The economic effects of the Covid-19 pandemic are set to be vast. Recent forecasts from the Bank of England suggest that UK GDP could fall by over 25% in Q2, with unemployment rising to 9%[1], despite almost 9 million jobs being supported by the Government’s furlough scheme. These are eye-watering figures.
We are working with Enterprise M3 Local Enterprise Partnership (EM3 LEP) on a recovery and renewal action plan, looking at the business exposure to Covid-19 within the area and what the impact of the pandemic might be under a number of different economic scenarios.
What could the recession look like?
Rarely has there been so much uncertainty about what the future may hold, particularly as the nature of this crisis is very different to previous economic shocks, such as the 2008 financial crisis. There are two major sources of uncertainty:
The progression of the outbreak is unknown. The UK has come down from the first peak and some restrictions are starting to be lifted. However, the prospect of a “second wave” is being talked about as a significant possibility and there is still a lack of understanding about the duration of immunity.
The central government policy response is also unknown. There is still some uncertainty over how the closure of Government support schemes will operate and it remains to be seen how the gradual lifting of restrictions will play out. There is also still some scepticism over whether the transition period with the European Union will end at the end of 2020 as planned or be extended.
As a result of the uncertainty, we have taken a scenario based approach to our analysis, to show what the major risks will be in key sectors and how EM3 and other clients could best respond to the eventual reality, applying our economic shock response model.
The scenarios have been modelled based on the policy response so far, forecasts produced by organisations including the Bank of England and the International Monetary Fund, and our own economic shock model. We have set out the three broad scenarios as follows:
Best case: A quick return to economic growth (a “V-shaped” recession): in this scenario, whilst a sharp drop is initially experienced in Q2 2020, recovery is relatively quick.
Middle case: A slow return to economic growth (a “U-shaped” recession): here, easing restrictions is not as straightforward as hoped and a return to long-run growth rates is not seen until early 2021.
Worst case: A lingering cloud over economic growth (an “L-shaped” recession): in this case, it becomes clear that Covid-19 is not a blip, with delays in finding a vaccine leading to a further global outbreak in 2021, with many firms ceasing trading and damage done to long-run productivity.
Which scenario is most likely?
Whilst it is unlikely that reality will fall neatly into one of the above scenarios, they cover the broad spectrum within which the economy could land.
In our view, the best case scenario is very unlikely at this point. The impact on consumer confidence is already severe, so consumers are unlikely to return to previous spending patterns quickly. The extension of the furlough scheme is an acknowledgement of this, whilst supply chain disruption will impact recovery across vast swathes of the economy, with some sectors such as aviation already being explicit that they expect recovery to be measured in years, not months.
Our current view is that the reality is likely to fall somewhere between the middle case and the worst case. The “U shaped” middle case is a possibility if most businesses can re-open in some form in 2020 and the furlough scheme gives consumers some confidence to continue spending. However, the “L shaped” worst case is also within the realms of possibility, particularly if the end of the furlough scheme generates mass unemployment, which in turn reduces consumer spending.
The wide possibilities mean hoping for the middle case, but planning for the worst case, is a sensible approach.
What could recovery look like?
We have been applying our model of the cycle of responding to an economic shock, which has four stages: Resistance, Recovery, Resilience, and Reorientation (the last two of which are grouped under renewal). The timing of the different phases varies depending on the type of shock. In the Worst Case scenario, the Resistance phase lasts a lot longer than in the Best Case, with Renewal not coming until much later down the tracks. Businesses will want to move onto Renewal as quickly as possible in all scenarios, and whilst the pandemic may accelerate changes in some areas, such as digitisation, longer term ambitions, such as Clean Growth and tackling climate change, may unfortunately be put on hold during a longer Resistance phase.
As part of our work for EM3 we are applying these scenarios to sectors across the area, such as digital, advanced manufacturing and aerospace. We are carrying out research and consulting with local businesses within the sectors, to understand what it is like ‘on the ground’ within each sector, and model what each could look like under the different scenarios.
To illustrate, we will focus on one particular sector: aerospace. The UK’s aerospace sector has an annual turnover of £35 billion and provides over 120,000 highly skilled jobs that pay 40% above the national average.[2] Yet the sector has been amongst the most immediately impacted in the crisis, particularly within the commercial air travel space. In the last week of April, the number of commercial flights was approximately 65% below the number in the last week of February. While air traffic has consistently shown a solid recovery from previous crises, there is uncertainty over what the future of the industry will look like, with Rolls Royce and Airbus having already said that significant job cuts are coming. There are questions over what it will mean for the aircraft manufacturing industry and supply chains.
The outlook is not so alarming for defence aerospace, where demand is expected to remain much more robust, as it is more protected by budgeted government spending through MOD framework contracts. Many of the suppliers cover both defence and civil aerospace, however, with most suppliers expecting to see a 40% reduction in supply during the next two to six months. Defence remaining relatively strong is helping the UK supply chain during this survival phase and will play an important role in the sector’s recovery.
What will this mean for places?
One thing that seems clear is that this pandemic is likely to widen regional inequalities. A key challenge for local and national Government is to lay out a policy mix to address these inequalities and target those areas that will otherwise struggle to recover. For instance, in the retail sector, this might include urban design interventions and support along the lines of the Future High Streets Fund, alongside schemes to support companies in taking their businesses online such as shared platforms. An approach to recovery that is not inclusive will result in even more left behind towns and cities and make the Government’s “levelling up” challenge all the more difficult.
To understand how Covid-19 is affecting your area, get in touch to start a conversation at: admin@metrodynamics.co.uk
[1] Bank of England Monetary Policy Report, May 2020. https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-report/2020/may/monetary-policy-report-may-2020
[2] Aerospace Sector Deal Policy Paper: https://www.gov.uk/government/publications/aerospace-sector-deal/aerospace-sector-deal