What are the big economic challenges facing the new Welsh government?

As the dust settles on the Senedd election results, the scale of the economic impact of Covid-19 in Wales is becoming clearer. In the face of huge challenges, the current fiscal outlook implies tough choices and trade-offs for the new Welsh Government.

Despite the gradual re-opening of the economy and easing of restrictions over recent weeks and months, the pandemic continues to take a heavy toll on the Welsh economy. Output remains well below pre-pandemic levels, especially for the hardest hit sectors. A significant share of the workforce – 159,000 workers as of the end of March – continues to be on furlough through the Coronavirus Job Retention Scheme.

The outlook for the economy and the labour market remains uncertain, but dealing with the economic effects of Covid-19 will be high on the agenda for the new Welsh Government. Economic recovery also sits alongside the need for improvements in public services, particularly in health and education, which are likely to demand increased spending and therefore create huge fiscal pressures over coming years.

How has the pandemic affected the Welsh economy?

The latest Office for National Statistics (ONS) data on the GDP performance for the countries and regions of the UK cover up to the third quarter (July to September) of 2020 (ONS, 2021). As Figure 1 shows, Welsh GDP made a significant recovery in the third quarter of 2020 (14.4%), although only in the context of a contraction of historical magnitude in the previous quarter (-15.2%). Although Wales experienced the smallest rebound, it is worth noting that the initial decline in Welsh GDP was somewhat lower than that registered across the UK.

Compared with the same quarter in 2019, Welsh GDP in the third quarter of 2020 was 6% smaller than the previous year – less of a reduction than for the UK as a whole (7.5%).

Alongside these latest GDP estimates, the Welsh Government has published short-term output indicators for key areas of the Welsh economy: construction, which accounts for 8% of the Welsh economy; market services, which accounts for 45%, including distribution, financial and insurance activities, and accommodation and food services; and production, which, at 20% of the Welsh economy, mainly consists of manufacturing. The indices can be used to gauge key trends and short-term movements in the output of companies in these sectors in Wales.

In the fourth quarter (October to December) of 2020, the index of construction, which measures output in the sector, rose by 8.7%. The indices of market services and production both also grew slightly, at a rate of 0.9% and 0.5%, respectively. Overall, the index of market services decreased by 8.4% on an annual basis, representing the largest fall since the series began (see Figure 2).

Figure 1: GDP growth for the UK nations, seasonally adjusted quarter on quarter

Source: Office for National Statistics - Regional GDP estimates

Figure 2: Short-term output indicators in Wales

Source: Short-term Output Indicators, Welsh Government, ONS and authors' calculations

One of the main attributes of the economic crisis has been its unequal impact across different sectors (Anayi et al, 2021). Service providers that have been able to work remotely, stay open during lockdowns and/or substitute online for in-person activities have been much less affected. In contrast, firms whose activities require physical proximity and face-to-face interaction have been more severely affected – with accommodation and food services at the top of the list.

Output in the accommodation and food services sector in Wales fell back again in the fourth quarter of 2020, with the emergence of a second wave of Covid-19 cases and measures reintroduced to curb its spread, such as the ‘firebreak’ lockdown. On an annual basis over 2020, output was 36.3% smaller than in 2019.

The first quarterly estimate by the ONS for the UK economy in 2021 shows a contraction of 1.5%, which means that output was still 8.7% below pre-pandemic levels. This was a smaller than the 3.8% contraction forecast by the Office for Budget Responsibility (OBR) in March.

The rapid rollout of the vaccine programme in Wales and across the UK offers hope for a faster economic recovery. In March, the OBR forecast that UK output would reach above pre-pandemic levels by the second quarter of 2022. It also forecast some ‘scarring effects’ of the pandemic and continues to assume output will be 3% below its pre-pandemic path over the medium term.

Forecasts by the National Institute of Economic and Social Research (NIESR) take a slightly more pessimistic view in terms of projected growth in 2021, In particular, NIESR expects the Welsh economy to experience a slower recovery over the coming years compared with the UK as a whole.

How has the pandemic affected the Welsh labour market?

As expected, given the magnitude of the economic recession, the pandemic has had a significant effect on the Welsh labour market, although this has been tempered by government support schemes.

Figure 3 depicts two measures of the demand for workers – weekly job adverts over time; and the number of vacancies – illustrating the extent to which labour markets have responded to the crisis. There was a sharp decline in total weekly job adverts in Wales at the onset of the crisis, falling to a third of pre-pandemic averages in May 2020. The series has since increased steadily. The number of vacancies fell by a similar magnitude (68%) between February and June 2020. But in March 2021, vacancies had recovered to around 80% of pre-pandemic levels.

In Wales, the unemployment rate among those aged 16-64 had been gradually falling since around 2011, reaching the historically low level of 2.8% in 2020 (see Figure 4). It has subsequently increased to 4.9% during the period from December 2020 to February 2021. This is below the level in England and remains low in comparison with the peak seen after the global financial crisis of 2007-09.

Figure 3a: Labour market impact of COVID-19 - Total weekly job adverts by UK country

Source: Adzuna, Online Job Advert Estimates, April 2021

Figure 3b: Labour market impact of COVID-19 - Total job vacancies in Wales and UK (seasonal adjusted)

Source: ONS Vacancy Survey/Labour Force Survey and authors calculations, March 2021

Figure 4: Unemployment rate (%) in the UK nations, aged 16 - 64

Source: Regional labour market statistics, HI00 Headline indicators for UK regions and countries ONS (April 2021)

On the other hand, the claimant count in Wales – reflecting those claiming Jobseeker’s Allowance or Universal Credit and currently ‘searching for work’ – showed a huge rise of 101% from 59,000 in March 2020 to 119,200 in August 2020 (see Figure 5). This surpassed the levels reached after the global financial crisis. But this measure overstates the true increase in unemployment and is likely to include many people still working, furloughed or in receipt of the self-employed income support (Brewer et al, 2020).

Figure 5: Claimant count rate in Wales, seasonally adjusted

Source: Regional labour market statistics: HI0 Headline indicators for Wales, ONS (April 2021)

Figure 6: Share (%) of employment furloughed by UK nations

Source: HM Revenue and Customs' CJRS claims and ONS (March 2021)

The ending of the furlough scheme, planned for the end of September 2021, will be an important milestone for the Welsh labour market. There is scope for a significant increase in unemployment unless the economy and labour demand rebounds strongly. If Welsh unemployment follows the path of the OBR’s forecast for unemployment at a UK level, then the unemployment rate would peak at around 6% towards the end of 2021, before recovering to pre-Covid-19 levels in the second quarter of 2023.

One particular concern will be the unequal impact of the crisis (Rodríguez, 2020). Workers under the age of 25 were almost three times as likely to have been working in shutdown sectors (see Figure 7). Fully half of the lowest-earning decile of Welsh workers were in shutdown sectors of the economy – making them ten times as likely to have been affected by lockdowns and social restrictions compared with the highest-earning decile. This uneven effect makes it likely that Covid-19 will exacerbate existing inequalities.

Figure 7: Share of employees affected by the lockdown in Wales, by socio-demographic and socio-economic group

Source: Labour Force Survey, 2019

Higher earners were also more likely to be able to work from home during the pandemic. According to longitudinal data, 33% of Welsh workers were always working from home in January 2021, with another 7% doing so often and 10% doing so sometimes. This level of home-working represents a significant shift away from pre-crisis working patterns and has been sustained during the last year (see Figure 8).

Based on an assessment of the feasibility of working from home across different jobs, one study finds that Wales was the UK nation with the lowest potential share of jobs that can be done from home (Rodríguez, 2020).

The Welsh Government has announced a ‘long-term ambition to see around 30% of Welsh workers working from home or near home’. This may have significant implications for longer-term trends in productivity (for example, if a lack of in-person contact leads to fewer social networks and less social capital), and for footfall and demand for retail and hospitality in towns and urban centres (Carter and Johnson, 2021).

Figure 8: Working from home by UK countries/regions

Source: COVID-19 Study 2020 (Wave 7), Understanding Society, January 2021

What are the economic and fiscal challenges facing the new Welsh Government?

The 30 seats won by the Welsh Labour party at the Senedd election on 6 May allowed it to form a government on its own (BBC News, 2021). Its manifesto promised continuity in terms of policies, little in terms of new specific spending programmes and a focus on Covid-19 recovery (Wales Fiscal Analysis, 2021).

Additional spending by the UK government in England on services devolved to Wales leads to a population-based share of funding for the Welsh Government budget through the Barnett formula (Paun et al, 2021). As such, the Welsh Government’s day-to-day spending budget grew by approximately 30% (or £5.2 billion) over 2020/21. Alongside UK government assistance for the Welsh economy, the Welsh Government has been responsible for providing significant support for businesses in Wales throughout the crisis (Economic Intelligence Wales, 2020).

Lower costs for personal protective equipment (PPE) and the devolved element of the test and trace system in Wales allowed a greater share of spending on business grants and reliefs in Wales (Ifan, 2021). The Welsh Government has approximately £2.5 billion of Covid-19 funding for its pandemic response in 2021/22. Non-domestic (business) rates and further grant support for businesses have been among the allocations made thus far (Welsh Government, 2021).

Supporting the recovery and dealing with the economic legacy of Covid-19 will require sustained additional investment from the Welsh budget. Arguably, the most significant commitment in the Welsh Labour manifesto was the promise of a new Young Persons Guarantee, which would give everyone under the age of 25 the offer of work, education, training or self-employment. This will require further spending on skills and employment policies, which are budgeted at £194 million this year.

The Welsh Government will also need to be mindful of new UK Government schemes that will operate in Wales – for example, Kickstart (which will fund six-month placements for 16-24 year olds on Universal Credit) and Restart (supporting Universal Credit claimants to find jobs in their area).

Simplified and joined-up support for those who need it will be important. Additional efforts will have to be made on issues such as wage progression and job creation for lower-educated workers, which have become central concerns about post-Covid-19 labour market inequality.

Finding sufficient funding for programmes from the Welsh Government budget will also be a challenge. Previous devolved interventions in this field – such as the ReAct and ProAct schemes introduced in 2008 – were often part-funded by the European Union and will no longer be available.

There are other huge pressures elsewhere in the Welsh budget. Post-pandemic, these are likely to come from many directions, including the cost of reducing the backlog in elective care in the NHS and the need for additional learning provision for students (Ifan, 2021; Education Policy Institute 2021).

Current UK government spending plans contain no Covid-19 funding after 2021/22, assume NHS and schools spending in England returns to pre-pandemic multi-year plans and imply cuts for other public services (Zaranko, 2021).

Since Welsh Government funding mainly depends on UK government spending plans in England, this implies a relatively austere outlook for the Welsh budget. Balancing competing demands in recovering from Covid-19 will be a huge challenge over the next Senedd term.

Where can I find out more?

The Wales Fiscal Analysis programme of Cardiff University’s Wales Governance Centre publishes regular reports on fiscal and economic issues in Wales.
The Welsh government’s Key economic statistics brings together monthly data covering topics such as employment indices, exports and earnings.
Economic Intelligence Wales, a collaboration between the Development Bank of Wales, Cardiff Business School and the Office for National Statistics produces quarterly, annual and bespoke reports on the Welsh economy.
The Welsh Parliament’s Senedd Research InBrief blog often collates research on the Welsh economy and other relevant policy areas.
The Bevan Foundation produces regular commentary on labour market data for Wales.
The Wales Centre for Public Policy collaborates with policy experts to produce research on economic and social issues in Wales.