Economic shocks that initially hit specific sectors can spill over into others—and have effects that long outlast the crisis period, highlights research by Chicago Booth’s Kilian Huber. The findings suggest that the economic impact of COVID-19 could be broader than previously expected.

“The recovery from big shocks can be slow, even if the shock itself is temporary,” Huber says. “This is especially true if productivity-enhancing investments are affected during the crisis.”

The findings come from an analysis of German companies during and after the 2008–09 global financial crisis. Commerzbank, one of the country’s largest banks, in 2008 made deep lending cuts because of losses on its international financial investments. Germany, unlike most developed economies at that time, hadn’t experienced a real-estate boom or bust, local banking panic, or sovereign debt crisis. This made it possible to track the effects of the lending cut without the interference of additional external factors.

Huber analyzed five data sets sourced from the government and business surveys. The lending shock reduced the growth of companies that relied directly on loans from Commerzbank, he finds. On average, over the four years following the lending cut, employment at directly affected companies was around 5 percent lower than at those with no direct exposure.

But the shock also reached companies that didn’t have a direct relationship with the bank. Indirectly affected companies experienced spillover effects due to both a general decline in demand and a temporary lack of innovation at directly affected companies. When Commerzbank’s customers made job cuts, overall household consumption fell, which then affected revenue and employment at other companies, Huber says. Further, declining production and research-and-development activities at directly affected companies spilled over to others, thus halting broad innovation. Indeed, the research finds that more-innovative companies were likelier to be hurt by the lending cuts.

As lending normalized, the pain continued. In the years following the recession, directly affected companies were worse off than companies with no direct connections to the bank, Huber finds, but indirectly affected companies also experienced continued challenges.

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How might these findings relate to the economic shock wrought by COVID-19, which couples a health catastrophe with a massive global halt to economic activity? The financial shock [of 2020] initially hit hospitality and tourism, and disrupted manufacturing supply chains. However, it quickly spread into other sectors as strict stay-at-home policies were enacted worldwide. Job cuts accelerated swiftly even as some companies—including shipping, grocery stores, and remote-work platforms—at least temporarily ramped up their hiring, a result of new pandemic-related needs.

Indirect effects of an economic shock can depress all growth. “If the directly affected firms fire workers, these workers will buy less from all types of firms,” Huber says. “That will lower demand also for firms that were not directly disrupted. As a result, all firms will grow more slowly.”

In the case of Commerzbank’s lending cut, companies hit by a temporary credit shock were persistently affected—and this suggests any current hit to companies, however temporary, could also have consequences that long outlast the initial disruption, Huber says.

But the findings also offer a lesson about investing in innovation during hard times. Companies that invested less in developing technologies, ideas, and products during the crisis period were particularly likely to experience long-term effects. “In the case of COVID-19,” Huber says, “it could be that firms end up worse off in the long run if they forgo productive investments into technologies and ideas that have a long-run payoff.”

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