Illustration by Adam Howling

Shock therapy: How the pandemic is resetting Britain’s whole free market model

The Brexit economy was meant to break free from the continent, but the force of events is fast pushing its ruling philosophy in precisely the opposite direction
December 6, 2020

The British government’s approach to the coronavirus pandemic has produced one undisputed success: the quick establishment of the furlough programme for workers in the first lockdown of spring 2020.

In very little time, the Treasury set up an ambitious wage subsidy scheme more or less from scratch. It was accompanied by a number of other economic support schemes for workers, some of the self-employed and businesses, especially in the hard-hit sectors. While complaints were made about many of the accompanying schemes which saw people fall between the cracks, the main furlough scheme was largely seen as well conceived and aptly executed.

What’s interesting about this British success story is that until 2020 it would have been regarded as anything but British—it goes against what has long been seen as the governing philosophy of the Anglo-American economies. At the very moment that Brexit was meant to reorientate the UK further away from the continent and realise its true “mid-Atlantic” nature, this direction of travel has been called into question.

The general approval of furlough stands in yawning contrast to the litany of failures in the rest of the pandemic policy response: most obviously, the dithering and inconsistent approach to public health restrictions and lockdowns. It also contrasts—if less dramatically—with later iterations of the furlough policy itself. A phased reduction in support got going without too much difficulty, but by late summer the insistence it would expire at the end of October was met with the objection that businesses were still not fully ready to return to normal activity. The government countered that it could not save all jobs, proposed a new Job Support Scheme exclusively for employers willing to pay employees to work at least part-time, and argued it was right to let market pressure sort out viable from non-viable companies and activities.

There was reasonable disagreement over how much, and how soon, to try and accommodate or delay this structural adjustment. The proposed 31st October cliff-edge, plus the undifferentiated nature of the furlough’s withdrawal, would have done little to cushion the transition from old, non-viable jobs into hoped-for new, viable ones. Admittedly, there was a youth hiring bonus, but it was criticised as poorly targeted. And to protect those at the bottom end, there was a £20 per week boost to Universal Credit, but this was only temporary and is set to be withdrawn in April.

In any case, within weeks this debate was overtaken by the government’s screeching policy U-turn. It decided to extend for a further six months the furlough it had stubbornly insisted could not be prolonged even for regions already in local lockdown measures. The PM mumbled the news as he announced a second lockdown on Halloween, the very evening the scheme was due to expire. The detailed briefing later revealed that the terms were suddenly being jacked back up to the original rates from the spring, something that areas in regional lockdowns had asked for but been denied. Whatever the pros and cons of various versions of wage subsidies, such about-turns are no way to plan, decide and announce policies. (The sudden swerve might have drawn more political heat had it not been for the even-greater chaos around the second national lockdown itself—like the restored furlough, it was resisted vociferously before abruptly being adopted.)

A paradoxical achievement

None of these ructions, however, should distract from the fact that the original establishment of furlough was rightly and widely celebrated. To set up a huge new labour market intervention successfully in so little time is to the government’s great credit.

But there is a paradox here, especially for the Conservative Party’s most zealous Brexiteers. While their project is to break free from what they regard as sclerotic European economic practices, the Treasury’s achievement in setting up furlough amounted in essence to establishing something that was already standard in many—if not most—European countries.

The UK scheme was seen as being inspired by Germany’s Kurzarbeit (short-working) policy. This labour market scheme discourages redundancies for reasons of short-term economic difficulty, by allowing companies to reduce hours worked with the state subsidising wages to compensate employees (the subsidy pays 60-67 per cent of the regular wage for hours not worked). The objective is to protect valuable employer-employee relationships against short-term fluctuations. While Germany may be the most famous case, it is hardly the only country that subsidises the bulk of normal wages in cases of temporary layoffs or reductions in hours. Nearly a dozen western European countries had such schemes in place by the 2008 financial crisis, including France, Italy and Austria. Many were then expanded in that crisis, and meanwhile much of eastern Europe began setting them up as well.

[su_pullquote]“The approval of furlough stands in contrast with the litany of failures in the rest of the pandemic policy response”[/su_pullquote]

Most countries that offer generous replacement of wages lost because of short-term drops in the demand for labour also offer regular unemployment benefits amounting to a high share of wages previously earned. The two things are not entirely separate: in some cases the “furlough” wages are operated through the unemployment benefit system rather than through employers. This illustrates a different philosophy of almost fully compensating for risks to workers’ incomes due to economic fluctuations—as opposed to the post-Thatcher UK tradition, shared with several other Anglo-Saxon countries, of offering only a basic safety net.

While every government had to adjust its benefit systems to the sheer scale of the pandemic emergency—making them more generous, easier to access, or longer-lasting—“adjustments” was generally the right term. Take Norway, where the standing scheme for compensation in a temporary layoff (or reduction in hours) had its rate lifted from 62.4 to 80 per cent of prior wage for the low-paid. Here parallel changes were made to allow workers to receive the payment for almost a year (nearly twice as long as before) and to shorten the initial period in which employers, as opposed to the government, have to foot the bill. All this merely changed the parameters of a pre-existing scheme to make it more generous.

Germany, France, and the Scandinavian countries all had many big and difficult policy decisions to take this spring, both in locking down and in scrambling together subsidies and credit guarantees for businesses. But they did not need to do anything conceptually unprecedented in the labour market; they could support mass furlough “merely” by tweaking and enlarging the support schemes already in place. By contrast, in the UK, furlough was a radical conceptual departure from the governing economic philosophy. Compared to much of western Europe, UK labour market policy has been based on a much lower proportion of wages being replaced by benefits when a job is lost, as well as a more “flexible”—meaning less strictly regulated—regime of protections and rights for workers on the job. In short, the labour market policy framework of continental Europe and Scandinavia proved fit for purpose amid the unprecedented shock caused by the virus; the UK system required radical innovation to be up to the task.

Tough love

The philosophy underpinning the “British model,” at least up until the pandemic, is one partly shared with the United States. We can describe it as seeking to promote both productivity and employment by declining to protect existing jobs against market headwinds, while also—through low out-of-work benefits—giving workers powerful reason to accept new (and hopefully more sustainable or productive) alternative jobs.

Some see this approach as political—about advantaging capital over labour, or profiting from divisive campaigns pitting strivers against skivers. Perhaps, but it is worth pointing out that New Labour enthused as much as Conservative politicians about the virtues of a flexible labour market. And it is not just posturing politicians, but officials and advisers who have often aired apparently sincere hopes that British “tough love” may actually help us end up with less poverty than elsewhere in Europe, by getting more of the jobless into paid work. But even if we consider the aims of the UK regime on the assumption of good faith, it has not been entirely successful on its own terms. While employment rates have been exceptionally high by continental (if not Scandinavian) standards, on any measure labour productivity has remained stubbornly below that in France and Germany. The challenge of the jobless poor has mostly been transformed into one of the working poor.

The move to embrace a furlough scheme lays bare both the political and economic brittleness of the British tradition. Consider, for a moment, what the labour market would have looked like if the furlough scheme had not been introduced, and employees had simply dropped off company payrolls and been forced to rely on the meagre pre-existing system of Jobseeker’s Allowance and Universal Credit. An immediate explosion in unemployment would have followed—similar to the roughly 10 percentage point drop in employment rates in the US and possibly worse, given that the US did not have a national lockdown and that the pandemic took a long time to reach the same nationwide proportions as in the UK.

It was obvious to everyone that this prospect was politically lethal. That is why even a Conservative government had minimal compunction about departing from longstanding British resistance and adopting “European” practices of high wage replacement rates, at least for the temporarily idle. (Interestingly, even the deadlocked and Republican-led US political system drew a similar conclusion, and introduced not just unprecedented fiscal stimulus and business support, but direct cash payments to households as well as boosts to unemployment benefits so significant that many of the newly jobless ended up with temporarily higher incomes than they did when employed.)

Economically, too, the writing was on the wall. A sudden plunge in income suffered by many millions of people having to fall back on the miserly means-tested safety net would, plainly, have made for a collapse in demand. The fact that even with the unprecedented furlough scheme the UK was among the worst economic performers in the second quarter of 2020 gives some inkling of how bad things could have been without one.

Forward or back?

If this is right—if the UK’s opting for a furlough scheme shows up the shortcomings of Britain’s governing economic philosophy—then we must ask whether this realisation can be forgotten. Will it be possible to return to a “mid-Atlantic” model after the pandemic? Or does the embrace of wage subsidies—and more generally of the need to protect workers against risk—mark a watershed, beyond which logic will push the UK permanently in the direction of more continental economic governing principles?

The UK may ultimately stick to its mid-Atlantic approach. The pandemic is, after all, an extraordinary sort of crisis, and unprecedented measures justified to combat it may equally justifiably be dismantled once we return to merely the “normal” fluctuations of capitalism. And indeed, when it looked like the pandemic was on the wane, the government was initially firm in its intention to stop “paying people not to work.” Nobody remains an atheist in a foxhole, as the saying goes, and we may all be Keynesians in a depression; but experience shows how easy it is to leave both God and Keynes behind when we are back to safety.

[su_pullquote]“The move to embrace a furlough scheme lays bare both the political and economic brittleness of the British tradition”[/su_pullquote]

But there are also strong reasons to think the pandemic will actually mark an irreversible change in the basic British framework. For one thing, until the virus itself is permanently neutralised, it will be politically difficult to remove the protective policies. That is precisely what the autumn U-turn on furlough showed. While optimism is currently high that vaccine developments will bring things “back to normal” in 2021, some sectors and activities may be permanently scarred. This shift to remote working and online retail, for example, will not be completely reversed, and a potentially large army of shopworkers will not thank a government that throws them straight on to its meagre safety net.

At the same time, “extraordinary” policies have a way of becoming ordinary once they are placed in the toolbox. Monetary policy is a case in point. In the global financial crisis, central bankers dramatically increased the size of their balance sheets to prevent financial collapse—but with time, a consensus has emerged that similar policies could be useful again and central banks should never return to the skinny balance sheets of the pre-2008 world. Their deployment during the pandemic has confirmed the wisdom of keeping new tools available. On this precedent, the UK will keep at least a “just in case” version of the furlough scheme ready to be activated at short notice—and once it is there, it could prove hard not to reactivate it in an ordinary downturn.

An additional reason to expect lasting change is that economic policy paradigms were already undergoing rapid change before the pandemic hit. There has, for example, been a growing appreciation of the problem of regional inequality. This underpins the government’s “levelling up” promise, and the broader recognition that market forces unchecked will tend to make regional disparities worse rather than better. This is already causing the Treasury to rethink how it assesses “value for money” in infrastructure investments. This greater willingness to question what was previously taken as axiomatic lowers the bar to asking whether US-style labour market “flexibility” is the right model for Britain at all—especially at a time when the (over-hyped but real) rise in “gig work” is causing anxiety about where employment relations could head.

Ever since the financial crisis, British politicians have had a nagging sense that the way the economy has been run is not popular. Hence they now vow to “build back better” post-pandemic, rather than “getting back to normal.” This redoubles pressure for transformational change.

The third road

There are, then, many reasons to think that the UK—voters and rulers alike—may come to think that the radical measures to protect workers that were introduced on an exceptional and temporary basis will be worth keeping in some form. If so, the changes seen in 2020 will eventually turn out to signal a sharp “European” turn in UK labour market and benefits policy.

But even if the old mid-Atlantic model looks increasingly unsustainable, one might still think that Britain’s political culture, economic structure and institutional history makes it hard for it to adopt “continental” worker protection. What, then, might a new “bespoke” British model look like?

It would presumably have to combine the old motivation to keep up “creative destruction” in the labour market—moving people quickly out of unviable jobs and into new ones, rather than protecting doomed employer-employee relationships—with a recognition that more of the risk currently falling on individual workers needs to be taken over by the state. If that is not going to be carried out by subsidising jobs, it has to be done through out-of-work, or more precisely the not-related-to-work benefits. To achieve more protection while giving market forces a free hand to cull unviable jobs requires enhanced cushioning, at least for brief spells of joblessness.

Could something like this be built on Universal Credit? Two of the original rationales for this system were to simplify benefits so the effect of decisions about work on take-home pay would be more transparent, and to reduce the exorbitant effective marginal tax rates for benefit claimants—the 90p+ in every pound of earnings lost when extra effort triggers not only payroll taxes, but also the reduction of housing support, local tax relief and tax credits. Note that these are also important rationales for Universal Basic Income.

We can imagine a revamped Universal Credit that fixes its logistical problems, drops the painful wait from job loss to eligibility, significantly increases the rates paid while meaningfully slowing the (still high) rate at which support is withdrawn as earnings rise. In short, a benefit that is reformed in the direction of a Universal Basic Income, making a continued “flexible” labour market compatible with reduced risk for individuals. This would cost money. But so would the alternative of a more continental-style system of job and wage protection. Those who object that Britain is far too centre-right a country to countenance anything resembling a citizen’s income should remember that Milton Friedman, an intellectual hero of the free-market right, was a strong proponent for it precisely because it neutralised the arguments for a more European-style welfare state.

It is not clear which of these three roads the UK will take: will it be back to the old “Anglo-American” ways, a sideways shift to the continent, or forward into a new bespoke model? For the first time, all three look conceivable. That in itself is a sign of how much the pandemic has transformed the country’s political and economic settlement. The irony is that an apolitical virus has ended up accidentally doing this—and more powerfully—at the same moment that the great political project of Brexit was meant to be resetting the order. And it is working in pretty well the opposite direction to what the most prominent Brexiteers had intended.

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