Is there light at the end of the tunnel for the economy?
“Scary” was the term used to describe the outlook for the UK economy when the Chancellor, Rishi Sunak, delivered his autumn spending review back in November following over eight months of COVID-related restrictions.
With the UK economy predicted to shrink by 11 per cent in 2020, recovering only half of that in 2021, a deficit of 19 per cent of GDP and unemployment expected to rise to at least 7.5 per cent this year after business support and the furlough scheme ends, it was not a pretty financial picture.
While the arrival of multiple viable vaccines at the tail end of the year provided hope for the beginnings of recovery in 2021, the rapid spread of a new variant of the virus, leading to further severe restrictions across the country, has been a significant setback.
Scottish business confidence plummeted in the final days of 2020, according to research from the Federation of Small Businesses.
While UK-wide small business confidence fell to -49.3 points, the second lowest ever recorded, the average Scottish firm was even less confident about its prospects, with the Scottish figure plunging to -69.0 points, down from -26.3 points in the autumn.
Although additional support for retail, leisure and hospitality businesses closed by the current level-four restrictions were announced this month by the Scottish Government, they will likely cover only a fraction of the losses of many businesses, and do not aid others impacted by the knock-on effects.
So where does this latest twist in the whole sorry COVID saga leave the Scottish economy now?
Professor Graeme Roy, director of the Fraser of Allander Institute at the University of Strathclyde, describes this new unexpected setback as a “sickener”.
“I think, from the economy point of view, it’s a real sickener in many ways, because … if you go back to early December, there were hopes and signs that things could start to build momentum and the economy could start to grow and recover relatively early in 2021,” he tells Holyrood.
“So, you know, continued restrictions, but with the rollout of the vaccine things were looking to be slightly more optimistic.
“It’s not to say that things were going to return back to normal anytime soon, or things were going to be easy, but at least there was a good dose of optimism there.
“I think the changes we’ve seen over the last couple of weeks, and the spread of this new type of the virus, and the consequential restrictions that have been implemented have really just kind of put that recovery back a good few months.
Roy says that for many businesses, the next few weeks and months are going to be “exceptionally challenging”.
“And not just in terms of restrictions, so in terms of businesses that can and can’t open, but particularly around things like schools, where people are having to do homeschooling and have greater caring responsibilities.
“That just means that that ability to work from home becomes much more difficult.
“And I think that for many businesses, even if they’re not impacted directly by the restrictions, that’s just going to have an impact on their recovery plans.”
The overall message, Roy says, is that this means the economy is going to take much longer to recover.
There’s the potential that the recovery stalls and “flips back a wee bit” over the next few months and it will be later on in the year before the momentum starts to build and the economy gets opened back up again.
The Fraser of Allander Institute’s prediction for the most likely timeframe for economic recovery was around August 2022 in its most recent economic commentary in December, so this suggests it is now more likely to be at least the end of 2022, but Roy notes it is very difficult to make economic predictions in such uncertain times.
“So much of this is very difficult,” he says.
“I mean, economic forecasting is difficult in normal times. I think in this time it’s even more difficult because it’s really at the mercy of what happens to the virus and how it can be contained.
“I think what we do know is that the economy has had an enormous economic shock and even at the end of the year, you’re talking about our economy still being around six per cent smaller than where it was pre-pandemic.
“And that’s a significant fall in comparison to previous recessions.
“So even after the period of recovery, the economy was still much smaller and significantly down on where it was pre-pandemic.
“And that’s just now going to last for longer and the recovery is now going to be that that bit further out.
“I guess the point that we keep on making to everybody, though, is that this recession is quite different from previous recessions in that the lockdown is entirely deliberate and temporary, so once we can get through this … and get the vaccines rolled out, then the economy will start to open back up again and the economy will recover.
“So there is light at the end of the tunnel, it’s just that that light’s been pushed back further.”
Roy warns that with job losses expected after the furlough and business support schemes end, “it will feel like we’re in economic crisis for a good while,” although the extent of this depends on whether the UK Government introduces new follow-on schemes to support recovery in its budget in March.
And he is of the view that government support is vital.
“There’s a general point now where I think, and we’ve been saying this consistently through this, there’s a risk that sometimes in recessions you do too little [rather] than do too much.
“So I think that the government are right to be doing everything they can and throwing the kitchen sink at trying to support businesses just now because there’ll be a time to pay this back.
“But equally, if you do structural damage to your economy, that can really undermine growth and wider outcomes beyond the economy, in well-being and health and social justice over the long term. So doing as much as you can [in terms of] government support now, the better.”
There has been controversy and bickering recently over COVID support funding. The Scottish Government has complained that £375m of funding announced for Scotland at the beginning of January was not new but fell within money that had already been promised, while the Scottish Conservatives have accused the Scottish Government of “hoarding” the COVID funding it has already been allocated. Both claims appear to be something of a storm in a teacup.
It’s not true that there isn’t extra money coming to Scotland, says David Phillips, associate director at the Institute for Fiscal Studies (IFS), but the £375m was not additional funding because Scotland has already been allocated more than its fair share under the Barnett formula.
He explains: “One of the things to bear in mind is that the Scottish Government was given a sort of upfront funding guarantee [of £8.6bn] …The upfront guarantee was more than it would have got under the Barnett formula.
“So it was more than the equivalent spending in England. That upfront guarantee was basically to provide more certainty for the Scottish Government.
“But of course, that means that until the spending in England rises to the equivalent level, unless the Treasury decides to further increase the guarantee, Scotland doesn’t get any more from the Barnett formula, because the guarantee is already above the Barnett formula.”
But the claims that the Scottish Government is deliberately holding back funding from businesses also does not seem to have much weight.
It’s a “classic kind of political dingdong, where people disagree furiously about things, which actually, there’s very little substance [to],” says Roy.
Both Roy and Phillips note that the Scottish Government should not have spent all the money yet, since it’s not the end of the financial year, but also that it could opt to put some into reserves for the next financial year.
This may be wise, as it is expected that next year’s COVID funding will go down to £1.3bn, after what the Fraser of Allander Institute termed the “eyewatering” extra £8.6bn this year.
“I think there’s strengths in each party’s argument to all of this,” says Roy. “I think the government are trying to spend the money as quickly as possible.
“There are legitimate questions about whether they are spending it as much as possible, not through any deliberate attempt not to spend it, but just because of the complexities of getting the money out the door.
“Some of the money is being held back, but that’s for the remainder of the financial year. And then some of the funding, they will be thinking about, well, how can we hold onto some of the funding to be able to use into managing the budget into next financial year as well.
“So, like all these things, there’s an element of truth in each party’s argument, but it’s just exceptionally complex.”
In addition to COVID, there is, of course, Brexit.
There were dire warnings of the severe effects a no-deal Brexit would have on the Scottish economy and businesses.
In the end, an eleventh hour deal was reached just before Christmas, but it is still a hard Brexit, with no mutual recognition of food safety standards, for example, which is already being felt particularly by the fishing industry and other food exporters.
But the effect of this will mainly be seen in the longer term, says Roy.
“I think where Brexit is an issue, and slightly different from the pandemic, is that the challenges that people have always identified around Brexit – aside from a no deal, which would have had a really short, sharp negative hit to the economy – the big challenges for Brexit are much more about the longer-term growth trajectory of your economy.
“So … if you put up barriers with your largest trading partner, that just means that you’ve got less.
“You’ve got a smaller market to trade into, it means you’re likely to be less innovative, less productive, and therefore that’s likely to harm your long-term growth potential.
“If you put up barriers to migration, particularly for an economy like Scotland, that creates real long-term challenges in terms of skill shortages, in terms of population ageing, so the consequences of Brexit for the economy are much more about your longer-term trajectory, whereas the COVID crisis is very much the here and now, if you see what I mean.
“The legacy of Brexit will hang around well beyond when COVID is hopefully a distant memory.”
All the uncertainty makes it very challenging for the Scottish Government to set what finance secretary Kate Forbes has called “the most important budget since devolution” on 28 January.
She will have the unenviable task of finding the resources to cover the additional costs of coronavirus to health and other public services as well as support for economic recovery while also dealing with reduced revenues due to the pandemic at a time when raising further revenue through, for example, increasing taxes is unlikely to be considered an option and without any borrowing powers.
Forbes says: “Coming amidst an unprecedented global pandemic, the forthcoming Scottish budget will be one of the most important since devolution.
“It is my task to prioritise our resources as effectively as possible to drive the country’s economic recovery from coronavirus (COVID-19) while also managing the ongoing impact of the virus.”
This is particularly difficult as the UK Government has chosen, for the second year in row, to delay its own budget to March.
While Phillips suggests that the “building blocks” are there from the autumn spending review for the Scottish Government to set its budget and that any major changes by the UK Government are likely to be top-ups rather than cuts, Roy is of the view that the Scottish Government “are essentially flying blind at the moment”.
Both agree that one significant difficulty will be what to do about business rates relief, which is due to finish at the end of March and which it is hard for the Scottish Government to make a decision on without a steer on what the UK Government plans to do.
Roy points out that the uncertainties over the budget allocation and the likely need for future revisions as the situation changes affects not only the Scottish Government but the opposition parties, too, coming into the Holyrood election in May, who are likely to be “heavily constrained” in setting out what their policy priorities will be because to do that, they need to know what money will be available to spend.
He says: “The fiscal framework that Scotland now has is exceptionally uncertain. It builds in uncertainty into it.
“In the current climate, it just becomes even more uncertain, which, to be honest, just doesn’t feel very satisfactory in the context of setting a budget which is going to be so important because the election is coming up.”
At this point it seems that nothing is as certain as uncertainty and change, and this is something we’re all going to be living with for a good while yet.
While there may be light at the end of the tunnel for the economy, it continues at the moment to be a will-o’-the-wisp that we can’t quite reach.