The almost-but-not-quite recovery

The latest forecast for the UK economy from the Office for Budget Responsibility shows an almost-but-not-quite recovery. It starts off v-shaped with a rapid bounceback, then becomes tick-shaped as the recovery slows. The tick has a long tail and, over the course of the forecast, it never quite gets back to where the OBR thought it would be before the Covid pandemic.

Chart by Office for Budget Responsibility

It was always likely that there would be rapid growth after the easing of the lockdown and the development of a Covid vaccine. Pent up demand delivers unprecedented growth after the unprecedented fall. The problem is how much of the economic damage has longer term effects. This is what the OBR describes as ‘scarring’.

As Chris Giles explained at a Zoom event I went to a couple of weeks ago, businesses face the problem of stranded capital – capital that was highly productive this time last year but is suddenly unable to do its job. City centre offices and passenger trains for example. The same could be said of human capital. Skilled workers in sectors like hospitality and retail are unable work. The question to which no-one really has an answer yet is how much of this capital will be permanently stranded. 

If assumptions and attitudes shift then so will employer, employee, consumer and investor behaviour. Even if there is a Covid vaccine, will the knowledge that a pandemic happened and might again make people more cautious? Will we be happy to pile onto crowded trains again, with our faces inches from someone else’s? Are we going to go back to city centre offices every day? Will we cram into crowded pubs? Will we shop till we drop again now that we have discovered we can order so much stuff while sitting at home? Our return to confidence looks likely to be almost-but-not-quite, so things never quite get back to where they were. For businesses with investments in stranded capital, this will be bad enough. For the stranded human capital – the people with skills they worked hard for but can no longer use – the impact will be devastating. Despite all the enthusiasm for re-skilling, changing sectors and occupations is a lot more difficult than it sounds.

As the OBR explains:

 The pandemic is quite likely, however, to leave lasting ‘scars’ on supply capacity. These can arise through a variety of channels, including: 

deferred or cancelled investment in physical capital and lower innovation as a result of the heightened uncertainty and increased levels of debt incurred during the pandemic; 

the destruction of valuable firm-specific capital and knowledge arising from business failures; 

a loss of human capital due to sustained unemployment as the economy restructures away from contact-intensive sectors; 

earlier retirement from the labour force prompted by the pandemic; and 

increased loss of days worked due to sick leave as it becomes unacceptable to turn up to work showing virus-like symptoms. 

The combined effect of all this is a hit to productivity, investment and employment. It is this that accounts for the almost-but-not-quite nature of the recovery:

The set-back to the recovery is deeper and more durable in our central forecast. But after an effective vaccine becomes widely available in the second half of 2021, output recovers to its pre-virus peak by the end of 2022. However, output never returns to the March path, mainly reflecting our 3 per cent scarring assumption. 

The Resolution Foundation summed it up succinctly:

The UK economy is set to shrink by 11.3 per cent this year, the biggest decline in over three centuries. Welcome news on vaccines means the economy will bounce back, but the recovery will be ultimately incomplete, with the economic ‘scarring’ leaving it permanently 3 per cent smaller, or £1,400 for every adult in Britain. 

But wait, there’s more. The forecast assumes that the UK will conclude a ‘typical’ free trade agreement with the EU. If, instead, it leaves the transition arrangements on WTO terms on 31 December, the growth path looks even weaker. 

Chart by Office for Budget Responsibility

Coming on the back of the pay stagnation after the financial crisis, the outlook for earnings is horrendous. The OBR’s forecasts see real average employee earnings not getting back to their 2007 level until 2026. That is nearly two decades of pay stagnation.

Chart by Resolution Foundation

As Resolution Foundation chief executive Torsten Bell remarked, what we are seeing here is the effect of three once-in-a-generation economic shocks. The combined effect of the financial crisis and its aftermath, Brexit and the Covid pandemic have left our economy permanently scarred. 

Covid has provided a smokescreen to cover up pre-existing problems. (This is true at company level too.) Things that were going wrong before the pandemic can easily be blamed on it. Were it not for Covid, we would have been discussing the fact that the economy had stalled and, most probably, gone into a mild recession during 2020. The economy hit the buffers during 2019 and shrank on Boris Johnson’s watch.

By February 2020, it was slightly smaller than when he took office and, under the threat of Brexit, showed no sign of recovering momentum. It might seem a bit mean to say it, given that the prime minister was very ill with the disease, but, in some ways, Covid got the government out of a hole. It can now blame the almost-but-not-quite recovery on the virus when at least some of it is due to the weakness of the economy beforehand and the self-inflicted wound on Brexit on top of it.

This is what the three once-in-a-generation economic shocks look like in a historical context. Per capita GDP growth for the first quarter of the 21st century will be lower than the preceding three. It looked almost as bad as this based on the forecasts before the pandemic because much of the damage had already been done.

Source: Bank of England and OBR Economic and fiscal outlook – November 2020

The 2008 recession wiped out most of the growth of the early 2000s and the economy never really recovered. After the pandemic, we will get a glimpse of what post-recession growth used to be like before we return to the per capita 1-1.5 percent GDP growth that seems to have become the norm.  

For an economy still based on the assumption of post-war growth rates and a population which still believes that, somehow at some point, we will get back to that again, this is going to present some significant challenges. The government will get away with blaming Covid for a while but it can’t get do that indefinitely. Eventually, people will notice that things aren’t ‘getting back to normal’. They will see it in their pay packets, living standards and job prospects. 

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5 Responses to The almost-but-not-quite recovery

  1. Patricia Leighton says:

    Another very thoughtful piece. I think you may have underestimated the damage of BREXIT on the labour market but also critical matters such as skills development Just as with the referendum of 2016, all the debate was seems focussed on trade. To sustain an economy there far more of importance, not least in a context of likely increased isolation and national self obsession. I would also add that decline will likely continue because to a greater and lesser extent this is the most incompetent and corrupt government we have had for some time. We appear to be losing the friends we still retain. And we can already see a ‘brain drain’ Rick can you check that one out-how much key talent are we losing or have already lost.

  2. roGER says:

    A really good article.

    One thing it doesn’t mention is the assumption that this recovery will be very lop-sided.

    Certain individuals and companies have done extremely well recently. Examples include online retail and deliveries. Furthermore, a large number of office workers have been able and willing to work from home for the past nine months. These people have managed to save money and/or pay down debt thanks to travel costs dropping to next to nothing.

    They’ve also benefitted from not having to buy work clothes, and being unable to eat out and socialise as in normal years. Savings like this all add up, especially to people who’s budget normally covers these costs, because they’re entirely normal and anticipated. These fortunate people will (hopefully) lead the way in consumption as things return to normal in the first half of 2021.

  3. Brownlow says:

    People will notice that things aren’t getting back to normal when their children are live-in domestic servants who get board and a small spending allowance. Which is, in fact, capitalism getting back to normal.

  4. Dipper says:

    well … to quote Hayek, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

    And from another sphere, Orgel’s second rule of evolution. “Evolution is cleverer than you are.” ‘Orgel’s second rule tells us that the process of natural selection is not itself intelligent, clever or purposeful but that the products of evolution are ingenious.’

    I would put money on the economy booming. In particular with a hard Brexit I would expect a big boom. Because people’s risk appetite changes. Because once the alternatives are clear, once it is clear that economists aren’t going to save you, people will work and innovate to save themselves.

  5. Dipper says:

    My views of the ability of economists to predict the future were formed in 1994. I was working in industry and everyone was flat out. At the end of the year there was a chart with economists predictions on growth – a bell curve centred around 2%. Actual growth was 4%. They had completely missed what happened.

    Economists are like evolutionary biologists. They can explain to you why what has happened has happened, but they cannot explain what is going to happen.

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