Will COVID-19 Cause Permanent Damage to the UK Economy?

Monday, June 29, 2020

Question 1: How quickly will the economy rebound (e.g. to the pre-pandemic trend) once the COVID-19 pandemic has been contained and absent major policy interventions?

Question 2: Which aspect of the economy poses the greatest risk for a slow recovery?

Summary

The UK economy is suffering its worst recession in centuries, with national income declining and unemployment rising at unprecedented rates. Despite this worrisome news, the CfM panel is optimistic that the UK economy will recover to its pre-pandemic trend within five years or less, no worse than past UK recessions. Panellists emphasised that these predictions depend on the government effectively containing the spread of the virus and not reverting to austerity policies following the pandemic. The panel was split on the biggest risks to the pace of recovery, with firms’ productive capacity, scarring effects of unemployment, and a slow demand recovery cited as prominent concerns.

Background

The June 2020 CfM survey asked its panel to assess the likely rate of recovery from the economic fallout due to the COVID-19 pandemic. Panellists were first asked to assess how fast the UK economy would recover to its pre-pandemic trend after the pandemic is contained. They were then asked to cite which factors pose the greatest threat to the pace of recovery.

The Recovery

By several metrics, the UK economy is in the midst of its deepest recession in centuries. The ONS estimates that GDP declined by 25% from February to April 2020, more than five times the worst quarter of the 2008-09 global financial crisis. The OECD projects that the UK will suffer the deepest downturn (a GDP contraction of 14%) among its members in 2020, due to its reliance on services, but the IMF’s World Economic Outlook places the UK in a slightly better position. Employment declined by merely 1.2% in April, relative to April 2019, and is estimated to have fallen by 1.7% year-on-year in May. However, these figures almost certainly understate the decline, as the government’s furlough scheme has kept many workers (currently over 9 million) that are effectively unemployed on companies’ payrolls at the government’s expense. A look at hours worked shows that they declined by 9% in February-April 2020 relative to the previous three months: the largest decline on record. Vacancies draw an even direr picture, having declined by nearly 30% in March to May relative to the previous quarter.

A debate has emerged as to the nature of the recovery. An optimistic take is that the economy is in an artificial “freeze” due to lockdowns and the pandemic itself. According to this view, the economy can be easily thawed back to its previous state and will be supported by substantial pent-up demand. Bank of England Governor Andrew Bailey writes, “There are reasons to believe that economic activity will return at a faster pace than in many past recessions, but this depends on how the measures continue to be eased, what degree of natural caution is shown by people, and how much longer-term damage is done to the economy.” Paul Krugman has also supported this view stating that this recession will have a “morning in America” type recovery that was more common pre-1990. Real-time estimates in the US (Chetty et al 2020) show substantial rebounds (but far from full recovery) in retail sales in May and in low-wage employment in small firms in May and June.

A different view suggests that the depth of the recession will have scarring effects that will retard economic recovery. The Chancellor has stated that “The longer the depth of the recession, I think everyone would agree – all economic forecasters and economists would agree – it is likely the degree of that scarring will be greater.” Leslie et al (2020) note that past UK recessions have led to permanent declines in GDP. Financial institutions are forecasting a “swoosh-shaped” recovery (see Jumana Saleheen’s exposition of recession shapes here, Costas Milas’ prediction here and Ricardo Reis’ exposition of “ABC recoveries” here), with GDP recovering to its pre-pandemic level only at the end of 2021.

The rate of recovery will of course be affected first and foremost by the pandemic itself (see David Miles’ study of several lockdown scenarios). It will also depend on the policy decisions of the Bank of England and the Treasury. To sharpen the question, panellists were asked to assess the rate of economic recovery from the COVID-19 pandemic after the pandemic itself is contained. Containment could mean the discovery and mass production of a vaccine, mass testing, herd immunity, or other developments that would allow a resumption of some semblance of long-term economic normalcy.

Question 1: How quickly will the economy rebound (e.g. to the pre-pandemic trend) once the COVID-19 pandemic has been contained and absent major policy interventions?

Twenty-three panellists responded to this question. The vast majority of respondents predict a recovery of five years or less. Nearly half of all respondents point to a recovery within a small number (one to five) years. An additional 30% are even more optimistic and expect a recovery within a year (to either the pre-pandemic growth rate or to its growth trend). A smaller share of roughly 15% is less optimistic and predicts a slow recovery or permanent damage to the economy.

Optimistic respondents believe that the economy can recover rapidly following the pandemic and the lockdown. Jumana Saleheen (CRU Group) explains that “the large rebound needs to be understood in the context of a recovery from the very low levels of activity witnessed during lockdown” and expects growth to return to its pre-crisis level of 1.6% year-on-year by 2023. Patrick Minford (Cardiff Business School) is even more optimistic: “the recession has been directly caused by the lockdown… the [UK] economy should restore activity in Q3 and Q4 [of 2020].” Meanwhile, Roger Farmer (University of Warwick) predicts a rapid recovery, but only to half or one third of its previous trend growth rate. However, he views productivity gains as possible, citing “some evidence that very low unemployment is correlated with slow growth”.

The panellists’ optimism is cautious. Michael Wickens (Cardiff Business School, University of York) describes the risks: “It is not clear how quickly employment income will be restored and how quickly the raised savings rates of employed households and the higher debts of other households will decline.” Michael McMahon (University of Oxford) expects that “there will likely be some specific sectors that take much longer or are permanently affected.”

Several respondents qualify that their optimism depends on the government’s policy response, and expressed concerns that the government would hit the fiscal breaks too soon. Simon Wren-Lewis (University of Oxford) emphasizes that “a V-shaped recovery is possible if the government gets its pandemic management right” with regard to lifting lockdown, failing which, “scarring effects will be significant.” Wouter Den Haan (London School of Economics) only estimates a rapid return to the pre-crisis growth trend “conditional on the government not quickly reverting to austerity policies to bring debt-to-GDP ratios down.” Francesca Monti (King’s College London) is also relatively optimistic in her outlook “assuming that stimulative policies continue to support the economy.”

Risks to a Rapid Recovery

In the second question panellists were asked which aspect of the economy poses the greatest risk that the recovery will be slow and prolonged. Readers should note that the panellist were asked about economic risks, putting aside the risk that the government policy may slow the recovery.

Question 2: Which aspect of the economy poses the greatest risk for a slow recovery?

Twenty-three panellists responded to this question. The most commonly cited risk factor (at 26%) was that the pandemic will have affected firms’ productive capacity. However, panellists choosing this option expressed less confidence in their answer than those choosing the second and third most common responses. 22% of panellists viewed scarring effects of unemployment as the greatest risk, with the share of respondents rising to 32% when adjusting for their degree of confidence. 13% of panellists believe that sluggish consumer demand poses the greatest risk, but this number also rises to 23% when weighting responses by their degree of confidence.

Concerns about all risk factors were widespread in panellists’ responses. Regarding firms’ productive capacity, Jagjit Chadha (National Institute of Economic and Social Research) expressed the view that dynamism of firm turnover will “provide the jobs for those moving between sectors and those joining the labour market.” Natalie Chen expressed concerns about labour markets and warned of “significant risk to the economy” from a rise in unemployment “once the furlough scheme ends”. David Cobham (Heriot-Watt University) links concerns around unemployment with the issue of human capital, stating that “there needs to be a lot of focus on retraining”.

With concerns regarding the scarring effects of unemployment and business dynamics abound, Jumana Saleheen (CRU Group) suggests that the government should “provide funds to control the virus, but also provide support that helps us live with the virus,” with a focus on “pubs, restaurants and cinemas” as the most affected sectors. Saleheen also mentions online schooling “to support the return of the relevant workers back to work.”

Several respondents view consumer demand as the main risk to the recovery. Michael Wickens (Cardiff Business School, University of York) argues that “the restoration of demand” is “the key to recovery” since “all of the other factors would automatically improve as a result”. Simon Wren-Lewis (University of Oxford) points to the timing of lockdown as both a consumer demand and labour market issue, with “a real risk that a significant proportion of consumers will not resume social consumption” followed by “persistent unemployment and bankruptcies” if lockdown is “ended too early”.

Other respondents placed greater emphasis on human capital or the risk of private debt overhang. Roger Farmer views “debt overhang and financial markets” as “the clearest opportunity… to support a rapid recovery.” Finally, but no less importantly, Chryssi Giannitsarou (University of Cambridge) warns of permanent harm to human capital due to “the effects on children of repeatedly missing school due to lockdowns and higher education offered in non-traditional ways.” In addition, childcare responsibilities have further skewed gender inequality. Giannitsarou points to “abundant evidence that the pandemic has affected women and parents disproportionately.”

References

Chetty, Raj, et al. "How Did COVID-19 and Stabilization Policies Affect Spending and Employment? A New Real-Time Economic Tracker Based on Private Sector Data." Opportunity Insights Economic Tracker, 17 June 2020, opportunityinsights.org/wp-content/uploads/2020/06/tracker-summary.pdf.

Leslie, Jack, et al. "Long Haul Lockdown: Three Scenarios for the Impact of Coronavirus on the UK Economy." VoxEU.org, Centre for Economic Policy Research, 11 May 2020, voxeu.org/article/three-scenarios-impact-coronavirus-uk-economy.

How the experts responded

Question 1

Participant	Answer	Confidence level	Comment
Michael McMahon University of Oxford	The economy will recover within a small number (1-5) of years	Confident	While I believe that the economy will, in aggregate, recover to the pre-Covid projected path within 5 years post-containment, there will likely be some specific sectors that take much longer or are permanently affected. It is also a difficult question as I believe there will be significant policy stimulus in this period though whether such policy assistance qualifies as unusual I am not quite sure.
Nicholas Oulton London School of Economics	The economy will recover within a small number (1-5) of years	Confident	I think recovery will be slow (1-5 years) and there is also likely to be a permanent level effect on GDP.
Jumana Saleheen Vanguard Asset Management	The economy will recover within a small number (1-5) of years	Extremely confident	I expect Covid-19 to give rise to a deep recession in the UK in 2020. GDP growth is likely to fall by 8-10% in 2020. Assuming the virus is contained by then, 2021 will be a year of sharp rebound. GDP growth is forecast to rise by 8-10% y/y. The large rebound needs to be understood in the context of a recovery from the very low levels of activity witnessed during lockdown. The UK will continue its recovery through 2022. By 2023 I expect the UK economy to return to its pre-crisis growth rate of 1.6% y/y. It is important to note that while the growth rate of the UK returns to its pre-pandemic trend, the level of activity does not. I expect the UK to endure a small permanent loss in the level of GDP. Put differently in 3 years’ time the UK will be 2% smaller than it otherwise would have been, absent Covid. That is what I define the UK recovery as U-shaped. It would be V-shaped only if all losses from Covid could be recovered later, such that there would be no permanent loss in the size of the economy.
David Cobham Heriot Watt University	Recovery will be slow (5-15 years)	Confident	If the issue is when the UK will return to the (not very impressive) trend level and growth of the l2-3 years before the pandemic, then 5 years seems too few (but 15 too many).
Natalie Chen University of Warwick	The economy will recover within a small number (1-5) of years	Confident	Even once the pandemic has been contained, I feel it will take time for the economy to fully bounce back because people's behaviour has changed and this will affect consumption for some time. The increase in unemployment, together with the large number of bankrupcies, also mean that the recovery cannot be very fast.
Kate Barker British Coal Staff Superannuation Scheme and University Superannuation Scheme	The economy will recover within a small number (1-5) of years	Not confident
Chryssi Giannitsarou University of Cambridge, Faculty of Economics	Recovery will be slow (5-15 years)	Not confident	To a large extent, the time to recovery depends on how quickly the pandemic gets contained, i.e. what is the starting point of recovery. The longer it takes to contain the pandemic, the more difficult it will be to revert to the old ways, and there is a clear risk that demand patterns will change permanently (e.g. large parts of tourism, entertainment or air travel could disappear if say the pandemic lasts a few years). At the moment there is substantial uncertainty about when we can expect a vaccine to become commercially available, with estimates varying from 2 to 30 years (some even say we may never have one). Additionally, a great unknown about SARS-CoV-2 is whether immunity wanes over time, as is true for many related coronavira. In Giannitsarou, Kissler and Toxvaerd (2020) we show that if immunity wanes over time the disease becomes endemic, in which case it may be hard to talk about "return to normalcy". This scenario could have detrimental effects on the economy, and could even have permanent effects on economic growth.
Patrick Minford Cardiff Business School	The economy will recover rapidly (e.g. within a year), with limited lasting effects on the supply and demand side of the economy.	Confident	The recession has been directly caused by lockdown. Lockdown is now being eased and the disease is dying out in its current 'wave'. Future local new outbreaks are containable by localised social reaction. Any totally new wave should come from a much weaker strain of the virus, the strong strains having died out as the result of deaths and survivors' antibodies killing them in the first wave. As this pans out popular behaviour will return to normal, in line with cumulative easing. The economy should restore activity in Q3 and Q4.
Jagjit Chadha National Institute of Economic and Social Research	The economy will rapidly return to its pre-crisis growth trend, but there will be a permanent effect on the level of GDP	Not confident	The central case of a rapid return once lockdowns are eased across the world is feasible but will require there to be no subsequent peaks in the rate of infections and Covid-related deaths. Even in this case and to limit infections social distancing will to remain in place until a virus is found or herd immunity is achieved. This means that we cannot return to the way we did things particularly in industries where face to face interactions are critical. This means that some significant changes in our practices will be needed and some permanent loss of activity will result. But it also means that I cannot be terribly certain about any path I pick.
Thorsten Beck Cass Business School	The economy will recover within a small number (1-5) of years	Not confident	It is very hard to predict how the economic recovery will play out in the coming months and years, following containment. There will certainly be some scars, as there will be the need for reallocation - many businesses in hospitality and tourism will not survive - this reallocation will result in a certain level of unemployment, but possibly also capital retained in zombie firms. Finally, the uncertainty on Brexit and the future relationship between UK and EU as well as other trading partners makes not only predictability of recovery very uncertain but will also undermine the recovery itself.
Linda Yueh London Business School	No opinion	Confident	Major policy interventions are likely to continue during the recovery which will affect the pace of the recovery.
Wouter Den Haan London School of Economics	The economy will rapidly return to its pre-crisis growth trend, but there will be a permanent effect on the level of GDP	Not confident	This estimate is conditional on the government not quickly reverting to austerity policies to bring debt to GDP ratios down.
Francesca Monti Kings College London	The economy will rapidly return to its pre-crisis growth trend, but there will be a permanent effect on the level of GDP	Not confident	I believe the most likely scenario is that there is a return to pre-trend growth, once a vaccine has been found and assuming that stimulative policies continue to support the economy. I do think however that there is a lot of uncertainty around this forecast. In particular, there are also quite big risks that the pandemic has permanent (or at least very persistent) effects on long-term growth, due to 1) scarring of beliefs, which could change the behaviour of the actors in the economy very persistently and 2) changing working styles (and the subsequently reduced need to be in cities), which could affect negatively big cities like London in particular.
Michael Wickens Cardiff Business School & University of York	The economy will recover within a small number (1-5) of years	Not confident	I expect a faster return to growth than usual from a recession but not a quick return. The main dangers to growth on the demand side are that it is not clear how quickly employment income will be restored and how quickly the raised savings rates of employed households and the higher debts of other households will decline. On the supply side, it is clear that many firms have gone out of business and most of the survivors will take time to respond to the return of demand.
David Miles Imperial College	The economy will recover within a small number (1-5) of years	Not confident	It may take a few years before recovery is complete - a V shaped recovery with output back to the pre-crisis levels by early 2021 no longer seems plausible given the likelihood of some restrictions lasting much of this year and the persistent effects of spells of unemployment. Recovery within 4-5 years seems more likely than within 1 year.
Simon Wren-Lewis University of Oxford	The economy will rapidly return to its pre-crisis growth trend, but there will be a permanent effect on the level of GDP	Confident	A key point not emphasised enough is that the answer depends critically on how well the pandemic is managed by the government. A V shaped recovery is possible if the government gets its pandemic management right, but if it fails to lockdown quickly, or ends lockdown to early, (both of which are true in the UK) then scarring effects will be significant.
Paul De Grauwe London School of Economics	No opinion	Confident	I find it impossible to answer this question. It all depends on how long and how intense the pandemic will be, and how governments will react to this. Nobody has a clue today. Any of these answers could be true
Lucio Sarno Cambridge University	The economy will rapidly return to its pre-crisis growth trend, but there will be a permanent effect on the level of GDP	Confident
Gino A. Gancia Queen Mary University of London	The economy will recover within a small number (1-5) of years	Confident
Rachel Ngai London School of Economics	The pandemic will have a permanent effect on trend growth	Confident
Costas Milas University of Liverpool	The economy will recover within a small number (1-5) of years	Confident
Roger Farmer University of Warwick	The economy will rapidly return to its pre-crisis growth trend, but there will be a permanent effect on the level of GDP	Confident	My best guess, is that GDP will recover by somewhere between a half and two thirds of the way to its previous trend growth path before the end of the year as employees return to jobs that were preserved. The remaining half to one third of the recovery will be slower as the economy transitions to a new normal with some industries shrinking and others taking their place. There is some evidence that very low unemployment is correlated with slow growth which raises the intriguing possibility that initially at least, we will see productivity growth that is noticeably higher than the sluggish numbers that have characterized the past decade. Policy has a huge role to play in determining the nature of the recovery and I have little confidence that the recovery will be well managed given the inadequacy of the models that guide current thinking.
Ethan Ilzetzki London School of Economics	The economy will recover within a small number (1-5) of years	Not confident	This depends very much on how long the pandemic will last. If a vacine or very effective treatments were found this year (unlikely), the economy could return to the pre-crisis growth trend very quickly. However, I expect the pandemic, and its economic damage will be with us for at least a year, at which point there will be scarring effects to both the demand and supply side of the economy.

Question 2

Participant	Answer	Confidence level	Comment
Michael McMahon University of Oxford	None of the above, other, or no opinion	Confident	It is a combination of many of these factors and their influence varies over different time horizons. In the near-term, post-Covid consumer demand will depend on confidence in the authorities that it is safe to return to more normal activities. If this doesn't happen, it will exacerbate pressures on firms making it more likely that firms go bankrupt and workers lose jobs at a time when it my be difficult to get jobs in similar industries/roles. This could contribute to hysteresis effects. As the recovery takes longer, and depending on policy actions to support firms and households through this, the effect of indebtedness could become an increasingly important constraint on investment and activity more generally. Such debt problems would likely spill over into the financial sector increasing the likelihood of problems there with the possibility of a damaging credit crunch as a result. Even longer term, the effect of lost human capital will likely have a more lasting effect on the economy.
Nicholas Oulton London School of Economics	None of the above, other, or no opinion	Confident	International trade is likely to be slow to recover and this is beyond the UK's control.
Jumana Saleheen Vanguard Asset Management	None of the above, other, or no opinion	Confident	Since this is a health crisis the most important policy is to tackle the virus. That failing (as track and trace has done so far), the government should support changes that allow the economy to operate well in a socially distanced way. As the economy opens up, people are keen to return to normal. They want to be able to earn money and spend it. But the virus creates actual and perceived (fear) difficulties in achieving that in certain sectors where social distancing is a challenge – hospitality, retail, and leisure. The best policy in this situation is for the government to provide funds to control the virus; but also provide support that helps us live with the virus. To do this the government should support firms and workers in the most affected sectors (pubs, restaurants, and cinemas) to transition to a world in which they can provide their services, in a socially distanced way. To support the return of the relevant workers back to work, government’s may also need to up their support of online schooling (should it be needed). This wider scope of support will benefit the labour market, firms, and society.
David Cobham Heriot Watt University	Labour markets (e.g. unemployment hysteresis effects)	Very confident	Labour markets should be understood to subsume human capital issues too: there needs to be a lot of focus on retraining. And please let's not put the emphasis on forcing people to accept low-paid low-productivity jobs as has been the norm since 2010, that's not a way to improve long run economic growth or create a decent civilised society. At some point policymakers might also like to reflect on the fact that their job in this situation, and the lot of many people, would have been much easier if the UK had already had in operation some sort of basic income stream.
Natalie Chen University of Warwick	Labour markets (e.g. unemployment hysteresis effects)	Confident	Unemployment is likely to rise significantly once the furlough scheme ends and this poses a significant risk to the economy.
Kate Barker British Coal Staff Superannuation Scheme and University Superannuation Scheme	Firms’ productive capacity (e.g. business failures)	Not confident at all
Chryssi Giannitsarou University of Cambridge, Faculty of Economics	Human capital (education and job experience)	Confident	Similarly the answer here depends to a large extent on how long we believe it will take for the pandemic to be contained. In a pessimistic scenario of a number of years, the effects on children of repeatedly missing school due to lock-downs and higher education offered in non traditional ways may harm human capital permanently. Unfortunately there is already abundant evidence that the pandemic has affected women and parents disproportionately, and the gender gaps seem particularly worrying.
Patrick Minford Cardiff Business School	None of the above, other, or no opinion	Confident	Given the sharp rebound I expect, none of these permanent effects are likely. My main concern is with possibly high inflation from the massive growth in money supply produced by QE and liberalisation of the banks. I would like to see monetary tightening and QE with drawal once recovery is in place, eg early 2021.
Jagjit Chadha National Institute of Economic and Social Research	Firms’ productive capacity (e.g. business failures)	Confident	Firm births (and deaths) are critical to the re-orientation to the "new economy". They will provide the jobs for those moving between sectors and those joining the labour market. The other factors are also important, as is the provision of key public goods that will complement positive firm dynamics and the availability of finance.
Thorsten Beck Cass Business School	Consumer demand	Confident	There will be many risks for recovery but in the short- to medium-term (next two years) I would say that depressed consumer demand and precautionary savings poses the highest risk. A close second will be debt overhang, corporate failures and possibly bank failures, which will require decisive policy action to allow for reallocation of resources within the economy, thus helping recovery.
Linda Yueh London Business School	Labour markets (e.g. unemployment hysteresis effects)	Confident
Wouter Den Haan London School of Economics	Private debt and financial markets (e.g. debt overhang, bank failures)	Not confident	But business failures must matter as well
Francesca Monti Kings College London	Firms’ productive capacity (e.g. business failures)	Not confident	All of the effect indicated above pose a risk in terms of the speed of the economic recovery, but possibly at different horizons. Presumably the effects of growth from a reduction of productive capacity, for example, would be felt especially at shorter horizons, while the effect on human capital would have a more persistent dampening effect.
Michael Wickens Cardiff Business School & University of York	Consumer demand	Very confident	The key to recovery is the restoration of demand. All of the other factors would automatically improve as a result. Without this they would not be effective. The rise in private debt is one of the dangers to the recovery of demand.
David Miles Imperial College	Labour markets (e.g. unemployment hysteresis effects)	Not confident
Simon Wren-Lewis University of Oxford	Consumer demand	Confident	By ending lockdown too early in the UK, there is a real risk that a significant proportion of consumers will not resume social consumption, and that may lead to persistent unemployment and bankruptcies.
Paul De Grauwe London School of Economics	None of the above, other, or no opinion	Confident	It could be a combinations of all these answers
Lucio Sarno Cambridge University	Firms’ productive capacity (e.g. business failures)	Confident
Gino A. Gancia Queen Mary University of London	Firms’ productive capacity (e.g. business failures)	Not confident
Rachel Ngai London School of Economics	Human capital (education and job experience)	Confident
Costas Milas University of Liverpool	Labour markets (e.g. unemployment hysteresis effects)	Confident
Roger Farmer University of Warwick	Private debt and financial markets (e.g. debt overhang, bank failures)	Very confident	The correct answer is: “all of the above”. We are asked which aspect policy makers should devote most attention to? I selected “debt overhang and financial markets” because that is where the clearest opportunity lies to support a rapid recovery.
Ethan Ilzetzki London School of Economics	Firms’ productive capacity (e.g. business failures)	Not confident at all

How the experts responded

Question 1

Question 2

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