The furlough scheme will end soon. What next?

The UK labour market remains in limbo. Today’s figures show that, although the total number of hours people actually spent working is down by almost 20 per cent, unemployment has barely budged—although employment fell, this appears to be more than accounted for by EU citizens returning home.  There are millions of people in jobs, but not doing them.

This, of course, is the entirely intended result of the government’s Job Retention Scheme, better known as the furlough scheme.  But it won’t last. Almost everyone expects a sharp rise in unemployment as a consequence of the government’s decision to wind down the scheme by the end of October. Predictions vary widely. The Bank of England is relatively optimistic, expecting 2 and half million or so unemployed; the National Institute of Economic and Social Research forecast is for 3.5 million, the highest level (although not the highest rate) in modern times.

So is ending the scheme “one of the biggest policy mistakes in modern British history”? If it were extended to the middle of next year, NIESR argue, the short-term cost would be relatively small—perhaps £10 billion—and over the longer term the scheme would actually more than pay for itself.

The argument made by NIESR, and others, is that we know that unemployment is not just damaging in the short-term—there are permanent “scarring” impacts on individuals, as their skills fade and they become more detached from the labour market. So high unemployment in the short-term leads to higher unemployment, and lower wages, in the medium to long term.

This argument has force. Indeed it was the original rationale for the furlough scheme. To the extent that the reason people didn’t have sufficient work—and firms didn’t have the money to pay them—was because of health-related restrictions imposed by the government, then it made sense for the government to give firms money to keep them on the books (pending the lifting of the restrictions) to ensure that the economic damage was indeed only temporary.

But the longer the scheme goes on the more one-sided this picture becomes. Job destruction and job creation is a necessary part of a dynamic economy. Indeed, every year more than three million people in the UK leave employment, and a similar number move from job to job. And when economies go through structural shifts in the patterns of supply and demand, as technology advances or consumer preferences change, then allowing this movement is even more important.

There are thus two risks arising from the furlough scheme. First, that it will inhibit the normal flow of workers from firm to firm and sector to sector. Consider the two sectors where the largest number of workers have been furloughed: accommodation and food services, and the retail and wholesale sectors. Both have above average levels of turnover in normal times, with perhaps a third of the workforce leaving or changing jobs every year.

And second, that to the extent that the aftermath of the pandemic leads to permanent—or at least prolonged—shifts in demand, then we are paying for people to do jobs that will no longer exist. If people and firms decide—whether because of government regulations, health concerns, or simply because, having tried it, they find that working from home much or all of the time is preferable—then demand for sandwich bars will fall. It is in the interests of both the economy as a whole, and, in the longer term, of workers themselves that sandwich bar employees find new jobs in new sectors. Just as long-term unemployment is likely to erode individuals’ skills, so is prolonged inactivity, even if it notionally still in paid employment. NIESR’s calculations include none of these possible costs.

In some ways this is a variant on the “zombie firms” thesis advanced in the aftermath of the financial crisis—that low interest rates, combined with banks’ unwillingness to call in bad loans, allowed unproductive firms to stay in business and continue employing people, hindering the necessary reallocation of capital and labour while holding back productivity. The jury is still out on how important a phenomenon this was. But it seems certain that at this point the furlough scheme is indeed preserving a significant number of “zombie jobs.”

However, none of this means that we can simply assume that the market will sort it out and there is no role for government. While the short-term hit to the economy was the direct result of the pandemic, the longer term consequences are very much under our control. In that sense, there are lessons from previous recessions. Technological change leading to the decline of manufacturing was not the Thatcher government’s fault; but long-term unemployment and the abandonment of the communities that suffered most was. Similarly, immediately after the financial crisis, a sharp fall in wages was inevitable; but the subsequent ten years of austerity and the hollowing out of public services was not. The human consequences, in both cases, were disastrous. We need to avoid repeating the mistakes of the past—cutting spending too soon, and assuming that restructuring and reallocation would happen automatically.

So what should we do? Three main sets of policies are required. First, support the incomes of those who lose their jobs. This makes sense from both a social and an economic perspective. Those most at risk are most likely to be young and poor. A substantial further increase in universal credit would reduce hardship and poverty and support consumer confidence and consumer demand.

Second, help people get new jobs. As an alternative to the £1,000 grant to employers who bring employees back from furlough, why not offer those who are not brought back a more substantial sum, for retraining, to help them start a business or become self-employed, or as a wage subsidy to employers creating new jobs?

Third, if the private sector cannot create enough jobs in the short term—and given the uncertainty about the extent and direction of structural changes, this is more than likely—then the public sector should step in. We already know that we need a larger, better paid and better trained workforce in the care sector; we have millions of children who have lost a term’s education and could benefit from help and support to catch up; we have dilapidated schools and hospitals up and down the country. If “building back better” means anything, there is no excuse for allowing people to drift into long-term unemployment when there is plenty of useful work to be done.

All of this will be expensive—at least as expensive as extending the furlough scheme. But if we don’t act now, we’ll be living with the economic and human consequences for decades. And it won’t be the virus’s fault—it will be our own.  The chancellor is right that we can’t—and shouldn’t—save every job, but there is nothing inevitable about mass unemployment.