PM Boris Johnson’s strategy is to pursue high levels of spending in order to stimulate a strong recovery, despite warnings from Chancellor Rishi Sunak over the budget deficit.
Although it has been a terrible year so far, with more than 54,000 deaths from Covid-19, the latest economic forecasts, due out on Wednesday, will show the economy on course to contract by one tenth or more. The dire news on growth and unemployment will form the backdrop to the chancellor’s announcement of the Treasury’s spending plans for 2021-22.
Mr Sunak will warn that he will need to take action to reduce the Government’s budget deficit next year. When the pandemic resulted in the first lockdown in March, the received thinking was that the UK would experience a classic V-shaped recession and business activity would return to its pre-crisis levels by the end of the year.
As it turned out, the recession has been shallower but more drawn out, though there have been worse years. In 1919, the UK, still traumatised by the losses in the First World War, suffered in excess of 200,000 deaths from Spanish flu. The row over spending cuts to benefits sank the minority Labour government in 1931 and forced the UK off the gold standard.
The contraction in the economy in 1981, although less than in 2020, was heavily concentrated among the towns and cities of northern England, Scotland and Wales and largely spared the South and South East.
Higher spending expected to lead to recovery
Predictably, businesses have gone bust and unemployment has risen sharply, because it is impossible to shut down large sections of the economy without grave consequences. Yet for most people, 2020 has been utterly miserable not because of reduced incomes, but the inability to lead a normal life and socialise freely.
The Government has taken most of the economic hit and has borrowed as never before in peactime to fight the pandemic and support the incomes of those furloughed. The Treasury’s willingness to pick up the bill explains why the Conservative party is still hopeful of winning the next election, despite a fall in its approval ratings.
However, the economy is likely to grow at a rapid pace once restrictions are lifted. Businesses will decide to plough on with investment plans put on hold during the crisis; and individuals will be spending the savings they have amassed but have been unable to use.
The level of gross domestic product (GDP) in the third quarter was still nearly 10pc below the level of the final three months of 2019, even after growing by 15.5pc. And there will be an even bigger mountain to climb by the end of 2020, due to the second lockdown in England and the more stringent restrictions in the rest of the UK.
Sunak must reach delicate balance
The good news is this means the economy can grow faster than its normal rate for some time before there is any risk of overheating. But it may be two or three years before all the ground lost in 2020 is reinstated.
However, if there were to be a third or, possibly, a fourth wave of Covid-19 that resulted in the reimposition of restrictions, the economic damage would increase regardless of any mitigating action the Treasury may take.
Accordingly, the chancellor has a substantial role to play. He will delay and stall the recovery if he hits the brakes too early and sucks demand out of the economy. Nevertheless, throughout the crisis, Sunak has warned that the borrowing will have to stop and the deficit must be reduced. The problem is that he may encounter problems in doing so.
The prime minister’s strategy, as spelt out in the large increase in the defence budget announced last week, is to continue spending considerable sums in the hope that a strong economic recovery will persuade voters that 2020 was an anomaly. Coincidentally, there are many economists who think Johnson is correct in his thinking.