The media has been dominated this week by scary headlines about the ‘mother of all recessions’, ballooning government borrowing, and the prospect of renewed ‘austerity’, whether in the form of public spending cuts or punishing tax increases. As usual, a sense of context and perspective is sorely needed.
Let’s deal first with the numbers released – or leaked – over the last few days. The official GDP data for the first three months of the year simply confirmed what we already knew: economic activity began to collapse in March, shrinking almost as much a single month (nearly 6%) as it did throughout the recession of 2008-2009, and by 2% in Q1 as a whole.
Indeed, as the chart below shows, other major economies also saw a large fall in GDP in many other countries (although in this respect, like many others, Sweden was an outlier…)
We also already know that the next set of numbers will be even worse. The lockdown may well have shuttered as much as a quarter of the UK economy in April. For what it’s worth (which isn’t much) I’ve therefore pencilled in a further 20% monthly decline in GDP in April, and an 18% quarterly decline in Q2 as a whole. (My indicative forecasts are shown in the charts below.)
The good news is that this is largely old news, and not even all bad. Remember that the whole point of the lockdown was to stop most people from doing what they would normally be doing, in order to save lives. No-one should be shocked that this has led to a sharp recession (and anyone still questioning whether we are in a recession really should rethink their definition).
It’s no surprise either that this has led to a sharp deterioration in the public finances. Back in April, the OBR’s first attempt at a coronavirus reference scenario predicted that the budget deficit could widen to as much as £273 billion (or just under 14% of GDP). Then earlier this week the Treasury reportedly leaked a new ‘base case scenario’ with a higher figure of £337 billion.
In the event, the OBR published a revised figure of ‘only’ £298.4 billion (loving the spurious accuracy), with the increase largely reflecting the higher costs of the job retention scheme. The main difference between the leaked Treasury ‘base case’ of £337 billion and the OBR’s £298 billion seems to be the underlying economic forecast. The Treasury’s alternative scenario assumes a slower recovery and more (i.e. some) long-term damage.
In contrast, the OBR’s new numbers for the public finances are still based on their April numbers for the impact of coronavirus on the economy. As it happens, I actually think these were a bit pessimistic, at least for this year, especially now that the lockdown is gradually being eased.
The government’s hugely expensive schemes have at least also succeeded in protecting the great majority of businesses and jobs. Indeed, there are growing signs that activity touched rock bottom last month and a slow recovery has already begun. This may yet mean that the OBR’s next revision is downwards.
Either way, though, these are all clearly huge numbers. With only a slightly different set of assumptions, it’s not difficult to come up with a borrowing forecast of £400 billion for this year. But the more important point is that the fundamental facts haven’t changed – and these are mostly reassuring.
Here we need to distinguish more clearly between a temporary increase in borrowing in response to a one-off shock, like coronavirus, and a longer lasting (or structural) deterioration in the public finances.
In the case of the former, we should simply take the hit, whether its £200 billion or £400 billion, and recognise that there will be a permanent increase in the level of debt. Low interest rates mean that the increase in debt is relatively easy to service and the burden (measured as a share of GDP) will still fall over time as the economy recovers.
It may be different if the annual deficit itself is permanently higher, most likely because an extended lockdown leads to permanent economic scaring, including an extended period of high unemployment. This is what the Treasury appeared to have assumed in the leaked alternative ‘base case’. It is also the context in which it might make some more sense to talk about tax increases or renewed public sector ‘austerity’.
Indeed, there’s a huge difference between a temporary increase in public spending and borrowing in response to a one-off shock (which I support), and a permanent increase in public spending and in the role of the state (which, aside from a limited increase in investment, I don’t).
But that’s a debate that can be left for another day. Provided the lockdown is eased sooner rather than later, and coronavirus remains under control, we may be pleasantly surprised at how quickly the UK economy rebounds and the deficit falls back again.
There should certainly be plenty of pent-up demand. Many families have actually saved money during the crisis, by cutting spending. They may be cautious about returning to the shops, but many purchases may simply have been postponed rather than cancelled completely.
The UK’s relatively flexible labour market is also good at creating new jobs, which will be more important than ever to help replace those will be lost. This could be an opportunity for new and more efficient ways of working, and for new businesses to replace old, as we adapt to the ‘new normal’ – whatever that may prove to be.
Nonetheless, the deterioration in the public finances can’t be shrugged off altogether. The government might find it relatively easy to finance higher levels of public sector spending and borrowing. But as the economy gets back on its feet, there will be a growing risk that this crowds out spending and borrowing by the private sector, whether directly or via higher inflation.
There is also a danger that a narrow focus on the fiscal numbers ignores the broader costs of continued high levels of state intervention in the economy. For example, the priority now, rightly, is to protect jobs. But the longer that the government continues to subsidise the wages of millions of people, the greater the distortionary impacts on the labour market and on the incentives to work or change job in particular.
In short, the government will soon need to step aside and let markets work properly again, resisting calls for tax increases or more regulations that would hold back the recovery. In the meantime, we should ‘stay alert’ to the fiscal risks, but there’s no need to panic.
PS. on the easing of the lockdown, I think it’s still right to focus on the impact on health and wellbeing rather than any short-term economic costs. But the balance is shifting even on this score, as the number of covid deaths falls and there is increasing evidence of the harms that the lockdown is doing to others (including patients with unrelated conditions who are missing out on treatment, and younger people missing out on education and job opportunities). What’s more, the longer the economy is kept shuttered, the greater the risk that more of the damage will be permanent, making it that much harder to pay for better public services and infrastructure in the future.