BU鈥檚聽Emeritus Professor Nigel Jump writes the next in a series of economic blogs looking at the impact of covid-19 on the economy.
鈥淗ard times, 鈥� such dark times鈥�
Although overall GDP is recovering, current economic conditions are difficult:
Oil prices now exceed US$80 a barrel and gas prices are up 500%+.聽 UK inflation is accelerating (input prices +11.4%, output prices +6.7%, consumer prices +3.1% year to September)
Materials and goods bottlenecks are evident in ports and supply chains and labour shortages are widespread from logistics to hospitality (see FT 26 October 鈥渃rippling shortages and rising prices hit the economy鈥�)
Covid19 infections and deaths persist at high and rising levels
Consumer demand is unstable - partly hesitant and partly panicky in the run up to Christmas as confidence ebbs and flows
Business confidence is softening too, according to the main business surveys, and investment remains weak, whilst open trade with the UK is a low priority for many of its economic partners
The world鈥檚 various lockdowns have disrupted all economies severely and the recovery is uncertain and volatile.聽聽 Lockdown costs are high, ranging from huge government borrowing from future generations to current damage to small business profits and supply chains, with expensive and constricted goods flows.
The authorities locked down the supply-side of the economy, while simultaneously printing and borrowing money to hold up the demand-side.聽 The economy cannot be turned on and off that easily.聽 As the 鈥榩ainkillers鈥� wear off, structural and cyclical adjustments resurface, hurting through inflation and output gaps (as exhibited in market barriers from natural resources and components through to shipping, transport and other services/retailing).聽
With the 鈥渋nvisible hand鈥� still half asleep, a winter with fuel and other shortages is feared.聽 Markets face impeded information and unclear policy/regulation.聽 Excess lubrication (inflation) may keep the engine running, but price rises do not feel as transitory as the Bank of England hopes.聽 Interest rates will rise sooner and maybe further than once seemed likely.
Given a long tail of inefficient businesses, the UK鈥檚 productivity performance has been poor in absolute and relative terms for a decade. 聽The new Bank of England Chief Economist, Huw Pill, talks about 鈥渢hree waves of uncertainty鈥�: the global financial crisis, the EU referendum, and the covid pandemic.聽 These 鈥榯hree waves鈥� have stymied investment in innovation, labour skills and R&D.聽 Currently, this is exacerbated by fractured supply chains.聽
The optimist would say, eventually, the lockdown 鈥榮hake-outs鈥� will encourage a productivity boost by reallocating resources to 鈥榖etter鈥� firms and 鈥榖etter鈥� activities.聽 The pessimist would say that the 鈥榙isruption鈥� of pay increases now happening will bite.聽 Any productivity gains that might come later will leak away through inflation.聽 The short-term 鈥榩ain鈥� may kill the patient before the long-term gain is achieved.
Against this background, we can be forgiven for being gloomy.聽 PM Johnson, however, remains upbeat, shrugging off immediate concerns as part of recovery from pandemic and adjustment to Brexit.聽 His brand of 鈥渧oodoo鈥� economics says, if employer pay higher wages, private and public productivity will rise.聽 We can all be better off with less reliance on external factors and more self-resilience, as investment skews more towards cost-saving technologies, methods and processes.聽 This is a bold belief that implies 30 years of increased globalisation can and should be reversed, at least partly, by allowing some domestic cost and price inflation to trigger efficiency gains.
This argument is, at least partly, the wrong way round.聽 The effective and sustainable route is not from wages to productivity to investment but from investment to productivity to wages.聽 If you start at the wrong end of causation, you get wages leaking into inflation, with less of an output or employment boost.聽 Then, compared with what might have been, you get higher interest rates and larger debt burdens, and more unemployment and lower living standards.
What to do 鈥�?
Investment is always the starting point for any sustained recovery and sustainable increase in well-being.聽 Investment needs to be efficient and effective and in the 鈥榬ight鈥� infrastructure, innovation, and skills.聽 It needs to encourage entrepreneurship and competitiveness, which allows a boost to productivity and, thereby, profits and wages.聽 The government鈥檚 job is to create the incentives and environment for 鈥榞ood鈥� investment through supportive fiscal, monetary, and regulatory conditions.聽 Intervention is justified when there is persistent market failure, and the moral hazards of specific actions can be assuaged.聽 The state needs to have sustainable finances, controlling inflation and favouring the goals and values society wishes to pursue.聽 These might include reforms of social and environmental, (such as levelling up and climate mitigation), as well as traditional economic, behaviours, incentives, and targets.
Do the spending review and budget facilitate such an approach?
On 27th October, the Chancellor announced a wide range of spending commitments, confirmed some tax increases, and promised some public sector and minimum wage rises.聽 Lots of money for lots of things, some of which will benefit business and services in our area.聽 But, the economy headlines (from the OBR 鈥� Office of Budget Responsibility) remain stark.聽 After (hopefully) a post-pandemic bounce in 2021 and 2022, economic growth is projected to slow back to 1.3% in 2024 and real GDP increases stay under 2% per annum thereafter.聽 This is still a low (relatively and absolutely) real growth trajectory made difficult by higher inflation (4%+ next year), and higher taxes and interest rates.聽 It implies a further loss of the UK share of global growth and activity.聽 The OBR says that average and most household incomes will go up by less than 1% per annum over the next half decade.聽 As tax increases bite, 鈥榮tagflation鈥� means many will feel worse off.
Still, the Chancellor鈥檚 rhetoric makes sense.聽 The plan is that various state programmes for investment in infrastructure, innovation and skills will encourage firms to raise productivity, making the UK more competitive and, thereby, able to increase employment, real wages and living standards. 聽He says he will address adverse geographical maldistribution - levelling up services and communities and, amongst other things, funding more resources for health, education, justice and culture.聽 Over time, therefore, the government hopes for a structural adjustment that reverses the potential loss of relative international performance.
Fiscally, the government offers a Charter for Budget Responsibility that allows borrowing for growth but not for current spending. 聽It suggests borrowing/GDP will fall over time, offsetting some of the threat to the state鈥檚 finances from increased interest rate sensitivity.聽 It promises higher departmental spending for all but, of course, this does not reverse the discretionary spending cuts made since 2010 and the financial crisis.聽 Reform of business rates, council tax, the universal credit taper, and alcohol and other duties is backed by promises of pay rises for the public sector.聽 However, it is not clear whether these changes will bring real economic advances for most of us.
The 2021 Budget and the Comprehensive Spending Review (CSR) depict a UK economy with low growth.聽 The economy took a worse hit from the pandemic (2% permanent scarring says the OBR) than many of its competitors.聽 And, it still faces difficult adjustments to Brexit.聽 The state looks set to be a bigger proportion of the economy for the foreseeable future.
The plan is to increase productive performance by actual and incentivised investment in the right kind of areas, but it remains to be seen if a real transformation is possible: one which more than offsets the short-term negatives for household living standards.聽 Delivery is crucial.聽 Add on a raft of changes needed to address the environmental crisis in terms of home, industrial and transport energy and materials carbon flows, and we face an uncertain future, albeit one with opportunities if private and public sector productivity can really improve.
