With the UK economy in recession, this article will look at what type of recovery we can expect to see? Business Leader investigates.
‘Your spending is my income’ is how Nobel Prize winning economist Paul Krugman summed up the ingredients to a successful and functioning economy.
Looking deeper at the statement, he meant that state intervention – ‘paying a man to dig a hole and fill it’ is better than having him unemployed and letting capitalism take its natural course and following a more liberal economic approach. Certainly, in the UK, over the last few months we have not seen state spending like this since World War Two. But how do we recover now? And what will the recovery look like?
Do we follow the economics of Krugman or do we look towards the school of thought proposed by economists like Milton Friedman, who believe state intervention only harms an economy further? Probably, it is something in between.
But firstly, it is important to assess where we actually are.
The economy now
The continuing impact of the COVID-19 virus is expected to see the UK economy contract by 10.3% in 2020, but a second lockdown of even just four weeks could exacerbate the drop in GDP to -12.6%, according to KPMG UK’s latest quarterly Economic Outlook.
However, given advancements in vaccine developments for COVID-19, there is a high chance that the pandemic will be overcome by mid-2021. Growth is expected to pick up to 8.4% next year if a vaccine is rolled out by April, with the economy reaching pre-COVID-19 levels by early 2023.
Three alternative scenarios were considered for the timing of the recovery, based on potential different dates of the vaccine being approved and then rolled out in the UK – and a Brexit deal outcome.
KPMG’s base scenario assumes that a vaccine will be approved in January, immediately reducing uncertainty, and rolled out by the end of April enabling all social distancing measures to be removed.
It also assumes the UK and the EU will reach an agreement on their future relationship before the end of the transition period this year. But even just a three-month delay in rolling out the vaccine could see GDP growth fall to 7.1% in 2021, instead of 8.4%.
A range of risks is also considered, where the outcome will impact potential growth. They include a no deal with the EU next year and limited progress in eradicating the pandemic. If these play out, growth in 2021 could fluctuate by between 8.4% and 4% at the least.
In regards to what role government has to continue play in the recovery, Yael Selfin, Chief Economist at KPMG UK, comments: “The pandemic has had a more significant impact on sectors that are more labour-intensive – and the recession will generate permanent change in some of them, meaning there will be a bigger effect on the labour market than the fall in GDP would imply.
“The government has an important role to play. Not just in continuing to provide short-term support to the economy but in readying the UK for a more productive future, including upskilling a significant part of the workforce and upgrading the UK’s telecommunications network. If we get this right, we could come out of this crisis with a better economy.”
The shifting shape of the recovery
What has been interesting to note is different business leaders and economists talking about how the recover might be shaped differently.
To find out more about this, Business Leader spoke to Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, to find out how she feels the recovery might take shape.
Susannah said: “We’ve heard a lot about different shaped recoveries over the last few weeks and months. The question is: will it be V, L, W or even K shaped?
“The only part that’s certain for now is the first bit of the shape, that huge second quarter plunge in GDP of 20.4% after the unprecedented shutdown of the UK, with a fragile recovery emerging since May as the economy has started to reopen.
“The easing of lockdown measures has had to be balanced with wanting to avoid a second wave of infections and possibly another lockdown, which has dashed hopes for a sharp V-shaped bounce-back.
“Over the summer, footfall in high streets and retail parks has been encouraging, and the Eat Out to Help Out scheme has lifted the hospitality sector’s prospects. But the confidence and willingness of consumers to spend is key to any economic revival. Household spending makes up for 63% of our economy’s GDP and this will be very important in supporting a sustained recovery.”
Consumer spending is indeed key but how will this be impacted by the retracting furlough scheme?
Susannah says: “This is where unwinding the furlough scheme could have a major impact, with the prospect of further mass redundancies. The Office for Budget Responsibility is predicting that unemployment could peak at 12% before Christmas. So, there is no surprise that calls to extend the government’s job retention scheme beyond October are coming thick and fast.
“It also appears that the post-pandemic rebound in construction has dwindled. Despite a record surge in house prices, boosted by the stamp duty holiday, disappointing PMI data released last week indicates that the civil engineering sector fell back into contraction in August and growth in the commercial and housebuilding sectors slowed.
“So, even if a V-shaped recovery emerges it is likely to be a wobbly one, and could easily turn into a W if the gradual return to normality increases infection rates again, necessitating a second lockdown. Indeed, this has already emerged in pockets around the UK, where tough local restrictions have been imposed following spikes in coronavirus cases.
“What seems increasingly likely though, is that we’ll see a K-shaped recovery, with two lines diverging to indicate the growing gap between sectors recovering quickly and those that lag seriously behind. The Governor of the Bank of England, Andrew Bailey, has already described the recovery as uneven and, if current trends continue, winners and losers may emerge even more sharply.”
The K-shaped recovery
As Susannah mentions, the K-shaped recovery shines a light on the ‘haves and the have nots’ when it comes to different sectors.
Susannah elaborates further on which sectors are doing better than others and says: “Despite the tough conditions for most across the country, some industries have fared better through the pandemic and its repercussions. The shift to online shopping has resulted in a massive surge in sales for Amazon.
“As people shunned cinemas and dining out for streaming and eating in, that’s boosted the fortunes of Netflix and Apple, as well as supermarket chains and takeaway services with efficient delivery services. IT Support, computer programming and consultancy services also posted positive figures for the pandemic period as millions of people adjusted to working from home.
“The travel and tourism sector, on the other hand, is still depressed after a sustained drop in demand for flights and the re-imposition of quarantine measures. Although there are bright spots in the retail and hospitality industry emerging, strict social distancing rules means that any significant recovery in the theatre and live performance industry is likely to be delayed until next year.”
Struggling parts of the economy has meant government support, something which Krugman would have liked. Friedman, maybe not so much.
On the impact of this support, Susannah says: “The bill for supporting sectors in need has already ballooned and, with such huge government stimulus programmes around the world, there is a risk of significantly higher inflation down the road. Although the tech giants are looking like the big winners right now, higher inflation will have implications for their huge cash balances.
“We are dealing with a shape shifting recovery, buffeted by the winds of government policy, a crisis in consumer confidence and fears that the pandemic is far from over. That could lead to a perfect storm of a flat-lining L-shaped scenario for the economy. So now, more than ever, investors should maintain a balanced, diversified portfolio, and ensure they hold a mix of shares or funds in different sectors, to aim for more consistent long-term returns.”
Matt Griffith is Director of Policy at Business West – an organisation that supports business growth and works with government on shaping policy.
Business Leader spoke to him to get his views on how the economy is being impacted.
On how he sees the recovery, he said: “After a torrid few months, who feels confident to predict the economic future? Forecasting looks like a mugs game, but here are some critical issues to watch, gathered from intelligence gained from across our regional business membership.
“Covid-19 has revealed the cruel, happenchance nature of crisis – both on who is impacted and who won support. Some have thrived, others crippled. Recovery is also likely to be highly differentiated by sector and region. How strong the bounce back is relies upon other drivers of growth getting going quickly, but also on sectoral quirks of fate – will further restrictions make hospitality fall again, will lockdowns in other global countries squeeze our export recovery?”
When it comes to jobs and how this will impact the recovery
Matt says: “Our recent survey of over 500 firms found that, of those making redundancies, 86% of firms said they had already done this, or would do so by October. The jobs shock to the economy is ongoing, but is mercifully appears quite near term. But the main contingency identified was the overall health of UK plc. An uncomfortably large 20% of respondents said they were still unsure of their jobs intentions.
“How well overall UK demand holds up, and how quickly firms can return to business and absorb jobs back into the labour market, is a critical element of the speed of recovery. We have concerns that the counterbalancing interventions after the end of the furlough scheme may not be enough. So watch the employment statistics, not just for firing, but for hiring too.”
What is the long-term cost of Covid-19 underinvestment?
On how the pandemic is impacting the investment firms make, Matt continues: “Our survey highlighted how big an impact the Covid-19 crisis has on both firms’ financial health (with big drops to profits and cash reserves reported) but also how much firms had pulled or delayed investment.
“We have seen sharp drops in investment in physical plant, in human capital and skills, in product development or investment in new markets and exports. Any continuation of these trends will spell bad news for the UK’s long-term growth prospects and our already poor levels of productivity and wage growth.
“Firms have also racked up plenty of postponed bills, rent and taken on new debt – particularly via the government’s CBILS and Bounce Back loan schemes. These are going to rear their head – as the freeze on business evictions is ended and loans start facing repayment deadlines.
“What Rishi Sunak does to encourage businesses to get back to investing, and what government does to help with liabilities, are the next big challenges for government.”
Brexit finally rears its head
And then there is Brexit. The impact the UK leaving the EU will have on the economy can be argued over for days; but Matt feels that timing is a critical issue.
He says: “After dragging on for an age, the Brexit denouement could not come at a worse time. The game of negotiating chicken is hardly calming nerves. If handled badly – and resulting in ‘No Deal’ – the UK faces a very unwelcome shock, to those areas of the economy that have held up often best through the Covid-19 crisis: cross supply chains, manufacturing, food & drink and UK exports – just at a point we need the economy to be powering ahead.
“A bounce back from the dark days of April and May is undoubtedly happening. Firms should crack on to return to health, but government needs to steer the ship very wisely to avoid the big risks to growth.”
In conclusion, it seems that a V-shaped recovery is most likely, with lots of government help required for struggling sectors. Paul Krugman could be right – ‘your spending is my income’