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Quick recovery from pandemic depends on the Treasury being smart and lucky

Newspaper article

Last week the Bank of England forecast that this year would see the deepest recession in British history. Astonishing to say it, but in doing so it was being very, very optimistic. It foresaw that this very steep decline would be followed by a very quick bounce back with little or no permanent economic damage. If we get away with it that lightly we will have been exceptionally lucky.

We will have to be lucky with the virus, lucky with a vaccine, lucky with how other countries respond and lucky with the resilience of the economy. I’m not sure I feel that lucky right now. Nor do many other economists I know.

If we are to have a hope of acheiving this outcome, we are going to have to be very active and very clever in making our own luck. We need to get the response right medically. We also need to get it right economically. The two are interrelated, of course. Failing to control the virus properly will be bad for the economy. But we could get that bit right and still easily make more of an economic mess than needs to be the case.

As my colleagues at the Institute for Fiscal Studies have pointed out, this is a crisis in which there are externalities everywhere you look. That is to say, much more than usual, what any individual person or company chooses to do is likely to have important consequences for others, consequences that they would not necessarily account for in the decisions they make themselves. That’s what social distancing is all about: making sure we don’t impose costs on society by risking spread of the virus. That represents an unprecedented intervention by government. It will need to keep intervening, and in very clever ways.

A good starting point would be to provide as much clarity as it can about what will come next. One thing we know for sure is that pervasive uncertainty is bad for the economy in general and for investment in particular. Given that people will need to work in different ways for some time if they are to work at all, investment and innovation will be fundamental to our short-term success. Mixed messages such as those issued over the past few days aren’t just irritating and misleading for the public; the uncertainty they create can have big economic costs as well.

Government should also support and help to spread innovations that make safe working practices easier, either by directly funding research or facilitating the fast spread of good new ideas. It may need to be more active in the labour market, helping workers and firms to find each other more easily, outlawing exclusivity clauses for furloughed workers, or hiring some of the unemployed directly to further public investment schemes.

Appropriate policy will also depend on a clear understanding of the facts. From a medical point of view, we know that the under-25s, for example, are at very little risk. They are also less likely to be constrained by childcare responsibilities and are unlikely to be living with at-risk groups. But as bad luck would have it, many of them work in customer-facing roles such as hospitality and hence in sectors that have been locked down. This looks like the group that could most safely and easily be working in some capacity, but is in fact most likely to not be working. That doesn’t feel optimal to say the least. They should be helped to find work in other sectors while on furlough.

The biggest immediate conundrum facing government will be over how and when to move away from the job retention scheme which pays 80 per cent of salary up to £2,500 a month to furloughed workers. It looks like about a quarter of the workforce is being supported by this scheme at a staggering cost to the exchequer of more than £10 billion a month. It has turned out to be much bigger and more expensive than originally expected.

It is worth remembering the purpose of the scheme — to prevent exactly the sort of job losses and business closures that would lead to longer-term economic damage. Its existence is one of the reasons that the Bank of England is so optimistic about the medium-term economic prospects. So, we should be very careful in moving away from it. But that doesn’t mean it should remain as it is until all rules are relaxed. It is generous enough that leaving it untouched risks more businesses remaining closed than is necessary, and certainly more than was initially intended.

On the other hand, keeping it only for locked-down sectors such as hospitality would leave totally unsupported those sectors which are shutting because of a, hopefully temporary, collapse in demand. Equally there is little value, indeed a lot of cost, in providing open-ended support for sectors that look set to be smaller for some time to come. The economy post-Covid probably won’t look the same as the economy a year ago, and attempting to preserve the old economy in aspic is likely to be costly. Yet picking the winners and losers with any precision remains nigh-on impossible.

The scheme was deliberately introduced quickly as a simple and rather blunt instrument. It is likely to have to get a whole lot more complex. As this crisis goes on it will probably need to start differentiating by sector. There may need to be some elements of risk-sharing for some sectors, in which accepting payments will require some matched funding from the businesses concerned either now or in the future.

The Treasury is, with very good reason, institutionally averse to these sorts of complex and differentiated interventions. Whitehall is poorly set up for making them. But if we are to make our luck they will need to adapt, and fast.

This article orginally appeared in The Times and is used here with kind permission.