During the first quarter of 2020, the British economy shrank by 2%, the largest downturn since the 2008 financial crisis. This is despite the fact that the UK only began to implement lockdown measures on March 23, towards the end of the quarter. The UK’s GDP is expected to shrink by 25–25% in the second quarter as a result of lockdown measures implemented in April and May. British Prime Minister Boris Johnson announced that most businesses would gradually be allowed to reopen during the first half of June.
The UK government is trying to mitigate the impact of the coronavirus crisis on the labor market and unemployment rates. Unemployment sat at 3.9% at the start of the year, equivalent to 1.35 million people (an increase of 0.1% over the previous year, following a period of uncertainty and instability in the British economy owing to the delay in the UK’s withdrawal from the European Union). However, predictions issued by the Office for Budget Responsibility, an independent research institute funded by the UK government, indicate that the unemployment rate is likely to double to around 8%, equivalent to around 3 million people, by the end of the second quarter of 2020. Some analysts have predicted that, by the end of the year, around 6 million Britons will have lost their jobs. These percentages do not include employees or workers covered by the government’s job protection and income compensation scheme.
The cost of the UK government’s efforts to combat the impact of the pandemic is expected to reach £123 billion, thereby pushing government borrowing for 2020 up to around £298 billion (of which £127 billion is needed to cover lost government revenue, particularly that lost from taxes, and £119 billion will go towards direct government subsidies to support the economy). This is equivalent to 15.2% of the total British economy, the highest borrowing rate since the Second World War.
The government is also providing an estimated £330 billion in guarantees for loans and grants for the private sector, equivalent to 17% of GDP.
The government is expected to cover the costs of its current borrowing by raising taxes and increasing austerity measures, meaning long-term suffering for the British economy.
Current government measures to protect and support the British economy and the cost of those measures
Since the start of the crisis, the UK government has set up several schemes to protect jobs and the labor market, including the following:
Job retention scheme (furlough): This scheme costs the Treasury £10–12 billion per month. The aim is to discourage employers in sectors affected by the lockdown from dismissing employees as business slumps during the crisis, by offering to pay a proportion of their employees’ salaries in order to alleviate their financial burden. So far, the scheme has covered the wages of around 8.4 million employees who have been forced to stop work, reduce their hours to part-time, or work from home owing to health conditions or whose jobs have been threatened as a result of the loss of business and the lockdown measures. Under the scheme, the government pays 80% of employees’ wages, up to £2,500 per month. The government is also covering employers’ mandatory contributions to social security and retirement funds. While the government initially announced that the scheme would run until the end of July, it has since decided to extend the scheme until the end of October, albeit with some recent amendments: companies and business owners will have to cover their own social security contributions, and, as of September, they will be responsible for paying 10% of the wages of employees who are unable to return to work or who need to work from home as a result of health conditions that would make them vulnerable to virus. From October, that percentage will rise to 20%, and government contributions will drop to 60%.
The aim of the scheme is to combat the devastating effects that the lockdown has had on the labor market, prevent a sharp rise in unemployment, strengthen the social safety net, and protect companies’ human resources, the loss of which would deal a major blow to the economy in the long term, as companies would be forced to take time to rehire and train staff in the post-lockdown recovery period, which would have consequences for their productivity.
Self-employment income support scheme: Some 2.3 million individuals have applied for support through this scheme. For the first three months of lockdown, the government compensated self-employed workers for 80% of their average profits, up to a maximum of £7,500 for the three months, costing the government around £7 billion. The government has announced that it will extend the scheme for a further three months, during which it will pay self-employed workers 70% of their average profits, up to £6,750 in total. This is expected to cost the government around £6 billion.
The UK government has been particularly concerned about protecting SMEs during the crisis. It has set up several schemes to provide economic and financial support for SMEs and to reduce the likelihood of bankruptcy, closure, staff restructuring, or dismissals. At least 60% of the government’s bailout plans and programs have been aimed at SMEs:
As well as providing support for SMEs through its scheme to protect the labor market and prevent unemployment during the coronavirus crisis, the government has a number of other bailout programs aimed at SMEs:
The Bank of England has launched a scheme to make financial facilities available to large companies through the purchase of their short-term debt (known as commercial papers), as a way of rapidly providing such companies — which are financially strong but have suffered from liquidity and cash flow problems during the crisis — with operating capital, so that they can pay their employees’ salaries and their suppliers. Companies in the banking and financial sectors are not eligible for the scheme.
As of May 12, 12 banks and lenders have participated in the scheme, under which companies with annual revenue of more than £45 million are eligible to receive loans of up to £25 million, while companies with annual revenue of more than £215 million can apply for loans of up to 25% of the company’s annual returns, up to a maximum of £200 million.
The UK government has announced the launch of a bailout plan named “Project Birch”, in which it will use government funding to protect businesses that are strategically important to the British economy, such as those operating in the steel, aviation, and auto industries. Although the government announced that, in principle, special loans may be granted to such companies only once all other options have been exhausted, including other loan bailout schemes, observers have noted that the government may purchase shares in such companies “as a form of nationalization” to save them from collapse, if required.
One of the companies currently engaged in talks with the UK government is Virgin Atlantic, which has requested a bailout of £500 million as business has been affected by the suspension of flights. Loganair is in similar talks. Tata Steel has requested £500 million to save it from bankruptcy, and Jaguar has also filed a request for assistance under the scheme. In addition, the scheme will cover energy suppliers that are experiencing low demand for energy from factories and businesses, as well as the delayed payment of domestic energy bills as a result of job losses and rising unemployment. The scheme faces a number of obstacles, however:
Financial measures and monetary policy during the coronavirus pandemic
Lowering the interest rate:
On March 10, the Bank of England’s Monetary Policy Committee decided to slash the interest rate by 50% to 0.25%. Less than two weeks later, it reduced the rate even further to 0.1%, the lowest in British history. Having reached the conclusion that the government bond market was declining under the current economic conditions, both in the UK and around the world, the Committee decided to reduce the interest rate in order to support the economy and increase consumer confidence by providing funding and facilitating cash flow to businesses and individuals. However, lowering the interest rate may make private banks and lenders less willing to provide loans to businesses, especially SMEs, given the high level of risk. The government has sought to counteract this issue through the SME support schemes outlined below.
The Office of Budget Responsibility has revised its forecast for the UK’s net public debt for 2020 to £298 billion, making it the highest level of government borrowing as a proportion of GDP since the Second World War.
Will these government measures save the UK economy?
• Unemployment rates have continued to rise despite the government’s unprecedented program of bailouts. More than 2 million applications for unemployment support have been filed, and the unemployment rate has risen from 3.9% at the start of the year to 5.7% currently. Were it not for the measures taken by the government, the unemployment rate is expected to have risen much higher. The coronavirus crisis has had a unique impact on the British labor market. Between March and the end of May, the daily number of applications for unemployment support as a result of the crisis was three times higher than that during the height of the global financial crisis. This is just one of the signs that the current crisis is having a far greater effect on the British economy than the global financial crisis.
The Office of Budget Responsibility has predicted that the unemployment rate will double to around 8% by the end of the year, while a number of analysts are predicting that it will rise to 16%. The credit rating agency Fitch Ratings has developed three scenarios for the unemployment rate in the UK as a result of the coronavirus pandemic: the first is the most optimistic, giving an unemployment rate of 11%, whereas the second scenario predicts that unemployment will rise to 20% and the third that it will rise to 28%.
These predictions do not include employees and workers covered by the government’s job protection and income compensation scheme, nor do they account for the potential loss of jobs in the event that the UK leave the EU without an agreement.
• Most government and independent experts predict that the coronavirus crisis will have a far greater impact on GDP than the global financial crisis ever did. During the first quarter of 2020, the British economy shrank by 2%, the largest downturn since the 2008 financial crisis, despite the fact that the UK only began to implement lockdown measures on March 23, towards the end of the quarter. The UK’s GDP is expected to shrink by 25–25% in the second quarter as a result of lockdown measures enforced in April and May.
Fitch Ratings has developed three scenarios for GDP downturn in 2020. In the most optimistic scenario, the economy shrinks by 7.3%, whereas the other two scenarios predict a contraction of either 16.3% or 25.1%.
• Consumer confidence dropped dramatically during the lockdown period to levels last seen during the peak of the global financial crisis, owing to fears over job security and a drop in household incomes. This loss of confidence is expected to negatively affect UK businesses as consumers choose to save rather than spend and as individuals’ daily economic activities change. The car manufacturing sector — considered a vital sector of the British economy — is expected to be particularly affected. Consumer confidence is likely to depend on the government’s success in containing the epidemic.
• Weekly commercial data for the UK shows a gradual decrease in the volume of cargo shipping arriving at seaports and a severe drop in air freight. At the end of April 2020, airfreight had decreased by 62% over April 2019, not only as a result of the impact of lockdown measures on the UK business sector, but also as a result of the closure of other countries’ airspace and the decrease in global trade. The World Trade Organization estimates that global trade has reduced by 13–32% during the current crisis, compared with the 12% drop experienced at the height of the global financial crisis. The decrease in global trade will also have a negative impact on the UK’s economic productivity, following changes in supply and demand.
• Thus far, the UK’s Debt Management Office, which is part of the Treasury, has managed to raise £80 billion through bond auctions without disturbing market demand. Indicators show that demand for these bonds remain strong.
• At this time, it is difficult to assess the impact of the grant and loan schemes announced by the government to support businesses. Nonetheless, these schemes are expected to prevent many SMEs from falling into bankruptcy, and economists believe that the schemes may shield many businesses from the economic shock of the UK leaving the EU without an agreement. During a session of Parliamentary questions, however, UK Chancellor Rishi Sunak admitted that the loan scheme would not be able to save all businesses from bankruptcy.
• Any agreement made with any of the UK’s strategically important companies is expected to provoke opposition and political controversy, given the large sums involved. Furthermore, the government has yet to announce what criteria will be used to determine the level of support, and what guarantees will be put in place to ensure that any such support is used to save the company and that, where a loan has been provided, the company’s leadership do not profit from shares in the company. The government has also yet to announce what its exit plan will be for withdrawing from companies in which it has been forced to purchase a stake.
• The UK is expected to suffer further economic troubles if it withdraws from the EU without an agreement, leading to economic contraction, lower consumer confidence, and a drop in monthly spending. This would be yet another blow to businesses and may even further push up the risk of lending, even where backed by government guarantees, especially if the value of the sterling declines dramatically.
Comparison of the impact of the coronavirus crisis, the global financial crisis, and the UK’s withdrawal from the EU without an agreement
• The current crisis has brought a sudden end to the UK government’s policy of non-interference in the economy, pursued since former Prime Minister Margaret Thatcher first came to power, with the exception of the small-scale government interventions that took place during the 2007–2008 global financial crisis. While the UK government has prepared plans to address any economic disruption that may arise as a result of the UK’s withdrawal from the EU without an agreement, the coronavirus crisis has called for an entirely different type of government intervention, for the following reasons:
• Although both the global financial crisis and the coronavirus crisis has a global reach, the impact of the coronavirus crisis on each country’s economy has varied according to how widespread the virus is in the country and how the government has responded. Countries have therefore varied in their approach to the pandemic and in the policies adopted for each sector. The UK government has therefore been unable to make reliable predictions to guide its economic management policies during the next stage. The government has focused on absorbing the immediate impact of the crisis and providing an immediate response, rather than on developing long-term strategies to mitigate its impact. The Bank of England, for example, has been keen to maintain the stability of the financial and currency market by buying bonds, which has helped protect the sterling against significant devaluation. There are, however, serious concerns about the impact that such purchases will have on the UK’s public debt burden and on taxpayers’ purchasing power in the long run, including for basic services such as water and electricity.
• One of the problems facing economic policymakers in the UK is that, while the crisis has created a “new climate”, its existence will be temporary. How economic policymakers need to respond during the initial stage of the crisis and how they need to respond during the post-crisis period of economic recovery and rebuilding will differ dramatically. This will pose an obstacle for the UK, given the rigidity of the British financial system in general and its tendency towards conservatism. It will also be difficult to predict what the medium-term effects of the pandemic will be, given the extreme uncertainty experienced by the British economy as a result of both the UK’s withdrawal from the EU and the coronavirus pandemic. This is reflected in the initial forecasts produced by various UK government departments and agencies regarding the impact of the pandemic on GDP, which predict an economic downturn of anywhere between 5% and 14%. This large disparity will make it difficult for decision-makers to design suitable policies to combat the downturn. Experts believe that, given the difficulty of identifying what the best decision would be under such circumstances, the government will be forced to settle instead for whichever policy seems the least damaging.
• The economic and health impact of the pandemic will likely sway voters during future elections, particularly as the Conservative Party is facing numerous allegations of negligence. This will be compounded by the rise of the new Labour Party leader Sir Keir Starmer, as the party begins to overcome the difficult legacy of its former leader Jeremy Corbyn.
• The UK’s economic situation post-pandemic is expected to play a more critical factor than ever before in guiding the government’s foreign policy, as the government will make reviving the economy a national priority.
EPC | 21 Sep 2020
EPC | 16 Sep 2020
EPC | 13 Sep 2020