Economy heads into uncharted waters in wake of COVID-19 crisis
The worst recession in history may be on the way – but the speed of recovery is key
What a difference a year makes. When we launched our BrandZ UK report in 2019, Boris Johnson had just entered Downing Street with the slimmest of parliamentary majorities. The biggest challenge he faced was, as he put it, “getting Brexit done”.
The General Election that gave him the numbers to at least get part one of Brexit completed seems rather trifling now.
If the uncertainty around the UK’s future relationship with the European Union disturbed businesses and dampened consumer confidence in 2019, this was as nothing compared to the effects of the coronavirus pandemic as it swept through the country in the first half of 2020.
The COVID-19 crisis has redrawn the economic landscape, probably for years to come.
The UK government’s reaction to the virus, despite criticism that it was initially sluggish and under-prepared, has at least been fairly clear-cut – “Do whatever is needed to slow the rising number of infections and deaths”, seemingly, at least initially, at whatever the economic cost.
The newly installed Chancellor Rishi Sunak vowed in early March that the government would do “whatever it takes” to support households and businesses impacted by the coronavirus outbreak. At the time, the pandemic threatened to plunge the UK not only into a steep recession, but also serious social disruption.
The government placed the economy on what amounted to a wartime footing, offering life support to businesses and individuals affected by the virus, directly and indirectly. Government-backed loans of at least £330 billion were offered as early as mid-March, and more help would come as it was needed, it was promised.
By July it was clear that the government was on target to sell a colossal £525 billion of debt over the full year, more than double the previous high.
State intervention in the economy at this scale would have been anathema to a Conservative government only a few months earlier. The UK Treasury announced that it would pay 80 percent of the wages of those unable to work because of the coronavirus, up to a monthly limit of £2,500. By mid-July, 1.2 million employers were registered with the scheme and it was protecting the jobs of 9.4 million people at a cost of £28.7 billion to the exchequer.
While these people were not productive, they were not reflected in official jobless figures, which remained at a historically low 3.9 percent in May. The great fear is that the jobless rate will rocket once the government’s job support scheme comes to an end this October, hitting rates not seen since the 1980s when it reached almost 12 percent and more than three million people were out of work.
Hopes of a rapid economic recovery were given a jolt when it was revealed the economy had rebounded by a sluggish 1.8 percent in May, following its plunge of 20 percent in April.
The UK’s economic future is still far from clear, with disparate views on how far its economy will contract; but there is a consensus that the contraction will be very severe indeed.
Steering a course to recovery will be a secular political and economic challenge.
The key question, over which there is little agreement, is: how fast will recovery be? Will the crunch and recovery look like an extended U, with a sustained, deeply damaging low point, or will it be a much more desirable V, with a fast return to growth, and, crucially, a buoyant jobs market?
In its Monetary Policy Report for May, the Bank of England suggested the economy could shrink by 25 percent in the second quarter of 2020, and by 14 percent overall during the year. That would be the sharpest economic fall since 1706. Unemployment could rise to 9 percent, compared to a jobless rate of 8 percent seen during the last financial crisis; but, by 2023, the bank said, unemployment could be back below 4 percent.
Bank of England governor Andrew Bailey said it was plausible the economy could recover rapidly once the UK’s lockdown was lifted, with forecast growth of 15 percent in 2021. Even though there would be some “scarring to the economy”, this would be limited due to the economic tools being deployed, including government loan lifelines and a huge programme of so-called “quantitative easing”, or QE – buying government bonds to inject cash into the economy.
Not everyone takes such a sanguine view of recovery, however, largely because no one can forecast with any certainty the course of the virus pandemic.
Many economists believe the Bank of England’s forecasts underestimate the level of bankruptcies to come, as well as the rate of unemployment.
Keeping people in work, few would disagree, will be key to a UK recovery. And the effect on joblessness of any economic contraction usually takes effect some three to six months down the track.
A resurgence of COVID-19, with rising numbers of people becoming infected as the country heads into winter, would probably be the biggest barrier to recovery, and could lead to a much more drawn out W-shaped recovery, stretching well into 2021.
Certain sectors of the UK economy may take years to recover from the current crisis. As in other countries, industries such as tourism, aviation and mass sporting and cultural events have an uncertain future. Other sectors, such as hospitality, may well be transformed.
Ultimately, the question arises, as it will do in all countries: “Who will pay for all the extraordinary monetary and fiscal interventions by the state?”.
One note of optimism emerged from former Bank of England governor Mervyn King, now Lord King, who helped steer UK monetary policy through the 2008 financial crisis. He believes that a decade of austerity measures has left the UK economy well placed to take on large amounts of debt, something that will undoubtedly be necessary.
As if these COVID-related headwinds buffeting the UK economy were not strong enough, there is also Brexit to deal with. The UK government has been adamant it will not extend the deadline for ending its interim deal with the European Union beyond the end of 2020. Few believe a deal will be possible by then, and many now think an extension beyond December 31 is inevitable.
Brinkmanship or not, there remain fundamental differences between the UK’s and the EU’s position on a future trade relationship. It is unclear how either side can compromise while preserving their respective political projects – a clean Brexit that “takes back control” on the UK side; and a unified demand for a so-called level regulatory playing field on the EU side.
Now, however, the UK, often seen previously as having only weak cards to play, may have a stronger hand.
The EU is facing its own internal strains, some of a fundamental nature. Even before the pandemic there was growing resentment among those southern European states struggling economically and the rich north, specifically Germany.
These strains have become far more serious as a result of the virus. National borders that for years have been invisible between Schengen Pact countries have been going up across the continent.
Brexit negotiations have always been a poker game, each side using whatever advantage they may be dealt. Some observers now believe the UK sees in the challenges the EU is facing as a weakness in its negotiating position.
The EU has never wanted a messy divorce from one of its largest trading partners, and an ill-tempered split that could leave the UK truculent, uncooperative and ready to deregulate in order to compete with Europe for much-needed investment could be disastrous.
On top of this, the nightmare scenario for the EU is that a clean break between the two parties results in a newly unshackled UK economy out-performing its EU counterparts in the medium term, so resulting in other EU members, several with economies badly damaged by the coronavirus crisis, contemplating the previously unthinkable.
But, even as the day of reckoning looms over the UK’s long-term relationship with the EU, the bigger priority will remain halting the spread of COVID-19.
As Chancellor Rishi Sunak said back in March, “It’s clear that we must defeat this virus as quickly as possible. That’s not a choice between health and economics”.
How quickly that happens, either by effective treatments, a vaccine, or social measures that stop the spread of the virus in its tracks, will ultimately determine the trajectory of the UK’s economy.