The risks to a rapid recovery: Views from top UK economists
The UK economy is suffering its worst recession in centuries, with national income declining and unemployment rising at unprecedented rates. This column reports on the latest Centre for Macroeconomics survey, which reveals that despite this worrisome news, the panel is optimistic that the UK economy will recover to its pre-pandemic trend within five years or less, no worse than past UK recessions. Panellists emphasised that these predictions depend on the government effectively containing the spread of the virus and not reverting to austerity policies following the pandemic. The panel was split on the biggest risks to the pace of recovery, with firms’ productive capacity, scarring effects of unemployment, and a slow demand recovery cited as prominent concerns.
The June 2020 Centre for Macroeconomics (CfM) survey asked its panel to assess the likely rate of recovery from the economic fallout due to the COVID-19 pandemic. Panellists were first asked to assess how fast the UK economy would recover to its pre-pandemic trend after the pandemic is contained. They were then asked to cite which factors pose the greatest threat to the pace of recovery.
By several metrics, the UK economy is in the midst of its deepest recession in centuries. The ONS estimates1 that GDP declined by 25% from February to April 2020, more than five times the worst quarter of the 2008-09 global financial crisis. The OECD projects that the UK will suffer the deepest downturn (a GDP contraction of 14%) among its members in 2020, due to its reliance on services, but the IMF’s World Economic Outlook (IMF 2020) places the UK in a slightly better position. Employment declined2 by merely 1.2% in April, relative to April 2019, and is estimated to have fallen by 1.7% year-on-year in May. However, these figures almost certainly understate the decline, as the government’s furlough scheme has kept many workers (currently over 9 million) that are effectively unemployed on companies’ payrolls at the government’s expense. A look at hours worked shows that they declined by 9% in February-April 2020 relative to the previous three months: the largest decline on record. Vacancies draw an even direr picture, having declined by nearly 30% in March to May relative to the previous quarter.
A debate has emerged as to the nature of the recovery. An optimistic take is that the economy is in an artificial ‘freeze’ due to lockdowns and the pandemic itself. According to this view, the economy can be easily thawed back to its previous state and will be supported by substantial pent-up demand. Bank of England Governor Andrew Bailey writes, “There are reasons to believe that economic activity will return at a faster pace than in many past recessions, but this depends on how the measures continue to be eased, what degree of natural caution is shown by people, and how much longer-term damage is done to the economy.”3 Paul Krugman has also supported this view stating that this recession will have a “morning in America” type recovery that was more common pre-1990.4 Real-time estimates in the US (Chetty et al. 2020) show substantial rebounds (but far from full recovery) in retail sales in May and in low-wage employment in small firms in May and June.
A different view suggests that the depth of the recession will have scarring effects that will retard economic recovery. The Chancellor has stated that “[t]he longer the depth of the recession, I think everyone would agree – all economic forecasters and economists would agree – it is likely the degree of that scarring will be greater.”5 Leslie et al (2020) note that past UK recessions have led to permanent declines in GDP. Financial institutions (HM Treasury 2020) are forecasting a ‘swoosh-shaped’ recovery, with GDP recovering to its pre-pandemic level only at the end of 2021.
The rate of recovery will of course be affected first and foremost by the pandemic itself (see David Miles’ study of several lockdown scenarios)7. It will also depend on the policy decisions of the Bank of England and the Treasury. To sharpen the question, panellists were asked to assess the rate of economic recovery from the COVID-19 pandemic after the pandemic itself is contained. Containment could mean the discovery and mass production of a vaccine, mass testing, herd immunity, or other developments that would allow a resumption of some semblance of long-term economic normalcy.
Question 1: How quickly will the economy rebound (e.g. to the pre-pandemic trend) once the COVID-19 pandemic has been contained and absent major policy interventions?
Twenty-three panellists responded to this question. The vast majority of respondents predict a recovery of five years or less. Nearly half of all respondents point to a recovery within a small number (one to five) years. An additional 30% are even more optimistic and expect a recovery within a year (to either the pre-pandemic growth rate or to its growth trend). A smaller share of roughly 15% is less optimistic and predicts a slow recovery or permanent damage to the economy.
Optimistic respondents believe that the economy can recover rapidly following the pandemic and the lockdown. Jumana Saleheen (CRU Group) explains that “the large rebound needs to be understood in the context of a recovery from the very low levels of activity witnessed during lockdown” and expects growth to return to its pre-crisis level of 1.6% year-on-year by 2023. Patrick Minford (Cardiff Business School) is even more optimistic: “the recession has been directly caused by the lockdown… the [UK] economy should restore activity in Q3 and Q4 [of 2020].” Meanwhile, Roger Farmer (University of Warwick) predicts a rapid recovery, but only to half or one third of its previous trend growth rate. However, he views productivity gains as possible, citing “some evidence that very low unemployment is correlated with slow growth”.
The panellists’ optimism is cautious. Michael Wickens (Cardiff Business School, University of York) describes the risks: “It is not clear how quickly employment income will be restored and how quickly the raised savings rates of employed households and the higher debts of other households will decline.” Michael McMahon (University of Oxford) expects that “there will likely be some specific sectors that take much longer or are permanently affected.”
Several respondents qualify that their optimism depends on the government’s policy response, and expressed concerns that the government would hit the fiscal breaks too soon. Simon Wren-Lewis (University of Oxford) emphasises that “a V-shaped recovery is possible if the government gets its pandemic management right” with regard to lifting lockdown, failing which, “scarring effects will be significant.” Wouter Den Haan (London School of Economics) only estimates a rapid return to the pre-crisis growth trend “conditional on the government not quickly reverting to austerity policies to bring debt-to-GDP ratios down.” Francesca Monti (King’s College London) is also relatively optimistic in her outlook “assuming that stimulative policies continue to support the economy.”
Risks to a rapid recovery
In the second question panellists were asked which aspect of the economy poses the greatest risk that the recovery will be slow and prolonged. Readers should note that the panellist were asked about economic risks, putting aside the risk that the government policy may slow the recovery.
Question 2: Which aspect of the economy poses the greatest risk for a slow recovery?
Twenty-three panellists responded to this question. The most commonly cited risk factor (at 26%) was that the pandemic will have affected firms’ productive capacity. However, panellists choosing this option expressed less confidence in their answer than those choosing the second and third most common responses. Twenty-two percent of panellists viewed scarring effects of unemployment as the greatest risk, with the share of respondents rising to 32% when adjusting for their degree of confidence. Thirteen percent of panellists believe that sluggish consumer demand poses the greatest risk, but this number also rises to 23% when weighting responses by their degree of confidence.
Concerns about all risk factors were widespread in panellists’ responses. Regarding firms’ productive capacity, Jagjit Chadha (National Institute of Economic and Social Research) expressed the view that dynamism of firm turnover will “provide the jobs for those moving between sectors and those joining the labour market.” Natalie Chen expressed concerns about labour markets and warned of “significant risk to the economy” from a rise in unemployment “once the furlough scheme ends”. David Cobham (Heriot-Watt University) links concerns around unemployment with the issue of human capital, stating that “there needs to be a lot of focus on retraining”.
With concerns regarding the scarring effects of unemployment and business dynamics abound, Jumana Saleheen (CRU Group) suggests that the government should “provide funds to control the virus, but also provide support that helps us live with the virus,” with a focus on “pubs, restaurants and cinemas” as the most affected sectors. Saleheen also mentions online schooling “to support the return of the relevant workers back to work.”
Several respondents view consumer demand as the main risk to the recovery. Michael Wickens (Cardiff Business School, University of York) argues that “the restoration of demand” is “the key to recovery” since “all of the other factors would automatically improve as a result”. Simon Wren-Lewis (University of Oxford) points to the timing of lockdown as both a consumer demand and labour market issue, with “a real risk that a significant proportion of consumers will not resume social consumption” followed by “persistent unemployment and bankruptcies” if lockdown is “ended too early”.
Other respondents placed greater emphasis on human capital or the risk of private debt overhang. Roger Farmer views “debt overhang and financial markets” as “the clearest opportunity… to support a rapid recovery.” Finally, but no less importantly, Chryssi Giannitsarou (University of Cambridge) warns of permanent harm to human capital due to “the effects on children of repeatedly missing school due to lockdowns and higher education offered in non-traditional ways.” In addition, childcare responsibilities have further skewed gender inequality. Giannitsarou points to “abundant evidence that the pandemic has affected women and parents disproportionately.”
Author’s note: The author acknowledges Dhruv Narayanan for his able editorial assistance.