Long Covid economic scarring could deal lasting £1,000 hit for every adult in Britain

Government spending put on wartime footing as its set to reach 60 per cent of GDP

The Chancellor is set to unveil his Spending Review against an economic outlook shaped by the long-term scarring effect of Covid – including a GDP hit lasting into the middle of the decade worth £1,000 for every adult in Britain, according to new research published today (Saturday) by the Resolution Foundation.

The Covid state examines the economic and fiscal outlook ahead of the Spending Review next Wednesday, what this means for government spending this year and next, and how much appetite the Chancellor is showing to set out a post-Covid economic plan.

The report notes that, while the Office for Budget for Responsibility (OBR) is likely to upgrade the UK’s economic outlook for 2020 on Wednesday, their forecasts are still likely to show the economy shrinking by more than 10 per cent this year – the worst performance in 300 years.

The OBR will also show unemployment peaking lower and later than previously expected. Unemployment in Q4 2020 is set to be half the level expected in July, in part because the extension of the furlough scheme will limit the number of job losses over the autumn. The Foundation says that, with firms reluctant to hire, unemployment will continue to rise over the winter, despite the furlough extension, and is likely to peak after the scheme ends next Spring.

The Covid state warns that some near-term improvements will be overshadowed by the wider economic outlook, including forecasts highlighting the long-term damage Covid may well cause.

It finds that the economic impact of Covid could reduce GDP by around 3 per cent – or £1,000 for every adult in Britain. This would have a lasting impact on the public finances, increasing borrowing by £50bn a year by the middle of the decade.

The return to lockdown and higher spending on public services mean that borrowing is on course to reach £400bn this year, significantly more than the £322bn forecast back in July, and hit a peacetime record of 21 per cent of GDP (over twice the 10 per cent peak reached during the financial crisis).

The vast majority of this additional borrowing is due to around £275bn of Government policy measures – including around £20 billion on the Self-Employment Support Scheme, and over £50 billion that is likely set to be spent on the Job Retention Scheme over 12 months.

The Foundation notes that this has put Government spending on a wartime footing – with spending as a share of GDP rising from 40 per cent in 2019 to around 60 per cent in 2020 – a figure only ever reached before in 1943 and 1944.

Faced with a grim economic outlook and uncertainty, the Foundation says the Chancellor is likely to avoid many of the tough choices that they have created, such as resetting the UK’s fiscal framework or the balance between tax and spend in future years that would force Ministers to confront the prospect of tax rises. Recent Resolution Foundation research found that tax rises of around £40bn will be needed by the middle of the decade.

The report says that with substantial Covid spending likely to continue into the next financial year, from rolling out the vaccine to deploying additional Jobcentre Plus staff to tackle high unemployment, the Chancellor should announce a specific Covid reserve fund to run alongside departmental budgets in 2021-22.

The Foundation says that while the Spending Review is likely to be limited in scope, there are important policy decisions that should be announced alongside it as efforts to combat the crisis continue. These include extending the £20 a week boost to Universal Credit into next year to support families during a period of rising unemployment.

Torsten Bell, Chief Executive of the Resolution Foundation, said:

“The Chancellor is set to deliver his Spending Review against a brutal economic outlook. Far from being a V-shaped crisis, the economic scars from Covid will be with us at least until the middle of the decade, with the economy set to be permanently smaller by £1,000 per adult.

“With public spending likely to reach 60 per cent of GDP, the state has grown this year to levels never seen outside of wars. The immediate question the Chancellor will be answering is how much of that extra spending will continue into next year, not least to pay for ongoing NHS costs and the vaccine roll-out.

“His answers should include a special reserve that recognises the huge uncertainty about how much pandemic related spending departments will need next year. But with total certainty that unemployment is rising, he should also extend the £20 a week boost to Universal Credit so that it supports households through 2021.

“Further ahead, the lasting economic impact of Covid will force the Government to make tough choices on tax and spending. The Chancellor has chosen to go ahead with announcing good news on higher capital and defence spending. But as and when he decides that the UK’s economic policy should again operate within some sort of fiscal framework, much more difficult decisions lie in wait.”