Further fiscal stimulus to reduce risk of long-term scarring - Capital Economics
UK Economics

Further fiscal stimulus to reduce risk of long-term scarring

UK Economics Update
Written by Ruth Gregory

With further fiscal support likely to be unveiled at some point in the next few weeks, the government appears willing to sustain the fiscal stimulus into the years ahead rather than lurch towards austerity as it did after the Global Financial Crisis. This should help to limit the long-term economic scarring from the crisis and provide a platform for a solid recovery.

  • With further fiscal support likely to be unveiled at some point in the next few weeks, the government appears willing to sustain the fiscal stimulus into the years ahead rather than lurch towards austerity as it did after the Global Financial Crisis. This should help to limit the long-term economic scarring from the crisis and provide a platform for a solid recovery.
  • Fresh fiscal support is on its way, with Prime Minister Boris Johnson’s speech on Tuesday likely to set the wheels in motion for a “decade of investment”. Indeed, a revival of the government’s pre-crisis pledge to increase investment spending by £100bn over five years, could see public investment rise by about £20bn (1.0% of GDP) in 2020/21. Further pledges to increase “current” spending may be announced too, perhaps on the NHS, social care or more help for local councils.
  • The Chancellor, Rishi Sunak, will also unveil further fiscal support in a statement next week in which his first priority will presumably be to limit the damage to the labour market. This might involve reducing the outflows of workers from the hardest-hit sectors, perhaps by helping employees moving to short time working and providing tax breaks for employers. There may also be incentives for firms that have been less hard hit to increase hiring via an increase in the NICs threshold, or apprenticeship subsidies for new workers. We wouldn’t rule out an extension of the job furlough scheme in its current form beyond the end of July either for the hardest-hit sectors.
  • Mr Sunak’s second priority will be to deliver help for certain sectors and businesses. This might include support for businesses that are still unable to open, an extension of the business rate holiday given to the retail, leisure and hospitality sectors to other companies, or more flexible terms for the repayment of government-backed Coronavirus Business Interruption Loans (CBILs) and bounce-back loans (BBLs). A car scrappage scheme, similar to that in 2009, has also been mooted, in which old cars can be traded in for electric or hybrid cars. And further support may be announced for a small number of companies as part of the government’s “Project Birch” rescue scheme.
  • Table 1 provides an illustrative example of how a combination of some of the various measures that might be announced in the next two weeks might add up to a net fiscal loosening of about £35bn (1.8% of GDP) or so in the 2020/21 fiscal year. That would be on top of the £133bn (6.8% of GDP) of direct tax and spending measures announced so far this year, bringing the total to £168bn (8.6% of GDP) in 2020/21.
  • Clearly, this would have adverse effects on the already dreadful state of the public finances. We have been warning that the deficit is set to rise to £330bn (17% of GDP). (See Chart 1.) This would push the deficit even higher to about £365bn (18.8% of GDP). But we suspect that if anything the government will err on the side of providing more, rather than less policy support. After all, the risks attached to providing too little support – greater long-term economic scarring from the virus – are greater and more immediate than those attached to providing too much support – higher inflationary pressures. (See here.)
  • Of course, the possible fiscal package won’t prevent the economy from contracting by between 15-20% in Q2. But if the measures are well-targeted, they have the potential to limit the fallout in the labour market and put the economy in a good position to recover quickly from the crisis in 2021 and 2022.

Chart 1: Public Sector Net Borrowing (% of GDP)

Sources: OBR, Capital Economics

Table 1: Possible Fiscal Package Cost (-) / Yield (+) (£bn)

2020/21

Investment spending

-20.0

Current spending (e.g. NHS, social care, help for Local Councils)

-5.0

Labour market support

Retraining & apprenticeship schemes

-2.0

Tax breaks for employers taking on new staff

-2.5

Support for businesses

Extension of business rates holiday to various other sectors

-5.0

Car scrappage scheme

-0.5

Total

-35.0 (1.8% of GDP)

Source: Capital Economics


Ruth Gregory, Senior UK Economist, +44 7747 466 451, ruth.gregory@capitaleconomics.com