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.
The Year Ahead
Welcome to 2022. After two difficult years, we seem to be entering another of high economic uncertainty in which the recovery looks fragile, at best.
The current state of play
Supply
Industrial production is recovering from the lockdown recession but remains fragile. By October 2021, it was still 2.1% below the February 2020 peak. Overall, manufacturing is flat, but this hides a wide variation, for example, between strong pharmaceuticals and weak electrical equipment. Services are equally mixed and volatile, with hospitality growing well in Q3 2021 but less so in Q4. In Q3, real GDP was still 1.5% below the Q4 2019 peak. In the near term, labour shortages due to Omicron isolation and Brexit restrictions will constrain supply.
Demand
Retail sales volumes were positive in November, but the recovery was mixed and modest for several sectors. Moreover, Omicron fears have dampened consumer confidence in December-January. Demand volatility and uncertainty looks set to persist, especially for areas, such as leisure/hospitality, where considerable consumer discretion on spending exists. In contrast, higher and rising prices for non-discretionary items will pull spending away from other areas. Household and business incomes and resultant spending remain under pressure from accelerating inflation and uncertain market provision.
Prices
In the year to November, UK CPI inflation was 5.1% whilst output and input prices rose 9.1% and 14.3% respectively. Higher cost and price pressures are clearly in the pipeline. A range of sectors are seeing big price rises, including energy, transport, clothing and some foods. Inflation is a problem for living standards in most households. Ultimately, this means some suppression of activity levels.
Trade
UK trade figures have been adversely affected by Brexit and the pandemic. A trade deal was signed with Australia in December – the first after leaving the EU. Given the other headwinds, this agreement is “small beer” but at least it is “some beer”, notwithstanding the standards and competition issues for agriculture. Generally, trade with non-EU is growing more than EU trade but, reflecting Brexit, the pandemic and supply disruption, figures have been volatile and restricted for two years. From the start of 2022, more import bureaucracy is required on EU trade. Brexit is thought to be costing the UK economy about 4% of its wealth potential (FT 24/12/21) with trade flows, supply costs and chains, and skills migration suffering worse here than for our competitors or partners.
Labour
In the August-October period, the UK unemployment rate was low at 4.2%. Vacancies were rising sharply as the recovery got underway, but skills mismatches meant that gaps in the market were evident in key areas. Employers are having to offer higher wages, more training and other benefits, such as apprenticeships, to attract the right potential for new workers. This may be a good national investment for the long term but, right now, it is disruptive to business capacity and performance.
Productivity
Productivity has picked up since the worst of the lockdown recession, but it remains low by historical and international standards. The recent recovery in productivity does not look sustainable in the medium term unless we address skills shortages and investment weaknesses. As competitiveness wanes, the UK’s development needs (through innovation and entrepreneurship) are, if anything, bigger and more urgent than ever.
Policy
The Bank of England raised its official interest rate from 0.1% to 0.25% in December. On its own, that is unlikely to rein back the economy or inflation, but it is a symbolic first step towards a potentially more stable monetary environment. Bond markets were spooked by the decision because it may mean the Bank starts to be a net seller of gilts in 2022, having been a net buyer for some time. In contrast, some shares, such as those of the commercial banks, did well after the announcement.
The Treasury has tried to withdraw most of its emergency pandemic measures but has had to make further commitments in response to the economic effects of the latest new variant wave. The Chancellor’s statements about being a tax cutter in the long run looks to be an aspiration that is a long way off. Meanwhile, there is a risk that fiscal ‘crowding out’ continues for some time yet, as announced budget measures, such as the NI increase, come into effect from 2022 onwards.
The prospects for 2022
At a global level, a number of key areas of risk are evident.
Demographic fertility (ageing burdens), migration flows (war and environment) and population divergence (wealth distribution)
Climate change (disorder and mitigation), resource competition (disruption and wars) and natural sustainability (diversity and conservation)
Digital (cyber and social media), political (China and Russia particularly) and personal health (Covid19 variance) security
Financial (debt and values), energy (supply and price) and broader supply (trade and logistics) vulnerability
Against this background, the current consensus is for UK growth of about 4.7%, inflation about 3.1% and unemployment of 4.3% this year (see HMT latest survey of forecasters). On average, growth and inflation rates are expected to be down on 2021 outcomes (about 7% and 4% respectively). Given current low confidence measures, however – as time goes by, the likely trend is for each of these forecast rates of change to be revised towards more ‘stagflation’ (lower growth and higher inflation) and more ‘misery’ (higher inflation and unemployment, weakening household and business incomes).
Accordingly, the local, business prospects for 2022 are decidedly mixed. Some sectors will be more profitable as excess demand boosts prices and returns whereas others will be constrained by costs and demand volatility. Some firms and traders may face the dilemma of closure or survival, as restrictions on movement and weak engagement continue to affect people’s behaviour. For the long term, such restructuring and reallocation to higher productivity activities is inevitable and desirable, given recent major structural and tactical changes to competition and competitiveness. This year, however, the impact is likely to be disruptive, testing the resilience of economic actors in key markets.
It is even more difficult than usual to be precise about such trends. Indeed, within most industry definitions, there is likely to be a wide range from strong winners to dire losers, as intense competition in response to external shocks separates ‘the wheat from the chaff’. We might speculate that four groups will emerge.
High growth and high returns – perhaps in some pharmaceuticals and aspects of construction
High growth and low returns – perhaps, in some care and other personal services
Low growth and high returns – perhaps, in some engineering and foods
Low growth and low returns – perhaps, in some public, leisure, transport and distribution services
The consensus is that 2022 will be another year of divergent fortunes, with businesses needing to plan for short run market disruption as well as long term structural change. The initial consensus, however, is often wrong. Certainly, it will adjust and evolve as the year unfolds. In this environment of uncertainty and change, anticipating unreliable market change, there remains no substitute for well-founded innovation and investment, particularly in skills and entrepreneurship. In 2022, the economy is likely to continue to emerge from the Covid recession, whilst facing a number of profound macro and micro shocks and adjustments. Government policy will have to be formed extremely carefully whilst businesses planning will need to be framed very flexibly.
Here’s wishing health, wealth and well-being to you all.
