The economic policy response to the COVID-19 pandemic

Chris Martin is a Professor of Economics, and Magdalyn Okolo is a Doctoral Candidate, in the Department of Economics at the University of Bath.

Months into the COVID-19 pandemic, we can begin to evaluate the main economic policy choices made in response to it.

The centrepiece of the response in the UK was the Job Retention Scheme (JRS), introduced in March 2020. The JRS has enabled firms to furlough their workers, with the state paying 80% of a worker’s pre-pandemic wages, up to a limit of £30,000 (slightly above 2019 UK median earnings of £29,400). Two thirds of UK firms made use of the scheme, which covered 11 million workers at its peak.

By giving firms an alternative to firing workers whose employment was not profitable at the height of the crisis, the JRS will have delayed and reduced the inevitable rise in unemployment. But we do not as yet know by how much the JRS has reduced unemployment. Estimates of this are required for evaluation, which will weigh these benefits against the large expense of the scheme, expected by the Office for Budgetary Responsibility to be close to £60bn.

Another important economic policy response was announced in the “Plan for Jobs” on 8 July. This plan confirmed the decision not to take further steps to prevent the rise in unemployment. The JRS is to begin winding down in August, and firms will start to pay a larger share of the costs before the scheme ends in November.

A “bonus” of £1000 - paid to firms for any worker who returned from furlough and remained in employment at year’s end - was announced; but this covers less than two weeks of wages for the average worker, and so will have little impact on employment decisions. £1,000 grants to firms who take on young trainees, with a further £2,000 if these trainees are then hired, were also announced. Although useful, these are not expected to have much impact on overall unemployment, as most unemployed workers are not eligible. The Chancellor could have instead announced a large scale “Jobs Package” that aimed to reduce the rise in unemployment by extending JRS and introducing hiring subsidies in an attempt to accelerate job creation.

In recent research, we have addressed two questions: what has been the impact of the JRS? And what would have been the effect of adopting a Jobs Package? The scale and rarity of the COVID-19 pandemic means that answering these questions is difficult. The only comparable modern event is the “Spanish Flu” pandemic of 1919-20, but there is too little data on the impact of this on labour markets, and the economy has changed so much in the past 100 years.

So, to answer these questions, we constructed a model of the UK labour market and simulated the impact of the pandemic by subjecting the model to a series of shocks – namely impacting worker sickness, job losses, productivity and demand. We also modelled the impact of the JRS and the monetary policy response of the Bank of England. We found the impact of the pandemic on the economy by tracking movements in employment, output and wages in response to the shocks. In our baseline model, we sought to match the initial responses of employment and unemployment to the pandemic and modelled the recovery from the pandemic by tracking how these evolved over time.

To answer our main research questions, we considered two scenarios. The first was designed to show the impact of the JRS by modifying the shocks to reflect what they might have been without the JRS, so the impact on job destruction is larger, support for wages is lower, and more workers become sick (as more workers will be at work and exposed to infection). This is offset by a smaller fall in productivity, as more workers are at work.

Our second scenario was designed to show the possible impact of our proposed Jobs Package that was not announced. The rate of job destruction was reduced for longer, and the costs of hiring workers for firms were reduced, incentivising firms to create more jobs and recruit unemployed workers to fill them.

Our model was designed to reflect key features of the UK labour market. First, the labour market experience of different types of worker differs markedly. Some workers, typically those with university-level qualifications, have higher wages and greater job security than non-graduates. The pandemic has highlighted this disparity, as lower paid workers with lower qualifications were more likely to be in key occupations and at higher risk from the virus. Second, the distribution of graduates across occupations is complex, with over one third of graduates employed in “non-graduate” occupations. And third, there is substantial movement of workers between jobs and between sectors, with most hires coming from workers who are already employed rather than from the unemployed.

Our baseline model was in line with projections by the Bank of England, IMF and OECD, but with more detail on the impact on different types of workers. Unemployment rose to three million workers, of whom 2.2 million are non-graduates. Employment fell by 6.6%, while non-graduate employment fell by 8.1%. The real wage fell by 0.9%, while the wages of non-graduates fell by 2.0%. Output recovered quickly, but employment remained below 2019 levels for several years.

We found that JRS had a large impact. Without the JRS, unemployment rose to five million, employment fell by 20% and real wages fell by 16%. But we also found that the JRS increased the loss of output due to the pandemic, by removing workers from the workplace at the height of the pandemic.

These provisional findings suggest that the JRS has been a major success, even at a cost of close to £60 billion. We also found that the benefits of the JRS could have been strengthened and prolonged if the “Summer Statement” of July 2020 included a commitment to the “Jobs Package” outlined above. The rise in unemployment could have been reduced from three million to 2.2 million; the recovery in employment could have been brought forward by three to six months; and the projected reduction in the real wage could have been avoided. Although expensive, the social and economic benefits of preventing the rise in unemployment to three million suggest that the failure to introduce a Jobs Package was a policy mistake.

All articles posted on this blog give the views of the author(s), and not the position of the IPR, nor of the University of Bath.

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