (figure b) at the expense of investment. Specifically, numerous stages (represented by the shadowed area in figure c) in the production process are abandoned, a very large portion of the population stops working (either because of death or voluntarily), and the survivors earnestly devote themselves to consuming consumer goods (the prices of which, in monetary units, skyrocket due to the reduction in their supply and the widespread decrease in the demand for money). Transactions in the time market and loanable funds practically come to a halt, and interest rates on the few that do take place go through the roof.

In contrast to the above scenario, there is no indication that the current Covid-19 pandemic has been accompanied by a significant change in the social rate of time preference (aside from the effect of a temporary increase in uncertainty, which we will discuss later). To begin with, the current circumstances in no way resemble those of a pandemic as virulent as the one Boccaccio describes in the Decameron. As I have pointed out, the expected mortality among people of working age is virtually negligible, and expectations regarding the successful completion of investment processes that will mature in the distant future remain unchanged. (For instance, investments are still being made in the design, innovation, and production of the electric cars of the future and in many other long-term investment projects.) And since the social rate of time preference remains basically unchanged, the productive structure of capital-goods stages described in a simplified manner in our Hayekian chart also remains unchanged, except for three effects – one in the immediate short term, another in the medium term (one to three years), and another in the long term (which may become indefinite).

1. First, there is the immediate, short-term effect (lasting a few months) exerted on the real productive structure by the coercive confinement measures governments have imposed. We can assume that the economic standstill decreed for several months has, in relative terms, affected mainly those productive efforts furthest from final consumption. After all, the population – even people confined to their homes and unable to work – have had to go on demanding and consuming consumer goods and services (even if through e-commerce – Amazon, etc. – since many stores and final distributors were forced to close, because their activities were considered “non-essential”). If this is so, and assuming the final demand for money intended for consumption has not significantly changed, either because households on government-imposed lockdown have dipped into their financial reserves or because they have made up for their decrease in income by relying on temporary unemployment subsidies (lay-off compensation, etc.), the productive structure in monetary terms will have fluctuated over a short interval like a pendulum, as shown below (in Chart 2).


At any rate, when the compulsory “disconnection” from the production process ends and productive factors are again employed, the production process can start again where it left off, since no systematic, malinvestment-causing errors requiring restructuring have come to light.[6] Unlike what happened in the Great Recession of 2008, the productive structure has not been irreversibly harmed, and thus there is no need for a prolonged, painful process of reorganization and massive reallocation of labor and productive factors: All that is needed is for entrepreneurs, workers, and self-employed people to go back to work, pick up their tasks where they left off, and use the capital equipment that was not damaged (several months ago) and is still available now.

Concerning this first effect in the immediate short term, I should clarify that it would also have appeared – though it would have been much gentler and less traumatic and, thus, would have caused a much smaller fluctuation than the pendular movement reflected in the chart – if confinement had been voluntary and selective and the decision had been made on the “micro” level by families, companies, residential areas, neighborhoods, etc. in the context of a free society in which either no monopolistic governments exist (and instead we have the self-rule of anarcho-capitalism) or they are not centralist and do not impose widespread, coercive, and indiscriminate confinement measures.

2. Second, various sectors fundamentally associated with the stage of final consumption are still experiencing a dramatic decrease in demand after the confinement and may continue to do so for many months[7] until the pandemic has ended and activities have completely returned to normal. These sectors deal primarily with tourism, transportation, the hotel industry, and entertainment, and relatively speaking, they are very important to certain economies like that of Spain, where tourism accounts for almost 15 percent of GDP. Such sectors require a more profound change than the mere pendular fluctuation described in the first point above. Instead, circumstances necessitate a change which has an impact on the productive structure for a longer period of time (around two years). Obviously, other things being equal, if households spend less on air transportation, hotels, restaurants, and theater performances, they will spend more on alternative consumer goods and services, or substitutes, they will devote more of their income to investment, or they will increase their cash balances. Aside from a possible increase in the demand for money, which we will discuss later when we consider uncertainty, clearly the productive structure will have to adapt temporarily to the new circumstances by making the most of the active resources remaining in the sectors (at least partially) affected. I am referring particularly to those resources that are, for a time, involuntarily unemployed and will have to be reallocated to alternative lines of production where they can find fruitful (temporary or definitive) employment.

As an illustration, certain restaurants will stay open against all odds by adapting their offerings (for instance, preparing meals for home delivery), reducing costs as much as possible (laying off personnel or retraining them directly or indirectly – for example, to be delivery people), and adjusting their liabilities to suppliers in order to minimize losses and capital consumption. In this way, the owners avoid having to throw away years invested in building a reputation and accumulating highly valuable capital equipment that is difficult to repurpose. And they hope that, when circumstances change, they will be better positioned than their competitors and have a great competitive advantage when coping with the renewed recovery that is expected for the sector. In contrast, other entrepreneurs will choose to withdraw and “hibernate” by temporarily closing their doors but leaving the corresponding facilities and business contacts prepared for a reopening as soon as circumstances permit. Yet another group of business people – generally those whose entrepreneurial projects were marginally less profitable even under pre-pandemic conditions – will be forced to permanently shut down their businesses and liquidate their respective entrepreneurial projects.

All of these entrepreneurial activities and decisions can and must take place relatively quickly, and costs must be minimized. This will be possible only in a dynamically efficient economy which encourages the free exercise of entrepreneurship and does not obstruct it with harmful regulations (especially in the labor market) and discouraging taxes. Clearly, it will not be the government or public officials who will manage to make the most appropriate decisions at every moment and in each set of specific circumstances of time and place. Instead, it will simply be an army of entrepreneurs who, in spite of all adversity, wish to move forward and, with fortitude and unshakeable trust in a better future, remain confident that sooner or later it will arrive.

Regarding the triangle we use to represent, in a simplified way, the productive structure, the most we can depict (see Chart 3), assuming no significant change in the social rate of time preference occurs, is a horizontal fluctuation of the hypotenuse, first to the left, which shows the overall impact of the decrease in demand experienced in the affected sectors (and by suppliers in those sectors), and then back to the right, as it is replaced by new demand over the period of months it takes for complete normalcy to return, and to the extent that most of the money demand lost in those sectors is recovered.

Obviously, the chart does not permit us to show the countless entrepreneurial decisions and real investment transactions that result in the rapid and flexible horizontal fluctuation represented by the two-way arrows. The chart does, however, permit us to visualize the grave risk involved in launching policies that tend to make the productive structure more rigid by maintaining zombie companies that should be liquidated as soon as possible and by making it more difficult, via regulations and taxes, for a rebound to occur and push the hypotenuse of our triangle back to the right. In fact, fiscal and regulatory intervention can fix the real productive structure in the BB position indefinitely and prevent it from rebounding toward the AA position.

It goes without saying that all of these rapid-adjustment and recovery processes require a highly agile and flexible labor market in which it is possible to lay off and rehire personnel very quickly and at minimal cost. We must remember that unlike what happened in the Great Recession of 2008 (and happens in general after any financial crisis that follows a lengthy process of credit expansion), in the current pandemic we are not starting from a widespread malinvestment of productive factors (in the building sector, for instance, as occurred in 2008) which could justify a large volume of long-term structural unemployment. Instead, it is possible now to reallocate labor and productive factors in a quick, sustainable, and permanent way, but the corresponding labor and factor markets must be as free and agile as possible.

3. Third, we have yet to analyze the possibility that certain changes in the consumption habits of the population may occur, become permanent, and require permanent modifications to society’s productive structure of stages of investment in capital goods. We should point out that in any uncontrolled market economy, the productive structure is always adapting in a gradual, non-traumatic way to changes in consumers’ tastes and needs. It is true that the pandemic may hasten most consumers’ discovery and definitive adoption of certain new behavioral habits (pertaining, for instance, to widespread participation in e-commerce, the increased use of certain payment methods, and the mainstreaming of video conferences in the world of business and education, etc.). However, in practice we may be exaggerating the impact of these supposedly radical changes, especially if we compare them to the changes that have arisen, since the start of the twenty-first century, both from an even greater globalization of trade and exchange and from the technological revolution that has accompanied it and made it possible. These developments have enabled hundreds of millions of people to escape from poverty; billions of people (particularly from Asia and Africa) who until now remained outside the circuits of production and trade distinctive of market economies have been incorporated into the flows of production. Thus, the productive forces of capitalism have been unleashed like never before in the history of mankind. And despite the burden of state intervention and regulation, which continually hinder progress and clip its wings, humanity has achieved the great social and economic success of being 8 billion strong and maintaining a standard of living that only a few decades ago could not even have been imagined.[8] From this perspective, we should justly give less importance to the long-term impact of the current pandemic in a context of much bigger and more profound changes to which market economies are constantly adapting without major difficulties. Hence, we should again turn our analysis to the study of the short- and medium-term effects of the current pandemic, since, due to their closer proximity to us, we can regard them as more significant at this time.
Uncertainty and the Demand for Money

To wrap up the first part of this paper, we will now consider the impact of the uncertainty the pandemic has caused. In taking this approach, my main purpose is to highlight, as we will see in the final part, the fact that this uncertainty has led to even further promotion of fiscal and (especially) monetary intervention policies so extremely lax that they are historically unprecedented, pose a serious threat, and may well continue to have severe consequences once the current pandemic has ended.

Initially, the impact of a pandemic on uncertainty and, thus, on the demand for money can range between two opposing extremes. A pandemic may be so virulent that, as we saw in the case of the bubonic plague in Florence in the mid-fourteenth century, which Boccaccio describes so well in the Decameron, more than uncertainty, it gives a very large swathe of the population the certainty that their days are numbered and that hence, their life expectancy has been drastically reduced. Under such circumstances, it is understandable that the demand for money collapses and money loses much of its purchasing power in a context in which no one wishes to part with goods or provide services whose production has largely nosedived, and most people wish to consume these as soon as possible.

Of more analytical interest to us now are pandemics like the current one, which are far less virulent and in which, though the survival of most of the population is not in danger, uncertainty does escalate, particularly in the early months, with respect to the breadth, evolution, and rate of the spread and its economic and social effects. Cash balances are the quintessential means of dealing with the ineradicable uncertainty of the future, since they permit economic actors and households to keep all of their options open and thus to adapt very quickly and easily to any future situation once it emerges. Therefore, it is understandable that the natural increase in uncertainty stemming from the current pandemic has been accompanied by an increase in the demand for money and thus, other things being equal, in its purchasing power. Chart 4 can help us to visualize this. The chart contains several triangular diagrams which represent the productive structure in terms of the demand for money. These diagrams depict the effect of the increase in the demand for money as: a uniform movement of the hypotenuse to the left when the rate of time preference does not change (diagram a), a movement to the left that reflects greater relative investment when cash balances are accumulated by decreasing consumption (diagram b), and a movement to the left that reflects greater relative consumption when the new money is accumulated by selling capital goods and financial assets but not by reducing consumption (diagram c).

Although any of these three effects is theoretically possible, it is most likely that under the current circumstances there has been a combination of them, particularly of the situations reflected in diagrams a and b. Hence, we could superimpose these diagrams on those we analyzed from the charts in earlier sections. To make those initial charts easier to understand and examine separately, we did not consider the effects of a possible increase in the demand for money, and we are now including this in our analysis. There are three important points to bear in mind concerning the increase in uncertainty and in the demand for money stemming from the pandemic.

First, the increase in uncertainty (and the accompanying increase in the demand for money) is temporary and of relatively short duration, since it will tend to revert as soon as we begin to see the light at the end of the tunnel and expectations of improvement emerge. Therefore, it will not be necessary to wait until we have completely overcome the pandemic (around two years). Before then, there will be a gradual return to “normal” levels of uncertainty; the movements depicted in diagrams a, b, and c, will change direction, and the productive structure in monetary terms will return to its prior state.

Second, as the new money balances accumulate due to the reduction in the demand for consumer goods (diagrams a and b) – and this certainly does occur in the sectors most affected by mobility restrictions (the tourism and hotel industries, etc.) – this lower monetary demand for consumer goods will tend to leave a significant volume of them unsold. As a result, it will be possible to cope with both their production slowdown (which arises from the inevitable bottlenecks and the greater or lesser confinement of their producers) and the demand derived from the need to continue consuming experienced by all of the people who completely or partially stopped working during the early months of the pandemic’s impact. Therefore, the increase in the demand for money serves an important absorber with respect to the supply shock that occurs in the production of consumer goods as a result of the obligatory confinement. Hence, in this way, the relative prices of these goods are kept from skyrocketing, which would seriously harm the broadest sectors of the population.

Third and last, we must point out that monetary, fiscal, and tax interventionism by governments and central banks can increase uncertainty even further and may actually prolong it beyond what is strictly necessary and the pandemic alone would have required. Without a doubt, and as we will see in greater detail in the third section, governments and central banks can create an additional climate of entrepreneurial mistrust which hampers the quick recovery of the market and obstructs the entrepreneurial process of returning to normalcy. It would even be possible in this way to replicate the perverse feedback loop I study closely in my article, “The Japanization of the European Union.”[9] In this perverse loop, central banks’ massive injection of money supply and lowering of interest rates to zero produce no noticeable effect on the economy and are self-defeating. This is because they are neutralized by the simultaneous money-demand increase that follows from the zero opportunity cost of holding liquid assets and, especially, from the additional rise in uncertainty caused by the very policies of tighter economic regulation, blocking pending structural reforms, raising taxes, interventionism, and a lack of fiscal and monetary control.



[1]  I will always remember my friend Arthur Seldon’s story about losing his parents. After graduating from the London School of Economics, Seldon went on to become, together with Lord Harris of High Cross, a Founder President of the Institute of Economic Affairs (IEA) in London, a distinguished member of the Mont Pelerin Society, a great writer on a wide range of subjects, and a defender of the market economy. Both of Seldon’s parents passed away from the Spanish flu within a short time of each other – at the age of thirty – when he was just two years old. So, when Arthur Seldon was still a very young child, he became an orphan and was later adopted. With time, he managed to overcome the traumatic experience, but it left him with a permanent stutter that stayed with him for the rest of his life. It did not stop him from becoming one of the UK’s most brilliant economists and, to a large extent, the inspirer of Margaret Thatcher’s conservative revolution, which began in the late 1970s. See Arthur Seldon, Capitalism (Published by Wiley-Blackwell, 1991).

[2]     See, for example, Murray N. Rothbard, America’s Great Depression, 5th ed. (Auburn, AL: Ludwig von Mises Institute, 2000).

[3]     See, for instance, Carlo Maria Cipolla’s comments on the effects of the fourteenth-century Black Death in his book The Monetary Policy of Fourteenth-Century Florence (Berkeley: University of California Press, 1982) and my critique of his remarks in Money, Bank Credit, and Economic Cycles, 4th ed. (Auburn, AL: Ludwig von Mises Institute, 2020), pp. 71-72 and especially note 56. However, the destructionist paranoia reaches its peak in Paul Krugman, who in his 2011 article “Oh! What A Lovely War!” actually states, “World War II is the great natural experiment in the effects of large increases in government spending, and as such has always served as an important positive example (!) for those of us who favor an activist approach to a depressed economy.” Cited by J.R. Rallo in his foreword to Murray N. Rothbard’s book La gran depresión (Madrid, Unión Editorial, 2013), pp. XXVI-XXVII. For the original English, see America’s Great Depression, op. cit.

[4]     “…All, as if they looked for death that very day, studied with all their wit, not to help to maturity the future produce of their cattle and their fields and the fruits of their own past toils, but to consume those which were ready to hand.” See G. Boccaccio, the Decameron, Day the First [] and the comments which, based on John Hicks’s related remarks (Capital and Time: A Neo-Austrian Theory, Clarendon, Oxford, 1973, pp. 12-13), I make in Jesús Huerta de Soto, Money, Bank Credit, and Economic Cycles, 4th ed. (Auburn, AL: Ludwig von Mises Institute, 2020), pp. 71-72 and 346.

[5]     Ibid., pp. 344-346.

[6]     Of course, I am not referring here to errors that already existed before the pandemic and are still awaiting liquidation or restructuring.+

[7]     In the case of the “Spanish flu,” this period lasted a little over two years. As for the current Covid-19 pandemic, in spite of the vaccines, we believe this second phase will have a similar duration, though it may end a few months sooner.

[8]     See, among many other studies, the one by Hans Rosling, Factfulness (London: Sceptre, 2018).

[9]     Jesús Huerta de Soto, “The Japanization of the European Union,” Mises Wire, Mises Institute, Dec. 11, 2019. []