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Centre for Education Policy and Equalising Opportunities (CEPEO)


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Unemployment: The Coming Storm

By IOE Editor, on 17 June 2020

By Professor Paul Gregg, University of Bath

What we Face

Covid-19 has already produced a dramatic shock to the Labour Market with unemployment welfare claims in UK rising 800k in April and HMRC records suggesting that employee numbers had fallen 1.7% by May. But the Job Retention Scheme is holding back a much larger surge in job losses. The question is: What do we now face for the second half of this year?

Historically, there have been very different experiences, in terms of GDP and employment contractions, in past recessions. In the 2008/09 recession job loss was small relative to the large reduction in economic activity. At a decline of over 6% of GDP, it was a severe recession. But the employment rate shrank by just over 2.8 percentage points (73.0 to 70.2% of working age population in work). By contrast, the 1990s recession saw employment fall by 4.5 percentage points when GDP shrank by just 3%. And the 1980s recession saw a 5% GDP decline and a 6 percentage point decline in the employment rate. There is thus huge variation in the extent of employment falls relative to GDP declines in each recession, from employment falls being half the size of GDP decline in 2008 to 50% bigger in the 1990s.

Predicting what’s to come is hard. The UK economy contracted by 20% in April (after 5% in March) but this is driven by Lockdown rules and does not reflect the underlying economic position. It will be clear how things look after Lockdown from July and through the second half of the year. The Bank of England suggests that over the year as a whole, the contraction will be 14% – more than twice as severe as the 2008/09 recession. The OECD is a bit more optimistic, predicting a contraction of just under 12%, with activity around this level in the second half of the year and still 4 to 5% down in the first half of next year. Both organisations suggest unemployment will peak at just over 9% at the end of this year, a rise of just over 5 percentage points.  They and most other forecasters expected this to be like the last recession with the employment fall (unemployment rise) around half of the GDP fall.

This raises the key question of what shapes the difference between employment and economic activity through recessions?

The first factor is the conditions required for firms to lay off large numbers of workers. Firms first respond to economic shocks by hiring freezes and not renewing temporary contracts. They are more reluctant to sack experienced and knowledgeable workers. They only shed labour heavily when they are in acute financial distress to avoid going bust. And some, of course, don’t survive. The crucial issue is how much financial distress are firms in and how long will they need to get back to near normal trading conditions. If this is acute and persistent, then employment will be hit hard.

The second factor is which sectors are hardest hit? If it’s highly labour-intensive sectors (such as retail, hospitality and leisure) then we would expect to see a larger shock to employment than GDP. In the 2008/09 recession, the first factor had little impact. We saw corporate profitability fall by less than a fifth. Corporate profitability was sustained in large part by the very large currency devaluation which meant exporting firms and those competing with overseas firms in domestic markets were able to maintain profitability.

The 1990s recession was driven by Norman Lamont rapidly and unexpectedly hiking up interest rates to defend the Pound. Consumer spending fell sharply and corporate profitability fell by a third from high levels in the Lawson boom. It was expanding firms who had recently taken on debt who were hardest hit large and those most reliant on consumer spending – labour intensive services. So both factors led to large employment shocks.

What do we face this time? The answer is that contrary to some current thinking, 2008/09 is not a good guide. Rather the 1980s and 1990s recession seem closer to the mark. The employment contraction will be very similar in magnitude (and may well be larger than the GDP contraction).

Even before the crisis, corporate profitability was down 20% on levels in the first half on 2017 and at similar levels to those at the height of the 2008/09 recession. The UK had narrowly missed recession at the end of 2019, before COVID-19 struck. Now, forecasts predict that GDP is 8-10% below peak as we emerge from Lockdown in July and 4% down in the first half of next year.  The absence of, or very limited, trading for some months will have pushed many firms to the edge of existence. Combined with this firms do not know their current trading position nor that which will emerge after lockdown. The Job Retention Scheme has covered wage costs but even so, no revenue means firms have no slack. With no financial buffers, firms will cut jobs heavily to protect the firm until clarity emerges of their trading position after September. The risk for the firm is that holding onto too many workers will push them into to bankruptcy, so firms will err on the side of laying off workers.

Further, the sectors who have and will continue to be hardest hit by Lockdown and social distancing will be the labour intensive sectors of retail, hospitality, leisure and tourism. The only positive is that the recovery is already underway and firms just need to get through to the New Year for a more normal recession situation (output down 4% or so).

The US is maintaining incomes by putting people on greatly enhanced Unemployment Benefits rather than keeping people attached to firms by subsidising wages. It is thus a reasonable guide of what we face here (before the hit to consumption from widespread income falls bites). It has seen open unemployment rise from 3.5% to 13.3% in three months. Firms in the US will often rehire the same workers using UB as a temporary layoff and this has started to happen as social distancing eases but as there is little lockdown in the US the effects of economic shock on jobs are clearer. So given the huge economic shock and the US evidence of its effects on jobs even with major support for demand in the economy, we have to anticipate that the employment rate will fall by 8 to 10% from its recent all time high of nearly 77%. Open unemployment is likely to rise from 4 to 14% without further policy intervention.

As firms can soon start trading, the full-time furlough becomes redundant and the part-time option that is allowed from July should be the only attractive option. This represents a period of short-time working. As proposals stand, firms start paying employers NI and pension costs from August. They also have to start paying 10% of the furloughed wage in September and 20% in October. This amounts to 35% of the furloughed wages in total. Under part-time working, this is around an extra 3% in August rising to 12% in October in wage costs per hour worked. This is at a time when they are up against the wall, financially.  It seems unlikely that many will be using this option by the end of September. Rather they will return some workers to normal hours and lay off the rest to cut costs. The Chancellor has clearly assessed that the scheme needs to end abruptly and accepts there will be an intensely concentrated volume of job shedding in September. This feels like a monumental mistake.

The central point here is that the government has ploughed huge amounts of money into preserving firms and especially jobs. A large part of this will be wasted if the Job Retention Scheme ends abruptly after lockdown ends. Furthermore, the fall out will be massive and the recession risks being more severe and sustained if there is a collapse of demand in the economy from widespread job loss and even more important, widespread fear of job loss kicks in.

 What Can We do?

The country needs two things. First, it needs to get these labour-intensive sectors operational as far as the science allows. Right now, the move to a 1 metre social distancing rule is being debated and seems likely to be accepted. Second, there needs to be a window between the end of lockdown and the full termination of the Job Retention Scheme to get firms through to the better conditions next year when they can more accurately gauge their employment needs.

The policy options are straight forward. The part-time furlough option needs to be a lot more attractive and to last longer, perhaps till the end December. This can be done in one of two ways. Full-time furlough costs the Treasury on average about £2000 per month for each job supported. By October this falls to £1350 for full-time furlough and to £675 for part-time as firms now contribute.  If the furloughed support for the Treasury was cost limited rather than a fixed proportion of salaries at say £900 per month irrespective or full- or part-time, then firms are incentivised strongly to move to part-time furlough and part-time trading. Here 80-90% of furlough wage costs are covered under the part-time option and this is highest for the low wage sectors under most stress.

The other approach would be a retention bonus, such that if all furloughed workers are still employed by the firm at the end of January then the firm receives £1200 per worker (or 3 ½ months of their part-time furlough costs). This could be reduced as the proportion retained falls to just 90% retained.

The coming storm of unemployment will be intense and incredibly accelerated, with almost all of it hitting in April and between August and October as the Job Retention Scheme winds down. The government and forecasters appear to believe that the rise in unemployment will be limited from 4% pre-Covid to around 9% and far smaller than the GDP contraction after Lockdown compared to the pre-Covid period. This would be in line with the last recession. However, firms this time are under far greater financial distress, as they have barely been trading for 3 months, and the hardest hit sectors are labour intensive. So everything points to this being more in line with the 1980s and 90s recessions where the employment fall was in line with that for GDP. If this is the case unemployment will rise closer to 14 than 9%. But this catastrophe can still be averted if changes are made (science-permitting) to the social distancing rules, and to the abrupt termination of the Job Retention Scheme.

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