It’s become a bit of a cliché in recent months to say that the situation we are in is ‘unprecedented’ or that we are in ‘uncharted waters’, but the Office for Budget Responsibility’s latest update really does illustrate this in stark terms. The UK’s debt-to-GDP ratio is set to soar well above 100% and be higher than it has been since it was brought down from its inflated level after the Second World War. The OBR expect the economy in 2022 to still be smaller than it was in 2019 in real terms (and that is despite a growing population). They expect the unemployment rate to go up to 12%, as opposed to the 4% they were expecting before the pandemic hit.
The OBR had already released a ‘reference scenario’ for the impact of the pandemic in April, but as I pointed out on this site at the time, this did not attempt to account for the longer-term impact of the colossal hit the economy and public finances would suffer. Their scenario in April assumed that borrowing and GDP would return to their expected pre-crisis trajectories relatively quickly, because it was too early to make any meaningful estimates beyond the immediate economic shock. The main story from their latest update is that they have begun to factor in the permanent damage which company closures, job losses and lower investment will do.
When this crisis began, there was hope in some quarters that we could contain the virus with a three-month lockdown and then return to normal relatively quickly. We were going down a steep decline, but the same economy would be waiting for us on the other side. It has gradually become clear that things are not going to be ‘back to normal’ for some time, and that in fact some things are likely to be permanently different. Some are still clinging to their optimistic predictions of a ‘V-shaped’ recovery, but sadly I think we will soon be in a position where those of us who were far more pessimistic can tentatively say we are being proven right.
The OBR are now saying that even in five years’ time the unemployment rate will still be significantly higher than they expected in March, productivity will be much lower than expected, and the overall impact of the economic ‘scarring’ could be an ongoing 3% hit to GDP. The crucial job for the Government over the coming months and years will be to work out where the greatest risks to the long-term outlook lie and do everything possible to mitigate them.
That has been the purpose of the Job Retention Scheme and the business loans that have been the major economic interventions thus far. We know from past crises that unemployment causes lasting damage as workers lose touch with the labour market. Losing firms means losing the connections, relationships and institutional knowledge which are the product of years of learning and growing and are the whole point of the firm as an economic entity.
In their central scenario, the OBR expect that 15% of those workers who were furloughed by their employer will end up unemployed, which would represent around 1.3 million jobs. The Chancellor has been realistic in stating that he cannot save every job and every business. His task will be to both minimise job losses while at the same creating the space for new jobs to be created at pace as firms adapt to changing consumer behaviour and demand.
On the fiscal side, the OBR are now forecasting that after four years of recovery, in 2024-25 the deficit will still be roughly double what they were forecasting in March. The scary thing is that is almost entirely down to the economic scarring effects, which they expect will represent a structural fiscal hit of 2.4% of GDP, and factors in hardly any discretionary increases in spending through government policy decisions.
This is because the OBR assume, in line with what has technically been stated by ministers, that virtually all the spending measures announced this year are temporary. In fact, their forecast for 2024-25 is that less than a billion pounds of the nearly £60 billion of additional borrowing relative to their pre-crisis forecast will be from policy measures.
That means they assume that the roughly £50 billion of extra spending on public services this year will all be temporary. They assume the £30 billion being spent this year on supporting businesses through tax holidays and grants will all be temporary. They assume that the £7 billion being spent this year on increasing weekly welfare payments will be ended.
The OBR can only make estimates based on stated policy, not on political reality, but let’s be realistic. Is the Government really going to be able to claw back all of that spending? Are they going to cut benefits by £20 a week in April? Are they going to be able to bring spending on the NHS, schools and other public services back down to the levels they were planning before the pandemic?
Rishi Sunak knows how difficult the politics of this would be, so it’s likely that the fiscal reality will actually be even worse than the OBR’s estimates. The Chancellor is going to have to make some incredibly tough decisions. It may be, for example, that some clever manoeuvring will be necessary to claw back spending which would otherwise have been permanent and offset it politically with other temporary giveaways. The Government needs to constantly have an eye to which of its spending measures are sensible one-off costs and which will end up adding to the structural hole in the public finances.
The OBR’s Fiscal Sustainability Report was a reminder that what really matters is not whether the deficit is 10% of GDP this year or 15%, or even whether GDP is 20% lower this year or 30%. What matters is whether in five or even 10 years’ time we are permanently poorer and still have rising public debt levels. While the numbers in the report might seem bleak, in some ways they are a flattering portrait of the situation we find ourselves in. We’ve fallen off a very steep cliff – it remains to be seen how painful and how long the climb back up will be.
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