Sunday, August 02, 2020
We have to say farewell to the furlough scheme
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt.

The idea that we have experienced two “once in a lifetime” shocks in little more than a decade is now becoming pretty well established. Both the global financial crisis and the Covid-19 pandemic share one thing in common. Nobody, despite many claims to the contrary, really predicted either.

Some warned about the unsustainability of the global economy, the build-up of debt and the dangerous reliance on risky financial derivatives in the run-up to the financial crisis but these general warnings did not add up to a prediction of the crisis in the way it panned out.

Similarly, from the time of the SARS (SARS-Cov-1) outbreak in 2003-4, plenty of people warned that there would in time be an even deadlier virus, in the sense of more infections and a higher death toll. Bill Gates, the Microsoft founder, did a few years ago. But these general warnings could never have told us about the extent of the economic impact, the lockdowns, and the timing of SARS-Cov-2, or as it is usually known Covid-19. I doubt that at the start of the year anybody had a global pandemic at the top of their list of risks for 2020.

Whether predicted or not, these two momentous shocks have had an enormous impact on the economy. The National Institute of Economic and Social research (Niesr), in its latest quarterly review, published a striking comparison of the UK economy’s pre-financial crisis trend, its pre-Covid trend and what the economic think tank now expects over the next few years.

We had got used to the idea that, in general, the economic cycle was rather like a laundry cycle, and that it all comes out in the wash. What was lost in recessions was made up during recoveries, which were usually strong, particularly in the early stages. The pre-recession trend was regained, with little or no overall loss. Between 1955 and 2005 the real level of UK gross domestic product almost quadrupled.

These two shocks are different. They have been big enough to knock the economy hugely off kilter, and to result in a permanently large loss of GDP. So, according to NIESR, real GDP in 2025 will be around £536bn a quarter. That compares with a projection in February, before the scale of the Covid-19 crisis was known, of around £584bn. It compares with a trend figure for 2025, if neither of these shocks had occurred, of around £743bn.

These are huge impacts. In the absence of these two shocks, the economy in 2025 would be nearly 40% larger than it looks like being. It will be almost 30% - 28% - smaller than it otherwise would have been. These shocks make us all poorer and reduce the size of the economy, and that may not have yet fully sunk in. For simplicity’s sake I have for now left out the Brexit shock, which also reduces the size of the economy relative to what it would have been.

It is in this context that I now turn to employment and unemployment. An economy that is not as big as it otherwise would have been cannot sustain as many jobs.

The National Institute also made the case, in this context, for the chancellor’s job furlough scheme to be extended beyond the end of October, to limit the rise in unemployment. Unemployment is on course to rise to nearly 10%, more than 3m, by the end of the year, from under 4%, it warned, and to average 7% next year. Extending furlough would be a “relatively inexpensive” way of keeping the rate to 5% or below and save more than a million people from unemployment. Uts calls for an extension was backed by the Trades Union Congress.

“The planned closure of the furlough seems to be a mistake, motivated by an understandable desire to limit spending,” said Garry Young, Niesr’s deputy director. “The scheme was intended by the Chancellor to be a bridge through the crisis and there is a risk that it is coming to an end prematurely and this increases the probability of economic scarring.

“The scheme has been an undeniable success in terms of keeping furloughed employees attached to their jobs. The incentives offered to employers by the Job Retention Bonus look too small to be effective given the uncertainty about the economic outlook ─ a one-off payment of £1,000 per employee compared to an average wage of £530 per week.”

The Treasury sees it differently. In his summer economic update last month, his Plan for Jobs, Rishi Sunak, described the idea of endless extensions of the furlough scheme as “irresponsible”. It would, he added, give people false hope that the jobs they had been furloughed from would still exist when many will not. Keeping people on furlough indefinitely would see their skills fade and hold them back from taking advantage of new job opportunities.

Nothing is set in stone but there is no reason to think that he has changed his mind. The Treasury also defends the £1,000 job retention bonus. The typical employee still on furlough is paid relatively modestly, and well below average earnings. The bonus payment to employers will cover roughly a fifth of earnings in the November-January period, after furlough ends, and is thus more generous than it looks.

It is a close call. Friday saw Boris Johnson’s announcement that casinos and bowling alleys, which were due to open, can no longer do so. Weddings are being postponed and local lockdowns spreading. Yesterday brought a change in the furlough scheme, so firms have to start to pick up some of the bill.

But I think Sunak is right. The job market has to clear, in economists’ language, and maintaining the furlough scheme is preventing it from doing so. True unemployment is far higher than the official figures are showing, for that reason.

Some sectors will never again employ as many people as before. Retailing employment has been declining for some time and jobs in hospitality look set to suffer a similar fate. Much of this reflects the impact of the Covid-19 crisis, but some sectors went into it with clear over-capacity. We have had big shakeouts in employment before, notably in manufacturing in the 1980s. This time consumer services look likely to bear the brunt, and a longer furlough scheme will not prevent that. This is the creative destruction you get, or should get, in recessions, though we have to hope that there are new phoenixes to rise from the ashes.

We should remember how unusual the furlough scheme was. While previous governments had put in place employment subsidies and other support measures, none had paid people 80% of their previous salary to be idle but still notionally attached to their jobs.

It is, a I say, a close call and the situation would change if the government were to change its Covid-19 guidance again, which is entirely possible. The furlough scheme emerged because the government had, in effect, stopped many businesses from operating. Boris Johnson has said there will not be another national lockdown but that does not rule out reversing the easing measures for pubs, cafes, restaurants, cinemas and gyms if there were to be a second spike in infections, as has happened locally. In that situation, the chancellor would have little option but to extend furlough for the affected employees, however much he wants to avoid it.