The UK’s Office for Budget Responsibility this week produced a scenario suggesting the coronavirus lockdown will lead to an economic crash of a scale not seen since the early 18th century. Economic activity is likely to plunge 35 per cent in the second quarter, the government’s budgetary watchdog said. The deficit would rise to £273bn in 2020-21, 14 per cent of national income, almost half as high again as at the depth of the 2008 financial crisis. Unemployment would soar close to 1980s levels.
But, in this scenario, the OBR said that after a horrific second quarter, life would gradually return to normal so that by the end of 2021 the economy would be back to the path predicted in the March 11 Budget. Apart from higher government debt, it would be as though the crisis had never happened.
The important economic question is how plausible is this outlook. The watchdog itself highlights profound uncertainties over the spread of the virus, government policy and the economic consequences. It repeatedly insists that it has produced a “reference scenario” which must not be described as a forecast. But it protests too much. All economic forecasts are scenarios. This year’s Budget forecast, for example, was a scenario based on the assumption there was no chance of a devastating global pandemic. This one has other assumptions underpinning its results.
The language here is not important. What matters are the forecast judgments that underpin the figures. Strip away the spreadsheets and ready reckoners and everything in the OBR’s figures this week rests on two assumptions. There is a good chance that one is too pessimistic and, sadly, every chance that the other is too optimistic.
First, the better news. The OBR’s estimate that economic activity is currently 35 per cent below its level in early March is merely an educated guess. It is based on taking broad sectors of the economy and allocating to each an estimate of output losses. Education, worth 6 per cent of the UK economy, is down 90 per cent in its scenario, for example. Add all these individual hunches up and the OBR arrives at the 35 per cent figure, similar in scale to comparable exercises in France and the US.
This exercise is perfectly reasonable and none of the numbers look wildly wrong. But other ways of estimating the same economic hit can give very different answers. Emerging evidence from the British Retail Consortium, Barclaycard and Visa also suggests household spending is low but do not yet point to a drop of more than a third. There is a big difference between a 20 per cent and 35 per cent drop. Surveys of income and household finances are more positive still. The Office for National Statistics will have a nightmare trying to reconcile all of this data, but we will soon get a better idea of how deep the downturn is.
The OBR’s second assumption was that the recovery will be rapid and total — that there will be almost no hangover from the crisis. Very few people believe this. When chancellor Rishi Sunak says he cannot save every business or every job, he is rightly accepting that the UK’s recovery will not be complete within a few quarters. Economies take time to heal from mass bankruptcies and unemployment. If the 2008 crisis is any guide, some losses are permanent. Despite the difficulties in assessing the extent of persistent economic weakness, the assumption of zero scarring is not realistic.
There is no doubt that the economic crisis infecting Britain and other countries is deep. We will soon get a good idea of how bad this quarter will be.
But to prepare the nation for potentially tough choices in the recovery phase, the much more important question is over the extent to which problems will persist once the government has lifted restrictions. On that, the outlook will surely be more shocking than the OBR suggests.