How will the UK economy emerge from the shadow of Covid-19?

End of furlough, corporate sector debt and continuing crisis in other nations all mean it is too soon to get out the bunting

It seems likely that later this year or early next the economy will return to the level of overall activity we recorded at the end of 2019. But even if activity in aggregate returns to pre-crisis levels, with services and construction in the lead, neither manufacturing nor agriculture seems likely to do so. We also expect to see considerable regional variation in the short run, with the economic prospects of London showing most resilience and the Midlands and Northern Ireland looking particularly vulnerable. More importantly, the economy has lost about two years of economic growth and sectors that are so important to UK plc, such as hospitality and the arts, may bear the scars for some time to come. It is far too early to get out the bunting.

There are three specific areas to watch carefully in the second half of this year.

First, in the labour market, as the furlough scheme winds down, we need to understand what fraction of those employees will be taken back on by firms and how many roles will be made redundant. Related to this, what specific support might be offered to help those losing their jobs, or entering the labour market, to search for work or train for new careers?

Second, there has been a good rate of new company startups and, so far, firms have not suffered large-scale bankruptcies and debt default. This tends to be a good indicator of future employment and may support future productivity, but the composition of these new firms has been strongest in sectors that are best able to withstand social distancing. These may not necessarily be the best firms to promote enduring prosperity. It is also of concern that the corporate sector is now carrying even more debt, which may act as a drag on hiring and investment.

Third, as an economy sensitive to the fluctuations in world trade, the UK is acutely subject to the maxim that this won’t end for anyone until it ends for everyone. This means that for as long as the crisis casts its shadow, the denuded prospects for tourism, international trade and labour mobility may act as a drag on UK activity. So as well as an ethical issue, self-interest also dictates that we ought to be taking the lead in arguing for waivers on intellectual property so that the vaccine technology can be shared with the world.

We cannot think simply in terms of a fixed capacity for production in the economy for which policy simply acts to stoke demand. Government and Bank of England policies should be used to support the most efficient and dynamic production of goods and services. Attention must be paid to maintaining the credibility of our institutions to manage inflation risks and the stability of the financial system. But as we face obstacles to the recovery from Covid-19, the Treasury and the central bank must also show flexibility to support our continued fightback from the pandemic.

At present our hapless fiscal framework – the rules the government sets for managing the public finances – is under scrutiny by the Treasury and we wait for its next iteration. But we do not need more arbitrary rules; fiscal policy needs to be directed at the regional and household inequalities that the pandemic has highlighted and exacerbated.

Last spring, monetary policy responded well to the initial lockdown with a cut in interest rates from the Bank of England and an increase in the size of the quantitative easing programme. With the recovery in train, it is now time to complete the task of forward guidance and explain better what might happen to the Bank’s base rate and the stock of asset purchases as the economy bounces back. It is simply not enough to focus our attention on small changes in the base rate that may or may not matter. What matters is that financial capital is matched with the most productive prospects at the best global terms.

Not so long ago, the only thing that seemed to matter was how and when we delivered Brexit, and what that might mean for an economy that had suffered a prolonged period of underinvestment. Now, as we think about how to plot a way out of the Covid crisis, it is precisely those gaps in human and physical capital that we need to nurture to deliver sustainable and balanced growth across the country. It is the biggest problem we face. Can we solve it?

Jagjit S Chadha is the director of the National Institute of Economic and Social Research

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