BU's Emeritus Professor Nigel Jump writes the next in a series of economic blogs looking at the impact of covid-19 on the economy.
Many are expecting the unprecedented, economic dip (Q2 2020) to have been up to 25% below the recent peak (Q4 2019) in terms of output (real GDP). A modest recovery may already be underway, but a return to ‘normal’ is not expected soon (see previous blog 2 in this series for a discussion of some possible future scenarios).
In response, policy makers have gone to extraordinary lengths to counter some of the effects of the recession and to prevent a depression. Success is far from guaranteed, but the Treasury and the Bank of England can be applauded for trying, especially with regard to their attempts to boost short term liquidity and to dampen the threat of higher unemployment.
Measures-to-date have included massive quantity easing (of money), ultra-low interest rates, the jobs furlough scheme, mortgage and business rate holidays, and other direct grants and loans – both general and sector specific. July 8th’s statement by the Chancellor added another raft of interventions and incentives, potentially worth about £30bn.
The highlights were:
- Young worker initiatives - a “kickstart” scheme including wage and other labour cost support to firms offering work placements, trainee posts and apprenticeships.
- Infrastructure and decarbonisation - support for housing and public agencies in areas of new investment and refurbishment.
- Job retention - £1,000 for every furloughed worker put back to work by November and retained until at least January 2021.
- VAT - rate reduction from 20% to 5% for a wide range of accommodation, catering and leisure (“hospitality”) services until 12/1/21.
- Stamp Duty - exempt limit increased from £125,000 to £500,000 for residential property until 31/3/21, meaning 9 out of 10 buyers will not pay the tax on transactions in this period.
- Energy Efficiency – up to £5,000 towards various home energy efficiency expenditures, such as improved insulation.
The Chancellor’s aim is to prevent the recession turning into a depression by supporting viable employment prospects and pursuing longer term environmental and other investment goals. The idea is to unlock household’s and firm’s precautionary savings (recently accumulated in their bank accounts) and to make business more economically active. By increasing confidence and making demand more effective, government spending can ‘multiply’ its consumption and ‘accelerate’ its investment impact and, thereby, help to sustain a positive recovery.
There are several risks to his approach:
- The first risk with all such interventions is that novel and higher public spending squeezes out or distorts private expenditure and decision making in a way which is not ‘optimal’ for long term growth and development. The economic shock is severe enough to warrant state action for the near term, but it should not become embedded in people’s choices in ways that encourage non-productive behaviour and relationships to persist. The Treasury should resist voices calling for it to keep its ‘special’ measures in place for too long. It has many other long-term issues needing future funding attention, including climate change, health and social care provision, and technological innovation.
- The second risk is that policies affect the timing but not necessarily the scale of the outcome. There is a chance that decisions on jobs and investments are brought forward or temporarily retained but there is a second ‘double dip’ in activity later when the measures are turned off. Whether workers are laid off in October or January matters little to the path of the overall economy, though it is crucial for the individuals involved.
- The third risk is that the net economic impacts are small because of: a)‘deadweight’ – that some beneficiaries get a hand-out unnecessarily for what they would have done anyway; b) ‘leakage’ – that some funds go to competitors outside the UK through our high propensity to import; c) ‘substitution’ – some firms move from a more efficient strategy to an inferior one just because of the new public d) ‘subsidies; and e) ‘displacement’ – some good activities/practices are ousted by these distorting alternatives. The Chancellor has acknowledged that some recipients will get public funding who do not really need it, but he argues that this cost is worth it to: a) keep things simple, b) get it out quickly, and c) capture a wider overall effect by demonstrating what is possible and boosting private confidence.
- The fourth risk is to the longer-term public finances and other incentives. The taxpayer has to foot the bill at some point. Even though interest rates are very low now, they may rise later in response to higher inflation that is allowed to slowly devalue the annual deficits (£300bn this year?) and growing debts (well over 100% of GDP). This will probably have to be managed over many years (even decades – WW2 loans from America and Canada were finally paid off in 2006). The negative impact on the public finances represents a persistent constraint on government and personal incomes compared with what otherwise might have been. Eventually, it will mean higher taxes and prices for some parts of the community: already there are discussions of further wealth taxes, ending the triple pensions lock, and higher fees for public services. This is the Treasury’s hangover and a political headache for future budgets.
- The final risk is external. How will the UK measures be judged by the financial and other markets at a time of great uncertainty over our future trading relationships (Brexit etc)? Many of our partners and rivals are in the same policy boat of increased public spending now and higher taxes to come. Growth potential may be adversely affected everywhere for a generation or more. During the recovery, there may be wider relative macro, finance and wealth losses associated with the UK’s perceived comparative increase in isolation and weakness in potential performance.
The public sector usually represents about 40% of our economy. This ratio is going to rise sharply in 2020 and beyond, but it is unrealistic to think the state can support all the other 60% now, or major parts of it indefinitely. Intervention needs to be choosey (who, what and how) and short-lived. Policy makers are showing a valuable lead. We can quibble about the details of their measures and we can be sceptical about the likely net impact. On balance, however, we can welcome the attempt whilst doubting the scale of the final outcome.
We are in highly uncertain times and that uncertainty is not going to ease soon. Local firms need to factor these matters into their decision making and planning as we make slow progress into a rocky recovery. Are you ready to profit from any short-term distortions of demand, e.g. positive for housing and hospitality, and medium-term adjustments of supply, e.g. defence and other public services? So, take advantage of immediate offers … but be prepared for policy reversals and broader monetary and fiscal restraint later. The Chancellor promises a full Budget and Comprehensive Spending Review in the Autumn. That will be the real test for local economic trends and government incentives into the long run.