Covid-19
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Budgets & fiscal events
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Economy and public finances

The Covid state

Analysis of the economy and public finances ahead of the 2020 Spending Review

Karl Handscomb
Karl Handscomb
Jack Leslie
Jack Leslie
Cara Pacitti
Cara Pacitti
Daniel Tomlinson
Daniel Tomlinson
James Smith
James Smith

The Chancellor is set to unveil his Spending Review against a radically changed economic and fiscal backdrop to the one he faced in March. Although unemployment is set to peak lower and later than had been expected back in the Summer, the long-term economic scarring from this crisis is set to be significant. The OBR’s forecasts for GDP could imply a lasting 3 per cent reduction in the size of the economy, worth £1,000 for every adult in Britain.

The return to lockdown and higher spending on public services mean that borrowing is set to surge, largely as a result of £275 billion of Government policy measures implemented in response to the unprecedented health and economic challenges the country faces.

Faced with a grim economic outlook and very high uncertainty, the Chancellor is likely to avoid some tough choices, such as resetting the UK’s fiscal framework or the balance between tax and spend in future years. But he will provide detail as to how much Covid-related spending will carry on into 2021-22, as well as the non-Covid departmental spending allocations for next year.

Key findings

  • The level of GDP in the third quarter of 2020 was 7 per cent higher than the OBR had expected in July. But with the accelerating spread of the coronavirus leading to additional social distancing restrictions through the winter, the economy is set to be 11 per cent smaller this year than pre-crisis, the largest annual contraction in GDP in 300 years.
  • Unemployment in 2020 Q3 was less than half of the level in the OBR’s central scenario published in July.
  • Borrowing is on course to reach £400 billion this year, significantly more than the £322 billion 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 combination of a weaker economy and much higher spending combine to mean that spending as a share of GDP is set to rise from 40 per cent in 2019 to around 60 per cent in 2020 – a figure only ever reached during the Second World War.
  • If Rishi Sunak decides to continue with increases to non-Covid RDELs in line with the growth rates set out in March, and the amount of Covid spending required next year is equal to one-third of the amount spent in 2020-21 (around £50 billion), then the cash increase in RDEL spending over the two years from 2019-20 to 2021-22 could be as much as £80 billion – equivalent to an increase in RDEL of 31 per cent over the two years.
  • While, on capital spending ‘key programmes’ will be allocated multi-year spending plans at the Spending Review, it is uncertain how much of the capital envelope this will apply to. And announcing capital spending plans without a medium-term fiscal anchor could lead to difficult decisions in the coming years if high investment proves inconsistent with the fiscal framework eventually adopted.

Recommendations

  • 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. The Chancellor should extend the £20 a week boost to Universal Credit into next year to support families during a period of rising unemployment, letting this boost expire would mean a £1,000 reduction in annual income for 6 million households.
  • The Chancellor should announce a ‘Covid reserve’ for additional time-limited Covid spending. Rather than have to repeatedly announce short-term funding top-ups to departmental budgets, a better approach would be to use a reserve from which funds could be allocated where required. This would make clear how much the Government expects to spend on Covid, and provide certainty for departments that their core spending allocations will not be affected by Covid spending needs.

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Karl Handscomb
Karl Handscomb
Jack Leslie
Jack Leslie
Cara Pacitti
Cara Pacitti Senior Economist
Daniel Tomlinson
Daniel Tomlinson
James Smith
James Smith Research Director