Journalists love to draw parallels with the past. It’s a nice shorthand way of illustrating a point.
Inevitably then, the pandemic has elicited comparisons with previous eras – not just the obvious virus-related ones like the Spanish Flu episode of 1918, but a variety of other epochs which supposedly illustrate the times we are living in by one characteristic or another.
When the pandemic initially struck, some commentators initially likened the times to the 1940s, a sombre period defined by austerity, slow rebuilding and high government spending. The assumption was that we were in for a period rather like the second half of the decade that followed the Second World War.
Then, as money piled up in peoples’ bank accounts while they sat at home (courtesy of furlough and ‘Work from Home’ initiatives) the press began drawing an analogy with the ‘Roaring Twenties’, a period of strong economic growth, fuelled by innovation, confidence, and a certain level of decadence, when the economy boomed following the Great War and the post-war recession.
More recently though, the parallel drawn most frequently has been with that of the 70s. This was a difficult time for the economy, when real GDP growth was low or negative, and inflation high – when in fact, the UK experienced one of the worst bouts of hyperinflation ever, with the Retail Price Index peaking at annual rates of 26%. The combination of a stagnating economy and out-of-control inflation became known as ‘stagflation’. With its industrial unrest and power shortages – on top of lower living standards – it is probably not something most of us would want to experience again.
Now it’s worth saying that a repeat of the 1970s is not a given. At present, broad projections for growth are still strong, with the Bank of England forecasting 7% growth in 2021 and 6% in 2022. But with labour and material shortages, plus a recent spike in energy prices, there is something in the 1970s parallel.
Lacklustre growth in July showed the worrying impact of the ‘Pingdemic’, with the economy growing just 0.1% over the month as workers were forced to isolate after coming into ‘COVID contact’. Services – by far the biggest component of the economy – were flat, while Construction declined for the fourth month in a row. Industrial Production was up, but only because some oil and gas fields had come back on stream after maintenance repairs.
The above chart shows UK GDP since January 2020, with Construction clearly weakening since the summer, and a slowing overall pattern evident.
The table above shows growth broken down by sector, with the peak to trough fall in GDP last year illustrated on the right-hand side. All sectors are below prior peaks, while overall UK GDP remains 2.2% below its February 2020 peak.
The chart below illustrates the relationship between a skilled labour shortage and lower output. The CBI index in blue is showing that management clearly believes labour shortages are leading to lower production. The black line, representing manufacturing growth, in all likelihood will follow the blue line downwards.
It seems odd that we can go from high unemployment a year ago to a sudden dearth of workers, but it looks as if this is what is happening, whether because of Brexit, furlough or people choosing to withdraw from the labour force or retire. In summary, the current labour shortages could limit output and temper the growth rebound.
Labour shortages contribute to both a shortfall in economic output and above trend inflation. Turning now to inflation, it is fair to say that most economists have significantly underestimated its rebound this year. UK inflation rose to 3.2% in August (year on year), while it is over 3% in Europe and over 5% in the United States. This is now a worldwide phenomenon.
Forecasters like Capital Economics have had to revise their forecasts upwards (shown in the chart below).
They previously forecast CPI peaking just below 3% by the end of the year, but now see it as high as 4% by early 2022. The Bank of England also sees inflation at 4% by year end, well above its own 2% target. In the past month, bond yields in the UK and elsewhere have risen quite dramatically as they factor in these expectations. Meanwhile, IHS Market survey data, which plot manufacturers’ output prices and have a strong correlation with CPI, also suggest that CPI will be considerably higher by the end of the year.
While the graph (right) suggests that the likely trajectory for inflation is one way, most economists and central bankers still see inflation dropping quite sharply to trend by the end of next year, as the current supply chain, energy and labour shortages ease over the next six months. So perhaps it is too soon to call an end of the disinflationary era of the last twenty years, on the basis that the longer-term influences of globalisation and replacement of labour by machines play out. It is also worth mentioning that long term consumer expectations for inflation are still anchored.
In summary, while the 1970s comparison looks good for the next six months or so, it may be that in a year’s time, commentators are fishing around for another elusive comparison to the world we are then living in.