This report was produced on 2 September 2020 with ICAEW's partner Oxford Economics, one of the world’s foremost advisory firms. Their analytical tools provide an unparalleled ability to forecast economic trends.
- The global coronavirus pandemic and subsequent containment measures have resulted in significant output losses across the UK. Following a q/q contraction of 2.2% in Q1 2020, GDP plummeted by a record 20.4% in Q2 as full lockdown measures took effect. Q2 also saw historic falls in retail sales, consumer spending, business investment, exports and imports.
- Such difficult economic conditions have spurred unprecedented intervention from the UK Government. There has been a particular focus on labour market support, with the Coronavirus Job Retention Scheme announced in late March. As a result, declines in employment have been modest.
- There are now signs that a recovery is beginning to take shape. Monthly data indicate that GDP bottomed-out as early as April, during the peak of lockdown, and rebounded strongly in June as social restrictions were retracted. Indeed, Oxford Economics projects that UK GDP will rise by 9.1% in 2021 after a 9.9% fall in 2020.
- That said, this is only a central forecast. The risks to recovery are high. A second wave of coronavirus infection might significantly derail the UK’s economic recovery, and just the fear of that happening may keep both consumer confidence and business confidence very weak.
- Complicating the picture are the UK-EU trade negotiations. There is great uncertainty over whether a free trade deal can be agreed. If not, businesses will face increases in both tariff and non-tariff barriers, which in the most severely affected sectors will materially damage their competitiveness. Even under a free trade agreement, some disruption is very likely. And these same remarks apply to trade with the rest of the world, and not just with the EU.
- Already, the coronavirus crisis has damaged exports as well as output. Businesses in some manufacturing sub-sectors, such as machinery and transport equipment, are facing particularly large challenges. In contrast, the chemicals sector is seeing a rise in export activity, reflecting increased demand for pharmaceuticals, cleaning materials, protective clothing, and the like.
- Sectoral variations are important drivers of differences in regional performance, not least where exporting is concerned. Wales, the North East, and to a lesser extent the East and West Midlands, are the regions most dependent on exporting. And some regions’ exports are particularly reliant on the EU market; Wales especially.
- In terms of employment, the overall fall this year is modest compared with output, thanks to Government support. Across sectors, those focused in hospitality, arts and culture, as well as manufacturing, are seeing the biggest falls. Looking ahead, manufacturing employment will continue to decline over the medium term, with the sector needing to rebuild its finances, being particularly vulnerable to any collapse in government trade talks, and continuing to experience long-term drivers, not least automation, which lead to fewer jobs.
- Sectoral structures are also key to understanding regional employment prospects. London will be the fastest growing region over the 2020-25 period in employment terms, as well as experiencing the smallest fall in employment in 2020. The capital has a small manufacturing sector, which helps hugely. As well as this, London has strength in sectors such as business services and information and communication, which are suited to homeworking and also set to experience underlying growth in activity.
- Yorkshire & Humber, Wales and the West Midlands are probably experiencing the largest falls in employment this year, and are likely to be among the slowest to recover over the medium term, reflecting their large manufacturing bases. However, it is the North East that will probably show the greatest under-performance over the period to 2025, with sectoral composition and long-term trends again important factors here.
In this report:
- UK economic outlook
- Policy issues
- Prospects for the UK/EU trade talks
- Sectors/regions most affected by trade issues
- Employment prospects by sector and by region
1. UK overview
1.1 Unprecedented times for the global and UK economies
The global economy has been through an experience unprecedented in recent history, and one which is clearly not yet over. As a result of the coronavirus pandemic, global output has shrunk, averaging a level 9% lower in the first half of 2020 than in the same period last year, with much of that decline concentrated in the three months from March to May.
In the UK, the first cases of COVID-19 were reported in January, but there were no restrictions on behaviour for a couple of months, and a full-scale nationwide lockdown was only imposed on 23 March. By then, the virus had spread nationwide. By late August there had been more than 300,000 confirmed cases in the UK, and over 40,000 people had lost their lives to coronavirus.
With a large proportion of workplaces closed, UK GDP contracted by 2.2% q/q in Q1 2020 and then, as lockdown measures took effect, by 20.4% q/q in Q2—the largest quarterly fall since records began in 1955. This means that for the first half of 2020 the overall reduction in output was 22.1% compared to the final quarter of 2019 or 12% compared with the same period a year earlier. Among major economies, only Spain reported a steeper decline in the first six months of 2020.
Figure 1: UK Quarterly GDP growth
1.2 Government intervention has supported the economy
The coronavirus outbreak spurred an unprecedented fiscal response from UK policymakers, with the Chancellor pledging in March to ‘do whatever it takes’. This was reflected in an initial £330bn stimulus package for the UK economy, including Government-backed rescue loans for small businesses and a year-long business rates holiday for companies in certain vulnerable sectors such as hospitality. The centrepiece was the Coronavirus Job Retention Scheme, providing grants to employers to fund 80% of the wages of workers furloughed, up to a monthly limit of £2,500 per person, and up until the end of October.
In July the Chancellor announced further measures aimed at kickstarting the economy, including an ‘eat out to help out’ scheme, providing support to the struggling hospitality sector, cutting stamp duty to help the ailing property market and a ‘job retention bonus’ giving employers £1,000 for every worker brought back from furlough and kept on until January. A kickstart scheme was also announced to encourage employers to recruit young people and the Government announced that it would provide financial assistance to companies hiring new apprentices.
1.3 Declines in consumer spending, business investment, exports and imports
Despite the Government’s measures, the second quarter saw a particularly severe fall in UK consumer spending (-23.1%, q/q). Many shops were closed and most forms of ‘social consumption’, such as visiting pubs, restaurants, cinemas and sports facilities, along with holiday and leisure travel, were prohibited for most of the quarter. Spending was also hit by job losses and pay cuts, as well as by a sharp decline in consumer confidence. Oxford Economics estimates that in Q2, UK consumers saved over a quarter of their disposable incomes.
There was an even larger decline (31.4% q/q) in private sector business investment during Q2 2020. The downturn in activity, both domestically and internationally, had put substantial pressure on business cashflows, while uncertainty over how the crisis would evolve was also making companies hesitant to invest.
With demand plunging around the world, and with many companies under lockdown, the UK saw a Q1 fall of 13.5% (q/q) in exports of goods and services. Imports of goods and services saw a less severe, but still sizeable, 9.4% decline. The situation intensified in Q2. The prevalence of imports in the consumer products sector, and the immediate hit that the sector faced during lockdown, resulted in imports falling by 23.4%, q/q. Exports still contracted significantly, but at the lesser pace of 11.3%, as the Government allowed some manufacturers to resume operations in early May, and as demand in Asian markets began to pick up. The result was an unusually high trade surplus of £17bn in Q2 2020.
Figure 2: UK quarterly export and import growth
1.4 The uncertain state of the labour market in mid-2020
The impact of the coronavirus crisis on employment and unemployment is proving difficult to measure. Figures from the Office for National Statistics suggest that employment fell by 220,000 between Q1 and Q2, and that the number of Job Seekers’ Allowance claimants rose from 169,200 in January to 307,600 in July. Both of these figures would have been much greater were it not for the furlough scheme, which had covered 9.3m workers by the end of Q2, a period which saw the largest quarterly decrease in weekly hours worked since records began.
The number of people recorded as unemployed in the national Labour Force Survey nevertheless fell slightly between Q1 and Q2, by 10,000, reflecting the fact that due to lockdown restrictions, most of those laid off were unable to actively seek new jobs, and so did not fall under the official definition of unemployed. Instead, there was a large increase in people categorised as ‘temporarily away from work’, up from 2.8m in the first quarter of 2020 to 7.3m in Q2.
Figure 3: UK labour market indicators
1.5 But activity did pick up in May and increase sharply in June
Despite all of that, many parts of the economy were already rebounding in Q2. Monthly GDP measures indicate that economic activity bottomed out during April, and rose a modest 2.4% (m/m) in May, as some working restrictions were eased and the Government announced its initial plans for phasing-out lockdown measures. More substantial relaxations of these measures occurred in June, and GDP grew strongly, by 8.7%, m/m.
Figure 4: UK monthly GDP growth
In addition to the growth in GDP, there are similar signs that consumer spending has picked up. In May and June retail sales grew by double digits, at 12.3% and 14.0% respectively, m/m, reflecting the reopening of DIY and garden centres in May, and then the reopening of all non-essential stores in June. Evidence of an economic rebound is also reflected in the latest available trade data, with export growth almost 10.0% in June (m/m). And imports saw a sharp rise of 19.5% in June (m/m), stemming largely from the reopening of businesses including many non-essential shops.
As a result, the likelihood is that private business investment has also improved. Oxford Economics expects growth in private business investment of 20% (q/q) in the third quarter, following a contraction in of 31.4% in Q2.
1.6 Strong recovery forecast for 2021, but clearly with large risks
Our central forecast is that these recoveries and activity in demand will continue during the coming months, with the result that GDP is now projected to be 21.0% higher in the second half of the year than in the first half. That means that although for 2020 as a whole the GDP contraction is 9.9%, a strong upward trajectory is already in place, and is likely to continue well into 2021. Oxford Economics projects an expansion of 9.1% in 2021, which means that by the first quarter of 2022 GDP should be back to pre-crisis levels.
There are, however, several potential challenges which could derail that recovery. The current furlough scheme is set to be phased out by the end of October. Many sectors will still be operating well below capacity, so there is a risk of a spike in lay-offs, as the Government withdraws its support. Indeed, we expect unemployment to rise sharply, hitting 6.5% by the end of 2020, before falling modestly to 5.7% in 2021. And we project a small fall in employment as companies seek to improve productivity and hence profitability.
Figure 5: Index of quarterly GDP and employment
So, one risk is that confidence will remain weak, undermining the recovery that we forecast. And if there are persistent fears of a coronavirus resurgence, then that could limit consumer and business spending, increase saving, weaken demand and generate job losses. Worse still, the emergence of a second wave of the infection could provoke a return to lockdown, which would repeat the pain of H1 2020, and possibly lead to a more protracted ‘W’ shape recovery, or even a situation where confidence and hence economic activity remain deeply subdued.
A broader worry is that the Government makes premature decisions about the recovery, and for reasons of fiscal prudence, shifts its stance towards reducing Government spending or raising taxes, with unintended adverse consequences for the recovery.
These considerations apply, not just in the UK, but internationally too. UK companies need rising world trade, as well as domestic recovery: so struggles globally could create difficulties at home.
Complicating the picture, there is currently little sign of progress on the trade talks that are taking place between the UK Government and the EU, and so the ability of domestic businesses to enjoy the full benefits of global expansion, assuming it continues, could be at risk. The Government will not be seeking an extension to the 1 January 2021 trade agreement deadline. And this may mean that business leaders face another period of anxiety in the closing months of 2020, even if the coronavirus crisis fades by then. Once again, consumer and business confidence could be the first casualty.
In the following sections we look in more detail at the issues of Government policy choices and prospects for the trade talks (Sections 2 and 3), and then proceed from there to consider the reliance of different sectors of the economy and UK regions on international trade, and likely employment prospects by sector and region (Section 5).
2. Policy issues
Government policy choices are always important to the trajectory of the economy, and especially so in present circumstances. The decisions made earlier this year in the face of the coronavirus pandemic involved accepting that a large and immediate cut in economic output was necessary, while seeking to cushion the impact on employment and, to a lesser degree, on company and personal finances—reflected in, for example, the temporary cut to VAT for the hospitality sector.
In addition, the Government has made significant revisions to its spending plans, primarily but not exclusively on health and social care, and the Bank of England has injected liquidity into the banking system, and has stood ready to support the gilt market if that becomes necessary. It is largely for these reasons, and also because broadly similar policies have been pursued around the world, that while the loss of GDP has been extreme, the likelihood is that the strength of recovery will be a similar order of magnitude to the decline just experienced.
Nevertheless, the Chancellor will face difficult policy choices. Public sector borrowing in the first four months of 2020/21 was £151bn - an extraordinary £128bn higher than a year earlier. Fortunately, the current trend is for the monthly deficits to decline, not least because workers have been coming off furlough and returning to work. We expect this to continue as the economy expands, and we project that public sector net borrowing for the full fiscal year will be around £310bn, or 15% of GDP. This is significantly more than UK Governments have historically deemed acceptable.
Figure 6: UK public sector net borrowing, excluding public sector banks
The Government will need to decide what to do under these circumstances. Even before the pandemic struck, it had indicated that it planned to revise its fiscal rules. In its election manifesto it put forward three ideas: to balance the current budget within three years; to keep debt falling as a percentage of GDP, and to ensure that debt interest costs are less than 6% of non-interest public sector current receipts.
Of these, the first would require either large spending cuts or large tax rises, or both. Realistically, however, there is little chance that it could be achieved, even several years out, since large tax rises or spending cuts would damage economic growth, and hence make the target harder, not easier, to achieve. So, this does not seem an obvious route for the Government to take, especially since the economic rationale for such a target was never entirely clear. It is likely that the Government will discard this idea.
The other two rules, are, however, probably more achievable, without the need for new cuts in Government spending or significant tax hikes, as long as the economy does recover in broadly the way that we forecast, and providing there is no surge in interest rates. It is indeed possible that there may even be scope to loosen policy, not just in the short-term but also further out.
Equally, however, if economic recovery proves to be much weaker than we project, then that will damage public finances, creating a risk of either a rise in interest rates and hence debt servicing costs, or cuts in expenditure plans, or higher taxes, or all three. Once again, the result could be a self-defeating spiral of austerity damaging public finances, requiring more austerity, and so on.
Perhaps the most likely way forward is that the Government will make some detailed changes to taxes, and will simultaneously scrutinise the details of departmental spending plans very tightly, to favour its pre-existing policy objectives. Before the pandemic these objectives had emerged as increased investment in infrastructure, and increased support for Research and Development (R&D), with a proclaimed aspiration that the result would be a ’levelling up’ across the UK’s nations and regions, understood primarily in terms of productivity performance. That theme may therefore become more prominent if, as we expect, the current public health crisis gradually retreats.
Past experience suggests, however, that regional disparities are deeply entrenched and resistant to simple solutions, that infrastructure spending does not always boost economic activity in regions that have other problems, and that increased public sector spending on R&D does not necessarily leverage increased economic growth. Our observations on key challenges facing the regions are outlined in Sections 4 and 5.