Keynes famously likened the economy to a piece of string which, in recessions, could not be pushed. A better economic metaphor now is that it is like a piece of elastic. Stretch it too far and the economy becomes permanently distended – so-called hysteresis.
The stretching of the economy’s elastic in the first half of last year saw activity fall anywhere between 10% and 25% across the world. There are very few historical precedents of the economy being stretched quite so far, quite so fast.
Well over 100 million people lost their jobs globally, according to the International Labour Office. Many more, perhaps around a billion, saw their incomes fall. An over-stretched economy led, naturally enough, to over-stretched finances for hundreds of millions of people globally and at least 10 million people across the UK.
The policy response to these events has been as dramatic, in scale and speed, as the collapse in activity and jobs. Central banks globally quickly cut short-term interest rates to around zero and provided an additional $6tn (£4.4tn) (and counting) of quantitative easing (QE) to keep borrowing costs low.
In the UK, the Bank of England’s monetary policy committee (MPC) has announced more QE in the past 12 months (around £450bn) than in the preceding 12 years.
Unlike 12 years ago, however, this monetary medicine has been supplemented by a massive dose of fiscal support too. In many cases, that has amounted to anywhere between 10% and 30% of a given country’s GDP. In combination, it is unlikely there has ever been a larger combined global macro-economic (fiscal and monetary) policy response. And it is not difficult to see why.
An overwhelming show of policy strength has been needed to protect demand and jobs from the near-term effects of the Covid crisis – and not just those near-term effects.
At least as important from a policy perspective was the desire to prevent any near-term hit to demand and jobs damaging the economy’s supply-side potential over the medium term (the output and income it can generate when operating at full capacity).
Experience in the UK and elsewhere during the 1980s illustrated the lasting damage large recessions can inflict on the economy’s potential.
If plant and machinery stands idle for too long, its usefulness depreciates and with it the economy’s potential growth. And if workers lose their job and cannot find a new one, their skills and experience will depreciate too, further damaging the economy’s growth prospects.
Once the recession of the early 1980s had taken UK unemployment from 1.4 million to over 3 million, it took 25 years to return it to pre-recession levels. Economists even borrowed the word “hysteresis” from physicists to describe this phenomenon. The scarring effect of that experience, financially and psychologically, has shaped public policy importantly in the period since.
At the time of the global financial crisis, macro-economic policy support was large and front-loaded to support jobs and demand and prevent the economy’s elastic being over-extended.
That policy playbook has again been followed, at even greater speed and in even larger scale, during the Covid crisis. Without it, UK unemployment might already be up to 2 million higher than it now is and the longer-term scarring on livelihoods would have been that much greater.
Even with this exceptional policy support, however, the changes in behaviour and business models as a result of the Covid crisis means some jobs, regrettably, will not return. Giving displaced workers the skills they need to re-enter the workplace, and thrive in it, will be key to preventing a longer-term economic scar being left.
Even before the Covid crisis struck, about 10 million workers across the UK faced a mismatch between their skills and the requirements of their job. The Covid crisis has added to those skills mismatches, hitting hardest the young, the least experienced and those with fewest skills.
This upgrading of skills should be easier than in the 1980s. Back then, the economy was pivoting from manufacturing to services. With many skills of these not readily transferable, this made the retraining journey a difficult one for many and increased the degree of hysteresis in the jobs market.
During the Covid crisis, it is jobs in the services sector that have been hardest hit. With service sector industries tending to grow over time, and with skills being more easily transferable within this sector, this should shorten and simplify the retraining journey for displaced workers and lower the degree of hysteresis.
Nonetheless, the scale of the skills challenge in the UK was huge pre-Covid and is larger-still now, particularly among the youngest and least-skilled. This means the risk of workers facing the jobs-equivalent of long Covid is considerable. Avoiding that chronic economic ailment will require structural, skill-focused policies, equivalent in speed and scale to the demand-side policies already put in place.
A useful down-payment on those policies has been provided in the UK, with new initiatives focused on vocational training and lifelong learning. But these will need to increase in scale, and expand in scope, to meet the skills challenge facing the UK economy and limit the long-term scarring to it.
The macro-economic policy response so far – large-scale, sure-footed and front-loaded – has reduced significantly the risk of hysteresis. But the only way of immunising against economic long Covid will be through a skills programme every bit as large-scale, sure-footed and front-loaded.