The economy after Covid-19
Never before in world history has economic activity fallen so quickly.
In the wake government-imposed lockdowns, the United States unemployment rate more than trebled in a single month, rising to 15%. In the UK more than four out of five retail outlets closed their doors (at least temporarily). Yet the government-imposed recession has also seen the government step in to support consumers and firms on an unprecedented scale. One quarter of workers currently have their wages paid by the government via the furlough scheme.
The announcement today of a further extension of the furlough scheme until at least the end of October could see the total cost rise to in excess of £80bn. Currently, the scheme costs approximately £15bn per month, an enormous cost only a little below the monthly cost of the NHS budget. At the same time, the government is underwriting the lending of hundreds of billions of pounds to firms small and large in the hope of avoiding mass unemployment and business closures.
The support for consumers and firms has gone further than ever before, notably much further than after the global financial crisis of 2008. While that crisis saw tens of thousands of households lose ownership of their homes, and fall into the trap of payday lending and unaffordable credit, in this crisis the government has corralled the banks into offering mortgage payment holidays and suspending interest payments on credit.
This radical shift in policy reflects not only the political economy of the government-imposed nature of the lockdown, but also what we have learned over recent decades about economic recovery: when jobs and firms are destroyed by economic crises, the economy loses skills and capacity that are hard to re-build. Workers lose skills, and suffer worsening mental health. Entrepreneurial talent and business acumen goes to waste. These things don’t bounce back in the way economists used to think they did - instead, they are scarred. The intensive care being offered to sustain the economy through its own period on life support should therefore maximise our chances of a ”V”- or “U”-shaped recovery over the next two years, avoiding the scarring effects of unemployment and business failure.
But the policy challenges for the government will extend well beyond the immediate recession. The legacy of the pandemic will have two long lasting, possibly irreversible, effects on the UK economy that the government will have to face over coming years.
"By the end of the 2020/21 financial year, the government will most likely owe in debt more than the value of everything produced in the economy in one year"
The first is the radical and widespread structural change brought about by the “remote revolution” due to enforced social distancing. The multi-decade, sluggish transition to online working occurring in many firms and industries—apparently held-up by all kinds of regulatory challenges, client preferences, and business transformation management—moved forward light years within a few days as firms moved their entire activities online (even the law firms finally swapped the sign-in-triplicate for the e-signature). Online retailers in non-traditional online markets have been inundated with orders many times in excess of their capacity, from garden compost to self-raising flour.
This rapid structural change is unlikely to reverse: the psychological effects of social distancing will persist (does anyone now fancy taking the bus into town to go shopping?) and the new-found convenience of remote living will become part of everyday life. Firms realise workers can be more productive at home than in the open plan office, and that the expensive commercial real estate is no longer needed. The benefits of this transition will be many and varied: reduced working time lost on unproductive commutes, reduced carbon emissions and inner-city congestion, increased job mobility due to the lesser need to locate close to an employer. These things are all good, and may act to increase worker productivity, growth of which has been paltry at best over the previous decade.
But this structural change brings - at speed - significant displaced employment and unused real estate in the retail sector, related hospitality sector and the inner-city coffee shops and bars which were once the second workplaces and post-work venues. The hundreds of thousands of workers displaced in these sectors need support into new employment. Ideally, by the autumn the government will be in a position to offer a route out of the furlough scheme into either additional training, or new forms of employment. Here, further education (much under-funded over the past decade) could offer the right level of training and skill development. Pathways to alternative semi-skilled, flexible and low commitment employment in other sectors could also help; your favourite barista might just become your regular swab-tester. Large city-local brownfield development sites (where shopping centres once stood) could present an opportunity for local authorities to build much-needed social housing, but only with the government-provided capital investment needed for such large-scale projects.
The second and greater challenge is one of paying for the immense increase in government spending on support packages offered to consumers and firms. The government deficit will increase to levels not seen since the Second World War, and with it the national debt. By the end of the 2020/21 financial year, the government will most likely owe in debt more than the value of everything produced in the economy in one year.
This will alter the complexion of the UK’s public finances for decades to come. While the UK has considerable additional capacity to tax (tax rates for median earners in the UK are the lowest among any large European economy), the political acceptability of higher taxes for middle-earners is low. We may hypothecate an “NHS tax” as an additional de facto income tax. Many recently-mooted measures to raise tax revenues may need to be implemented: ending pensions tax relief (at any rate), introducing a wealth tax for liquid assets, increasing taxes paid by the self-employed. The demographics of the virus may be an important political dynamic of the future. The pain of lockdown imposed to reduce mortality and morbidity among a well-pensioned and comfortable older generation will mostly be felt by the young and economically insecure. There are likely to be calls for those who benefited most from the lockdown to contribute most to paying for it.