UK Economic Outlook Summer 2020

How is Covid-19 affecting the UK economy?

There are substantial downside risks as the economy enters a phase where activity is expected to be subdued at the same time that government support measures are withdrawn.  The expected weakness of activity arises partly from the need to avoid ‘social’ consumption while Covid-19 is still present. While most businesses are allowed to trade, many cannot do so normally because of the need to maintain social distancing.  This is affecting the hospitality and travel sectors particularly, and also means that many people are not commuting to city centres to work, with knock-on effects on businesses based there.  Activity in these sectors and places is likely to be subdued for as long as Covid-19 is present with adverse consequences for employment.  On top of this, demand is weak because businesses are deferring investment and households are deferring consumption until they are able to spend on goods and services that are not currently available or thought not to offer the same experience.

What is the furlough scheme?

The government introduced the furlough scheme in March this year when it became obvious that many people would not be able to go to work due to the lockdown measures that it had introduced.  The government agreed to pay 80 per cent of the wages of those asked not to work up to a maximum of £2,500 per month.  Furloughed workers stayed on the payroll of their employer who could then claim back furlough payments from the government.  This was good for furloughed workers who were reassured that they still had a job, and good for employers who knew that they still had employees who were trained to do their jobs.  Obviously the scheme is expensive and this is why the government is now phasing it out.

What are the costs and benefits of extending the furlough scheme?

To assess the costs and benefits of extending the furlough scheme we compare our main forecast which supposes that the scheme will end in October with a ‘counterfactual’ forecast of what would happen if the scheme were extended to the middle of next year.  Rather than rising to around 3 million in the fourth quarter of this year in our main forecast, the increase in unemployment would be more muted if the scheme were extended.  In particular, 1.2 million furloughed employees who would have lost their jobs and become unemployed at the end of this year instead stay on the furlough scheme at an average gross cost of £2,000 per job per month.  This would also reduce unemployment below our main case forecast scenario by 700,000 through the first half of next year. The short-term budgetary cost of paying businesses to keep these employees on furlough is relatively small once account is taken of the taxes they would pay and the benefits they would not receive.  In this scenario, the cost would amount to around £10 billion in total by the middle of next year, around the same cost as the Job Retention Bonus.  The reassurance that the incomes of furloughed workers are protected in this way would also add somewhat to consumer confidence and aggregate demand.

Supporting jobs in this way would also have a long-term benefit. Keeping people in jobs, even when on furlough, is likely to protect productivity and guard against scarring as firm-specific skills are not lost and furloughed employees remain attached to the labour market.  Both of these effects are difficult to quantify, but there is substantial evidence that keeping people in work and preventing a rise in long-term unemployment reduces long-term equilibrium unemployment.