The economy could pleasantly surprise us at how fast it recovers

The focus of economic policy is starting to shift from protecting businesses, jobs and incomes during the lockdown towards supporting the recovery. Business lobbies, ‘big state’ think tanks, academics and the TUC are all lining up to call for a huge fiscal stimulus. However, more intervention now could be exactly the wrong choice.

Instead, we may be about to be pleasantly surprised at how quickly activity returns to something like normal – provided government gets out of the way.

Note first that the economy has already begun to pick up, even while the official lockdown is still in place. This trend is clear in high-frequency data, such as the volume of goods vehicles on the roads, and is beginning to show through in the monthly business surveys too, including the PMI indices.

Many of the companies that can still trade have found new ways to operate within the social distancing rules, such as retailers moving online and cafes reopening as takeaways. A mid-May ONS survey found that a quarter of businesses that had temporarily closed expected to start trading again in the next few weeks, even before the next phase of the easing of the lockdown had been confirmed.

For what it is worth, sentiment in financial markets has turned as well. The price of a barrel of Brent crude has edged back above $40 (after diving below $20 in April) and the FTSE is continuing to grind higher.

There has even been some encouraging news from Europe. The unemployment rate in the euro area rose only slightly in April to 7.3%, from 7.1% in March. This figure was flattered by job retention schemes (furloughed workers still count as employed) and by people dropping out of the labour force altogether, but was not as bad as feared.

The gradual lifting of the lockdowns, both in the UK and the rest of Europe, should provide a further boost. This statement is surprisingly controversial. Many have argued that activity was already weakening before the official lockdown and that it will remain depressed as fears about Covid persist. There are worries too about permanent ‘scarring’ in the form of higher unemployment and lost investment.

This feels too pessimistic. For a start, it is wrong on the timing. The deterioration in the high-frequency data accelerated after the Prime Minister’s advisory statement on 16th March, when he recommended avoiding non-essential travel, bars, restaurants and other indoor leisure venues, and to work from home if possible. But it only really took off after the formal restrictions were announced on 23rd March.

The international evidence is similar, even though it is inevitably complicated by many other factors. In particular, it is notable that Sweden’s economy – with a more liberal approach to the lockdown – has held up relatively well. Put another way, if lifting the official lockdown does not have a major impact on the UK economy, that would be another good reason to ask why it was necessary in the first place.

Admittedly, businesses and consumers will be cautious for a while yet. The practicalities of social distancing will have relatively long-lasting impacts in some sectors, notably leisure and hospitality. Some people will be reluctant to holiday abroad, eat out, or go to cinemas, concerts and major sporting events. But the ‘new normal’ may still look remarkably like the ‘old normal’.

Crucially, consumer tastes are unlikely to change significantly. Most people will still want to go back to spending on whatever goods and services they enjoyed before the crisis, as soon as they are able and feel safe to do so. This is already being reflected in a surge in restaurant bookings in Germany and in Australia, which are further down the track in lifting their lockdowns. Otherwise, the Covid crisis may simply accelerate trends that were already well-established, such as the growth of online shopping, more flexible working practices, and automation.

So, what should the Treasury do next? In my view, the Chancellor was right to confirm that the job retention scheme will be scaled back from August and then end in October, despite fears that the withdrawal of support could prompt a further wave of redundancies. By then, it is reasonable to expect the lockdown to have been lifted and the economy to be well on the road to recovery.

In turn, this will reduce the need for any further stimulus. There may a case for bringing forward some infrastructure spending, as long as the projects chosen already made sense in their own right – rather than as ‘job creation’ schemes. This might also be a good time to increase investment in skills training specifically to tackle the problem of ‘frictional’ unemployment.

However, the emphasis should be on measures that help the supply side, including targeted tax cuts and deregulation. The gradual easing of the lockdown and a rebound in confidence should already be enough to boost demand. They may even mean that the recovery looks more like a ‘V’ than a ‘U’ after all.

This article was first published on 3rd June by the Daily Telegraph (online)

You can also follow me on Twitter @julianhjessop



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