How to restore economic confidence

If economic forecasters were mildly frustrated by the government announcing an extension of furlough only hours before the scheme was due to end, for many whose jobs were on the line the timing was catastrophic.

The government was undoubtedly right to extend the Coronavirus Job Retention Scheme (CJRS)—as we at the National Institute of Economic and Social Research had called for since July. The economic damage from coronavirus estimated by the Office for Budget Responsibility alongside the Spending Review, while large in historical context, would have been far worse without significant government intervention. It would be a colossal mistake for that support to be withdrawn too soon.

But uncertainty exacerbated by repeated changes in policy (including a Job Support Scheme announced, amended twice then postponed) have badly dented the benefits we might otherwise have expected from fiscal policy. Employers who were told the scheme would definitely end in October have been steadily making redundancies over recent months, since the employer contributions to the CJRS were introduced. Unemployment is steadily rising, though official figures lag behind.

Clearly, policy must evolve as the challenges faced by society do, but minimising economic damage isn’t achieved by prematurely “returning to normal”—only to be forced to backtrack. We need a clearly laid out programme for different policies tailored to each future scenario, so that everyone can be aware of what will happen depending on how the virus develops.

The good news is that unemployment in the fourth quarter is now unlikely to reach the 7 per cent we expected based on the October end to furlough. However, a premature withdrawal of government support could still see it reach that level—or higher—next year. As well as hardship for those made redundant, a rise in unemployment typically brings with it a fall in vacancies. Based on the traditional relationship between unemployment and vacancies, the headline jobless rate could have shot up to 10 per cent in May without government intervention, and even now vacancies remain more than a third below their level a year ago.

Different sectors of the economy are experiencing differing degrees of economic pain. Public sector wages have fallen relative to the private sector in recent years but have held up better this year, as a far higher proportion of private sector workers have been furloughed on 80 per cent of normal earnings. The public sector pay freeze announced in the Spending Review will make little difference to the public finances; it seems odd to justify it by reference to falls in private sector wages which largely resulted from government policy decisions.

Looking ahead, with trade negotiations with the EU still deadlocked, industries (especially the arts) which have not re-opened since the first lockdown may not notice the immediate effects of a no-deal Brexit. But manufacturers could be hit with a second damaging shock if a deal is not agreed, and industries that were little damaged by Covid-19, such as finance, could feel the effects most sharply.

Fiscal intervention to support the economy through coronavirus remains necessary. The costs of mitigating the worst effects have been borne by the government, whose debt as a result is likely to approach 110 per cent of GDP. This may have been unimaginable little more than a decade ago, but financing costs remain low and are expected to remain so for a long time. Most forecasts, which already assume a sustained recovery in 2021, have partly factored in good news about a vaccine already.

A one-off rise in the level of government debt should not dictate tax and spend policy. As permanent changes to the size and shape of the economy are likely, at some point a wholesale review of how tax can best be raised in future is required. It was sensible that rises were postponed in the Spending Review (though the same logic was not applied to public sector pay). But we still desperately need a better framework for setting fiscal policy: one focused on the long-term weaknesses of the UK economy and less likely to lead to policy reversals, ad hoc decisions and announcement-by-newspaper-briefings.