The latest UK GDP numbers were better than expected, but it would still be dangerous to raise taxes in the March Budget. This would be far too soon after a year when the economy contracted by nearly 10% and with a renewed decline almost certain this quarter.
To recap, UK GDP rose by 1.2% m/m in December and by 1.0% q/q in Q4 2020. This was not as bad as some had feared, including the OBR in its November EFO forecasts, but still meant that GDP fell by 9.9% in 2020 as a whole. This was the biggest economic hit since the ‘Great Frost’ of 1709.
The relative performance of the UK compared to its peers in Europe was also not as bad as some of the headlines suggested. It is true that GDP fell further here in 2020 than in most other countries. This partly a result of policy decisions, such as the timing and severity of lockdowns.
But it also reflects factors which are largely outside the control of any government, including geography, demographics, the composition of the economy, and differences in the measurement of GDP itself.
On a true like-for-like basis, the fall in UK GDP was probably much close to that in France or Italy, and not much bigger than in Germany. Even on the official numbers, GDP fell further in Spain (by 11%), mainly due to the Spanish economy’s greater dependency on tourism.
What’s more, UK GDP fell by ‘only’ 4.8% in nominal terms in 2020, i.e. half as much as the 9.9% fall in real terms. ‘Nominal’ is the amount of money spent and ‘real’ is the volume of goods and services that this buys. Normally, we care much more about ‘real’.
However, given differences in how countries are measuring the output of the public sector (something I’ve written lots on before), nominal GDP may be better for international comparisons, and the UK data here are much closer to the falls elsewhere.
To be clear, this isn’t the whole story. (Sorry, Chancellor.) The UK government has also paid relatively high prices for some goods and services (e.g. PPE) during the pandemic, and both UK consumer spending and business investment have also been relatively weak. The true picture therefore probably lies somewhere between the nominal and real data. Nonetheless, the UK economy is not the outlier that the GDP headlines suggest.
Consistent with this, the UK economy did much less badly on other measures. Most importantly, unemployment is still relatively low compared to other countries. This has required a huge increase in government borrowing to protect jobs, but UK public debt remains relatively low (as a share of GDP) by international standards too.
Looking forward, activity and employment appears to be holding up much better in the current lockdown than the first. The earlier rollout of the Covid vaccines in the UK should also allow the brakes to be taken off sooner, releasing a wall of pent-up demand.
The economic impacts of Brexit (in either direction) will obviously be swamped by the fallout from the pandemic. But the initial disruption to UK-EU trade may already be easing, and the reduction in Brexit uncertainty should contribute to a strong recovery in business investment.
The UK economy should therefore rebound quickly from the spring onwards, and unemployment may not have much further to rise. (I’m still forecasting that GDP will be back to pre-Covid levels as soon as the third quarter of this year, and that headline unemployment, currently about 5%, will peak below 6%.)
What does this mean for the March Budget? In my view, the Chancellor should still focus on supporting the recovery, rather than do anything that may hold it back. Indeed, if the economy bounces back as strongly as I hope, taxes may not need to rise at all.
First published 12th February 2021