Recession in real-time
WRITTEN BY JONATHON PORTES ILLUSTRATION BY SIMON JENSEN
In the face of the second wave of the pandemic, the government reimposed restrictions on economic activities, which are still in place today. These differ significantly from those seen in March in several respects. Manufacturing and construction are not subject to new restrictions, and many ‘non-essential’ retail stores have improved their capabilities for online ordering and home delivery, while consumers are more accustomed to using such services. This will mitigate the short-term impact on output.
However, some firms, particularly smaller businesses, are under severe financial strain and may not survive a second round of closures. This is a particular risk for those that are usually heavily dependent on the pre-Christmas period for much of their revenues or profits, as is the case for some hospitality venues and retail stores.
On top of this, we now have significant additional disruption to trade, - particu-early - between the UK and the EU, as Brexit is finally implemented and new arrangements are introduced under the Trade and Cooperation Agreement – which means substantial new barriers to trade between the UK and the EU. As a result, the economy is likely to have shrunk again over the fourth quarter of 2020 and continue to do so during the first quarter of 2021. The impacts on household incomes and the labour market will be mitigated by the government’s decision to extend the furlough scheme (and some business support schemes) until March 2021; this means that unemployment is unlikely to rise as sharply as feared, although the fiscal costs to the government will be substantial.
The further downturn is likely to be concentrated in consumer-facing services (retail trade, food and beverage serving activities, travel and transport, and entertainment and recreation). These were hardest hit by the first lockdown, but recovered strongly, although this ‘catch-up’ has now been reversed. Meanwhile, recovery in other sectors is likely to remain slow and patchy at best.
Developments remain highly uncertain, and dependent on the success of latest restrictions in containing the virus, the early roll-out of a vaccine (so far so good), as well as a smooth transition to the new trading arrangements with the EU. While much of the most high-profile Brexit-related disruption reflects transitional issues, as businesses adopt to new procedures, increased trade barriers and costs are real, and will have longer-term effects on the UK economy, as supply chains are restructured to exclude the UK.
Under a positive scenario, a clear reduction in infections and the speedy roll-out of a vaccine would allow a gradual loosening of restrictions and a return to normality in a few months. This would likely lead to a strong recovery in the short term but one which was substantially differentiated between sectors. The very large overhang of ‘forced saving’ among some middle and upper-income households (those whose incomes did not fall much during the crisis but who could not spend as normal) could lead to very high demand for some discretionary spending (for example, high value consumer goods, up-market tourism).
But at the same time some sectors may remain weak for a prolonged period, in particular commercial real estate and customer-facing services that rely on office workers for demand, since at least some of the shift to working from home is likely to be permanent. And over the medium-term, Brexit will have a significant adverse impact on several sectors, including pharmaceuticals, chemicals, business, and financial services. Moreover, to the extent consumer spending does recover, this will reduce private saving and generate upward pressure on inflation and interest rates. In these conditions the government will need to move to tighten fiscal policy, necessitating significant tax increases.
A further constraint on growth may be the labour market; the latest statistics show a fall of more than 800,000 in foreign-born people of working age resident in the UK, mostly EU citizens. While this will mitigate the rise in unemployment, it might also mean that a significant upturn might be hampered by labour and skill shortages, particularly since the new points-based immigration system will make it much harder for Europeans to move here to work.
Under a more adverse scenario, in which the vaccine roll-out is delayed or a further new variant emerges, recovery would be further delayed. In these circumstances the government would continue to provide massive fiscal support, limiting the downside risks, but a prolonged period of stagnation would be in prospect, with slow growth in output and persistently lower employment.
Jonathan Portes
Jonathan Portes is a Senior Fellow of the Economic and Social Research Council’s ‘UK in a Changing Europe’ initiative, based at King’s, which promotes high quality research into the complex and changing relationship between the UK and the European Union. Previously Director of the National Institute of Economic and Social Research, Jonathon publishes articles on economic issues regularly in the UK and international press and comments frequently in the print and broadcast media. His recent book, Capitalism, is published by Quercus.