The enormous fall in GDP that we have pencilled in for Q2 as a result of the economic effects of the coronavirus implies that the unemployment rate will spike over the next few months and that incomes will be hit hard. However, the short duration of the recession and the massive government support package means that the unemployment rate may rise from 4% to 6% rather than to the GFC-peak of 8%.
- The enormous fall in GDP that we have pencilled in for Q2 as a result of the economic effects of the coronavirus implies that the unemployment rate will spike over the next few months and that incomes will be hit hard. However, the short duration of the recession and the massive government support package means that the unemployment rate may rise from 4% to 6% rather than to the GFC-peak of 8%.
- No one knows just how bad the next few months will be for the economy, but we have pencilled in a 15% q/q drop in GDP in Q2. (See here.) This will inevitably lead to a sharp drop in the number of people employed. But to work out just how bad it might be we need to consider four factors.
- The first factor is how much the total hours worked in the economy might fall. One possibility is that the total number of hours worked falls by the same amount as GDP, so 15%. However, in the Global Financial Crisis (GFC) the number of hours worked fell by about half as much as GDP. This made sense as many firms accepted a period of lower productivity rather than lose trained workers they needed when the crisis was over. Something similar will probably happen this time. But as most of the fall in GDP in Q2 will be in the relatively labour intensive services sector, it makes sense for total hours worked to fall by a higher proportion than in the GFC. As such, we have pencilled in a 10% q/q fall in total hours worked in Q2.
- The second factor is how the drop in total hours worked is split between people becoming unemployed and working no hours, and employers reducing the average number of hours worked. Taking the GFC again as an example, back then two thirds of the fall in total hours worked came from people becoming unemployed and one third from people working fewer hours. However, the unprecedented level of government support this time, such as paying 80% of furloughed workers’ wages, and the relatively short duration of the recession means that we think only about 25% of the reduction in total hours worked will come from a drop in employment and 75% will come from a fall in average hours worked. (See Chart 1.)
- The third factor is the unique nature of this recession. While some industries (tourism and entertainment) will shed a lot of their workers, others (supermarkets and delivery companies) are hiring as fast as they can. This won’t be enough to offset the surge in unemployment in the pipeline, but it might blunt it a bit. In total, we think that employment will fall by about 2.5% and the unemployment rate will jump from 3.9% in January to about 6.0% in the coming quarters. (See Chart 2.) That would leave it below the GFC peak of 8.4%, but it would mean that about 700,000 people lose their jobs. And the risk is that the unemployment rate rises further than we expect.
- The fourth factor is how all this will affect household incomes. Normally, such large falls in employment and hours worked would result in a 10% fall in total income. However, given that most of the people becoming unemployed and reducing their hours are relatively low paid (workers in retail and entertainment are paid on average about two thirds of the average wage) the impact on the total amount of income earned will be smaller. What’s more, now that the government will pay 80% of furloughed workers’ pay, the fall in hours worked won’t hit incomes as much. But it does mean that millions of workers may have to take a 20% pay cut for a few months. As such, we estimate that total income earned could fall by about 4%. (See Chart 3.)
- That said, the £7bn increase in funding for the welfare and benefits system announced by the Chancellor will blunt the impact of the loss in earnings. And the likely easing in inflation means that the impact on real incomes will be even smaller. In total, we think that real household disposable income could fall by about 2%. (See Chart 4.)
- The upshot is that the unemployment rate could shoot up to 6% in the middle of this year. And our fear is that if we are wrong, it is because the unemployment rate rises closer to the peak during the GFC of 8.4%. However, the damage to the labour market will be mitigated by the government support and lower inflation, which means that both the unemployment rate and household income will probably recover much more quickly than they did after the GFC.
Chart 1: Employment & Total Hours Worked (% q/q)
Chart 2: Unemployment Rate (%)
Chart 3: Nominal Earned Income & Total Hours Worked (% q/q)
Chart 4: Real Household Disposable Income
Sources: Refinitiv, Capital Economics
Thomas Pugh, UK Economist, +44 7568 378 042, email@example.com