On 23 April 2020, the Scottish Government published its regular ‘State of the Economy’ update, which naturally focused heavily on the impact that the public health response to the COVID-19 pandemic was having on Scotland’s economic output and labour market.
Much of the coverage of this publication has highlighted the headline figure which suggests economic output in Scotland could decline by 33% during the period of social distancing. Several other economic commentators have produced broadly similar estimates for the peak decline in GDP; the Office of Budgetary Responsibility (OBR) published commentary which suggested around a 35% decline in the UK’s GDP by the end of Q2 2020, with activity declining by 13 per cent for 2020 as a whole, while the Bank of England published a scenario which included a 14% decline in UK GDP for 2020.
Not many projections, but scenarios abound
While there is always uncertainty around financial projections, the COVID-19 pandemic presents additional unknowns which make specific projections for economic growth challenging. The Resolution Foundation published a note summarising the data from the most timely economic indicators in mid-April, and noted that:
The disruption to economic activity caused by a viral outbreak is a product of five main factors: (i) the number of people infected, (ii) the morbidity and mortality rates associated with people falling ill, (iii) the duration of the outbreak, (iv) the public health restrictions imposed to contain the spread of the virus, and (v) other voluntary social distancing measures that people take to reduce their chances of catching it.
There are broadly three distinct scenarios discussed:
- The so called ‘V shaped’ scenario is one where the rapid fall in economic activity as countries enact lockdown policies is almost matched by a rapid rise once these policies are relaxed. This scenario assumes that the relaxation of lockdown can occur over a relatively short period of time, at a steady pace without a second wave of the pandemic, and that there is limited permanent loss of productive capacity resulting from the lockdown. The recovery in economic activity is assumed to be slightly slower than the initial sharp drop, due to the time it takes for new jobs to be made available, and possible skill mismatches.
- A second type of scenario predicts an uneven ‘w shaped’ recovery, where GDP falls rapidly, recovers as restrictions are eased, but then falls again when restrictions are reapplied in the face of a second wave of the pandemic. This second wave prolongs the time taken for economic output to recover. It nonetheless does expect economic activity to rebound fairly rapidly when restrictions are eased and expects that in the medium term there will be little permanent damage to output. A key assumption remains that restrictions can be lifted at a relatively rapid pace, and that economic activity will quickly pick up in response.
- Finally, a third scenario anticipates more than one wave of the pandemic, but also assumes a far more moderate recovery as restrictions are eased gradually, and as the labour market adjusts. This scenario would see a far slower recovery in output as some form of social distancing remains in place for a longer period than in either the ‘V shaped’ or ‘W shaped’ scenarios, and assumes that this longer period of labour market restrictions will lead to some more permanent damage to output – businesses will close/ reduce activity to a significant degree, and so even as restrictions are lifted it will take time for demand to recover.
This animation shows the annual growth rate for the economy throughout the period of the crisis according to the three scenarios outlined above. The annual rate is used to reduce the volatility over the period of the crisis. It is purely illustrative in nature, and not an economic forecast.
In April 2020 the Scottish Government published ‘Coronavirus (COVID-19): framework for decision making’ which sets out the expected approach to lifting lockdown restrictions. There is currently no route map or precise timescale attached to this, but the Government have stated that this is unlikely to be soon, and likely to be a phased approach which makes the rapid recovery in economic output in the more optimistic scenarios seem very unlikely.
Early indicators suggest that the lockdown has had a significant impact on consumer behaviour
The Bank of England publish monthly data showing aggregate levels of lending and deposits in the UK, and the most recent data for March shows striking movements.
Both households and businesses (private non-financial corporations (PNFCs) –excluding financial businesses) significantly increased their Sterling deposits at UK banks and building societies during March. PNFCs’ deposits increased by £33.6bn, which is the largest monthly increase in this series which started in October 1997. Households’ deposits increased by £15.9bn, the second largest monthly increase in the series.
There have also been significant movements in lending data. Unsecured consumer credit (credit cards, overdrafts and fixed term loans) reduced by £3.8bn in March 2020, compared to an average monthly increase of £1.0bn for the previous 12 months. This is the largest monthly reduction in the series, which began in April 1993. The largest monthly fall during the financial crisis was £1.1bn.
While consumers are relying less on credit and reducing their spending, businesses need access to finance to replace lost income. Net loans to large businesses increased by £32.1bn in March, which is by far the largest increase in net lending since this series began in May 2011. Real estate, professional services and support activities lending increased by £8.4bn, manufacturing by £6.9bn and construction by £2.8bn.
While the value of credit provided for mortgage and re-mortgaging activity looks fairly unremarkable in March, we would expect this to lag slightly as it takes time for a housing transaction to complete and funds to be released – so this reflects deals agreed earlier in the year. However, new approvals in March 2020 have declined sharply, 15% lower than the average monthly value for the previous year and falling to their lowest level since March 2015 – so we can expect to see a significant fall in secured lending in future months.
What all this means is that although the lockdown was only implemented on 23 March, there has been an unprecedented drop in demand for consumer credit as the restrictions have prevented planned spending to a significant degree. We can also see that businesses are utilising credit facilities in the face of this huge fall in consumer spending. The full month data for April will be very interesting – demand for credit among businesses is likely to remain elevated as lockdown conditions persisted throughout the month, but we don’t know whether the same will be true of households – has consumer spending reached its lowest point already? Time will tell.
The labour market is also expected to be significantly changed during the crisis
The Scottish Government’s ‘State of the Economy’ publication sets out three possible paths for unemployment in Scotland during the pandemic, depending on the severity of the economic shock caused by the pandemic and the public health response to it, which broadly follow the three scenarios outlined above. The most optimistic scenario sees a huge increase in unemployment, which peaks in Q2 and Q3 2020, before declining rapidly towards four per cent.
Even in the most optimistic scenario, unemployment reaches a level in excess of any previous peak in the ONS series which goes back to 1992. The more pessimistic scenarios expect a similar trend for the initial rise in unemployment, but the steady recovery is interrupted by supply side shocks (sudden changes in commodity prices or wages) which result in further increases, and delays to the recovery. If the productive capacity of the economy is weakened and secondary supply side shocks occur, then unemployment could peak at over 14 per cent. However, even in the most pessimistic scenario the rate of unemployment recovers to a more normal level within around three years – considerably quicker than the eight years it took for unemployment to recover after the 2008 financial crisis.
There are of course huge uncertainties around these scenarios. We know from early indicators such as the Purchasing Managers Index (PMI – an index of the market conditions observed by purchasing managers tracking whether activity is expanding or contracting), that the pandemic and the lockdown policies have had a significant impact on the economy and labour market in Scotland and the UK. PMI fell to a record low of 32.9 for April, and unemployment has risen. According to the Scottish Government, since 15 March 2020 there have been over 100,000 new claimants of Universal Credit in Scotland, around 6.5 times higher than the same period in 2019.
While we can already see a significant impact on unemployment, we do not know how quickly and how far it will rise. We also do not know how effective Government policy aimed at mitigating these impacts has been – and crucially how sustainable support like the furlough scheme will be if economic activity does not pick up quickly.
The significant impacts of lockdown will not hit all sectors or economies equally
During the lockdown, some types of business can continue to trade in a way which more closely resembles normality, while other sectors have been hit far more heavily. We have already seen in the Bank of England data that lending to real estate, professional services, construction and manufacturing have increased significantly. There are also some sectors where the March data does not look out of the ordinary – lending to agriculture, hunting, forestry and fishing, mining and quarrying, and public administration was fairly close to the 12-month average.
While not a perfect measure of economic activity, we can also see these divergences in stocks and shares. Between 6 January and 28 April 2020, the overall FTSE 100 index declined in value by 19.3%, but the value of food and drink retailers on the index fell by just 2.1%.
The Scottish Government have estimated that the businesses which have been asked to stop physical trading during the lockdown account for around 22% of the economy, employing 920,000 people (32% of the February 2020 Scottish workforce). In order to understand how different sectors of the economy are being impacted, the SG analysis looks at three different channels – the supply change, demand for products and the labour market – and assesses how their disruption will affect each sector. The most significant impacts come through the restrictions that lockdown and social distancing have caused on the labour market, which is expected to cause some level of disruption across most sectors of the economy. Only agriculture, forestry and fishing, mining and quarrying, water supply and waste management, and information and communication are marked as ‘least exposed’ in this analysis. The differential impacts on the various sectors of the economy will be important to anticipate the impact on Scotland’s economy.
Agriculture, forestry and fishing, and onshore mining and quarrying are sectors which form a larger part of Scotland’s economy than the UK as a whole, albeit they are only a combined 2.5% of Scotland’s gross value added (GVA – a measure of the value of goods and services produced in an area, industry or sector of an economy). Public administration, another sector which may be less impacted by the measures of lockdown, is also a slightly larger part of Scotland’s economy. SPICe recently produced a blog looking at the outlook for the tourism sector, another sector which is proportionately more important to Scotland’s economy than the UK. Tourism workplaces are 11.2% of all workplaces in the Scottish economy which is a higher total share than the other nations of the UK, for example the comparable English rate is 9.5%.
How can activity be resumed without risk?
When the Scottish Government published its approach for considering how lockdown restrictions might be changed or eased, the First Minister commented that:
“What we will be seeking to find is a new normal – a way of living alongside this virus, but in a form that keeps it under control.”
Businesses and consumers are grappling with how they can adapt to operate in this ‘new normal’. How much of the old normal could be resumed without endangering public health? Questions about public health remain the priority just now. However, once we have data on economic output and the labour market, it could show that a significant number of households are facing hardship on a scale beyond the worst of the 2008-09 financial crisis. Should this be the case, the pressure to find a way to ease the lockdown and support a recovery in economic activity will only increase. However, those expecting a rapid rebound in economic activity are likely to be disappointed – The Economist notes in their analysis of China’s recovery that only around 90% of the economy can recover quickly, with transport and discretionary consumer spending still weaker than pre-crisis levels, and bankruptcies rising and unemployment heightened.
Andrew Feeney-Seale, Senior Researcher, Financial Scrutiny Unit
Andrew Aiton, Data Visualisation Manager