But this development has raised questions about the effects on workers’ productivity. A review of recent evidence indicates that policy-makers should be sceptical of general claims being made about the impact of home working on productivity, either negatively or positively.

Some quantitative studies indicate that the pandemic has had a negative effect on labour productivity. But at the same time, more qualitative studies provide important insights that are relevant to public and private decision-makers.

Indeed, productivity is a complex variable to determine, and different studies have applied varying approaches to capture the impact of Covid-19 on labour productivity. Recent studies have used three main approaches, which appear to give different results. These are based on: accounting data; systems for monitoring the activities and hours worked by employees; and self-assessment by workers.

While the first two approaches show a mainly negative relationship between working from home and labour productivity, the self-assessment approach reports mixed results.

Specifically, although some research seems to imply that a return to the workplace is necessary to recover economic performance, the preferences and perceptions of employees seem to suggest that working from home at least some of the time (‘hybrid working’) may become a permanent option.

This implies that employers will have to adapt to this situation by supporting its implementation, agreeing on a strategic position on hybrid working with respect to the specific organisational context, and facilitating it through training, provision of appropriate equipment and so on.

How might the pandemic have affected productivity?

In economic terms, the pandemic has led to a fall in investment, an erosion of human capital due to unemployment and a decline in global trade and supply chains. In addition, it could also be associated with a constraint on the ability of economies to raise incomes in the long run and a reduction in productivity (World Bank, 2021).

In the short term, the negative effects of the pandemic are most evident when considering the depletion of the labour force (people made redundant, becoming sick and/or on furlough), the tightening of financial conditions and the disruption of supply chains (World Bank, 2021).

Similarly, the measures to contain Covid-19 have increased firms’ intermediate costs, pushed down value-added relative to sales – that is, reduced the difference between the selling price of a product or service and its cost of production – and reduced productivity (Bloom et al, 2021a).

There are other effects that are less clear. The pandemic forced many firms to adopt working from home. At least initially, many employees were not provided with the necessary support or infrastructure for remote work, nor did many have the skills required.

As a result, productivity may have gone down due to increased distractions and communication costs. These include the time spent on coordination activities and meetings both within and outside companies, which has meant a reduction in the number of uninterrupted hours when working from home (Gibbs et al, 2021).

On the other hand, in this new way of working, greater job autonomy and self-leadership could have led to higher individual productivity (Galanti et al, 2021).

The adoption of working from home has also meant that at least a fraction of the time saved in commuting is devoted to work-related activities, which may increase productivity (Barrero et al, 2021). In addition, the closure of less productive firms due to the pandemic tends to increase average productivity in the short run (Bloom et al, 2021a).

Many of these mechanisms that can explain productivity changes in the short term may also apply further down the road. A prolongation of the pandemic would continue to have supply-side effects, mainly in terms of labour depletion (that is, people made redundant, sick and/or on furlough) and supply chain disruptions.

In addition, social isolation, family-work conflicts and longer working hours can affect workers’ wellbeing and their mental and physical health. This is likely to have a negative impact on their long-term productivity at work.

Similarly, it is likely that the time that senior managers have had to devote directly to the pandemic has in part been taken away from other long-term productivity-enhancing activities (Bloom et al, 2021a). Further, the effect of lower investment in research and development (R&D) and innovation during the pandemic is likely to affect productivity in the long run.

Nevertheless, while the adoption of working from home may have had negative effects on productivity in the short term, these can, in principle, be mitigated and even reversed in the long term. Indeed, there is scope for improving the management of remote working, and labour productivity can be increased by enhancing managerial support (Farooq and Sultana, 2021).

What do recent empirical studies say about the impact of Covid-19 on productivity?

Research in this area has focused on analysing the effects of the pandemic on productivity in specific economies, sectors and firms, mainly considering the effects of home working. This is due to the specific objectives of each study, the availability of relevant information and the complexity of measuring productivity in practical terms.

Although measurements in this context are diverse, three main practical assessment methodologies can be identified in recent studies.

First, there are studies that examine labour productivity on the basis of mass accounting or numerical information from statistical databases. For example, using data from the Decision Market Panel of the Bank of England, one study finds that the pandemic would have reduced total factor productivity – that is, productivity including changes in capital as well as labour inputs – in the UK private sector by up to 4%, estimating a 1% reduction in the medium term (Bloom et al, 2021a).

The study also suggests that the increase in intermediate costs associated with the pandemic would influence the reduction in ‘within-firm’ productivity, that is, how productive individual firms are. This is notwithstanding the compensating effect coming from the contraction of less productive sectors (and firms), which is known as the ‘between-firms’ effect (see Figure 1).

There is evidence of a negative relationship between Covid-19 and productivity in another study, which estimates that the pandemic reduced labour productivity by 4.9% in Latin America and by 3.5% in the 24 countries included in the sample, considering direct and indirect sector-level effects on the economy (Ahumada et al, 2022).

Figure 1. Contributions to the impact of Covid-19 on productivity

Panel A: Labour productivity per hour

Panel B: Total Factor Productivity (TFP)

Source: Bloom et al, 2021a

Second, other studies determine labour productivity on the basis of employee activity monitoring systems. One, which uses employee activity tracking systems in Asian information technology (IT) service companies, observes a reduction in labour productivity by 8-19% due to the pandemic (Gibbs et al, 2021). This is explained by the fact that employees worked longer but less productively, as output remained about the same (see Figure 2).

Another study, using a dataset of the daily activities of developers in one of China’s largest IT companies, finds varied results depending on the different comparison metrics used (Bao et al, 2021). The researchers observe that working from home has both positive and negative effects on overall project productivity depending on the metrics evaluated and the characteristics of each project.

Figure 2: Average outcome by month

Panel A: Input – Time worked per working day

Panel B: Output –tasks completed relative to target

Panel C: Productivity

Source: Gibbs et al, 2021

Note: the vertical line (month 0) indicates the switch to working from home.

Third, there are a large number of studies that analyse labour productivity from a self-assessment point of view. In other words, they address the workers’ own perceptions of their performance.

Only one study fully supports the negative relationship between working from home and labour productivity during the pandemic, particularly considering the possible influence of a less supervised work environment (Farooq and Sultana, 2021).

The results of other research show mixed or positive incidences. For example, one study observes that difficulties in reconciling family and work and social isolation negatively affect work productivity, while autonomy is positively related to work productivity (Galanti et al, 2021).

Another finds negative impacts in terms of decreased work motivation, distraction and multi-tasking, as well as positive effects related to work-life balance, flexibility and time savings (Mustajab et al, 2020).

Other work shows that factors related to working from home – such as having a comfortable workplace, making one’s own decisions about how to schedule work, combining work with household chores or avoiding commuting – can have a positive effect on job satisfaction and a negative impact on job performance, with positive and negative effects on productivity, respectively (Ramos and Prasetyo, 2020).

Other studies find no significant changes overall in workers’ perceptions of productivity before and during the pandemic. But this does vary by sector, occupation, worker characteristics and work context.

For example, one study observes that workers in industries and occupations that are less suitable for home working, such as those related to food, report a decline in productivity. This was also observed among low-income earners, the self-employed and women, particularly those with children (Etheridge et al, 2020).

Another study finds that women, older and high-income workers were likely to report increased productivity (Awada et al, 2021). Other research finds that self-reported productivity was higher while working from home despite self-reported negative effects on physical health, such as a significant increase in back pain and weight gain related to decreased physical activity and increased consumption of junk food (Guler et al, 2021).

Evidence also indicates that home working will boost productivity in the post-pandemic economy by 0.8-1% as conventionally measured, or by 3.6-4.6%, on a wider definition of productivity that includes reduced commuting time (Barrero et al, 2021).

In the data used by the latter large-scale survey, 45% of the respondents answered that their efficiency when working from home was about the same as working on company premises, while 39.7% answered that their efficiency at home is higher (see Figure 3).

Figure 3: Efficiency of working from home versus working on business premises

Source: Barrero et al, 2021

Note: Responses to the question ‘how does your efficiency working from home during the Covid-19 pandemic compare to your efficiency working on business premises before the pandemic?’

Overall, in studies that could be called more ‘objective’ – that is, those that use mostly accounting data in measuring the productivity of the corresponding economies, sectors or firms – it appears that Covid-19 has negatively affected productivity.

But when the monitoring of workers’ activities and workers’ perceptions of their performance are taken into account, the results are more diverse. They depend on the context and characteristics associated not only with the work, but also the workplace and workers themselves.

In addition to the studies mentioned above, a recent investigation of 1,612 engineers, marketing and finance employees at a large technology firm based in Shanghai used a randomised control trial (RCT) methodology in which half the group were arbitrarily assigned to being able to work from home for two days per week, while the other half worked full time in the office (Bloom et al, 2022).

Among other findings, this study found no impact in the group that were working from home or in any individual sub-group in terms of performance reviews or promotions. Lines of code written by the home working group – one measure of employee productivity for IT engineers – rose by 8% (as measured over the whole working week) compared with the control group. Employees' self-assessment of their productivity while working from home was also positive, with an average post-experiment assessed impact of 1.8%.

What are the implications of the results of the impact of Covid-19 on productivity?

The pandemic is a unique crisis that has affected both the supply and demand for goods and services. It has created a context in which incentives for product innovation and quality improvement are reduced, technological progress is held back and productivity is reduced (World Bank, 2021).

Consequently, a pro-active approach from both the public and private sectors is needed to boost productivity growth. Policy-makers will need to facilitate investment in physical and human capital. Firms will need to revitalise their capabilities to drive technology adoption and innovation.

Economic shocks caused by the pandemic may lead to structural changes that can improve productivity in certain sectors. The option to work from home could increase and may positively affect labour productivity due to the re-optimisation of labour arrangements (Barrero et al, 2021).

Additionally, the various measures taken by firms to deal with the productivity consequences of the pandemic, such as investment in home equipment to facilitate working from home, have not only mitigated the decline in output but also significantly changed work dynamics (Eberly et al, 2021; Bloom et al, 2021b).

The shift to home working seems to have affected not only labour productivity but also workers’ wellbeing, especially in the context of work-life balance.

One study observes that individuals working from home due to the pandemic reported lower stress, higher efficiency and better quality in their work. But the same study also finds self-reported weight gain and increases in lower back pain, both of which may have longer-term health implications (Guler et al, 2021).

Workers’ perceptions of home working are still subjective and depend on multiple factors, such as the complexity of the work performed, the need for interaction (or not) with other colleagues to complete certain tasks, the awareness of being observed and evaluated, and, even more importantly, family and workspace conditions at home.

Indeed, there is currently no consensus in economic research on the productivity effects of working from home, as it can be very unequal across people and locations (Behrens et al, 2021; Barrero et al, 2021).

Undoubtedly, policy-makers should be sceptical of general claims being made about the impact of home working on productivity, either in a negative or positive direction. The quantitative studies reviewed here mostly support the notion of a negative effect on labour productivity, indicating a necessary return to the workplace to regain pre-pandemic economic performance.

Yet those studies of a more qualitative nature provide important insights – on employee preferences and wellbeing – that should be considered by relevant public and private decision-makers.

Where can I find out more?

• London’s workforce during the pandemic: Report by the Policy Institute at King’s College London and King’s Business School.
• The WFH revolution: how new ways of working are changing London: King’s Business School and Policy Institute at King’s.
• Nick Bloom describes findings of why working from home will stick: National Bureau of Economic Research.
• Julia Hobsbawm ‘The Nowhere Office’.
• WFH Research.

Who are experts on this question?

• Nick Bloom, Stanford University
• Philip Bunn, Bank of England
• Steven Davis, The University of Chicago
• José María Barrero, Instituto Tecnológico Autónomo de México

Authors: Cristian Escudero and Mark Kleinman

Picture by monkeybusinessimages on iStock

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While a recovery is under way, limitations, ambiguity and complexity as a result of the pandemic and the war in Ukraine – which is also driving higher airline costs – might still prevent some passengers from travelling abroad this year.

A priority for policy-makers should now be to restore travel connections, to protect an industry worth 11.3 million jobs. Prior to the pandemic, the sector contributed almost $9.2 trillion (£7.6 million) to the global economy.

The global tourism industry, as it recovers from the effects of Covid-19, might have contributed $8.6 trillion (£7.1 trillion) to the world economy this year, according to data from the World Travel and Tourist Council (WTTC). That would be just 6% less than before the pandemic struck.

This forecast came just before the Russian invasion of Ukraine in February 2022 and was contingent on the vaccine and booster rollout continuing at current rates and restrictions to international travel being eased.

Currently, the recovery of the travel industry risks being delayed by 12-24 months to 2024 because of factors such as persistent inflation, high energy prices, labour shortages at airports, and lockdowns in China. The partial rebound this year is being driven mainly by the lifting of travel restrictions in many locations. Starting from June 2022, the United Nations World Tourism Organization (UNWTO) reported that there were no Covid-19-related restrictions in place in 45 locations, 31 of which are in Europe.

As more places reduce or remove travel restrictions, and the demand pent up during the pandemic is released, the expectation is that there will be a steady recovery, supported by the summer holiday season in the Northern hemisphere.

Before the war, international travel increased by 182% during the first three months of 2022, compared with the same period last year, according to the most recent UNWTO World Tourism Barometer.

Around 60% of international arrivals in the first three months of this year were registered in March alone, indicating that the recovery in the tourism sector was gaining momentum.

According to the same UNWTO data, the first quarter of 2022 saw over four times as many foreign arrivals (+280%) in Europe as in the first quarter of 2021. This increase was mostly due to high intra-regional demand. Arrivals in the Americas increased by 117% in the same three months.

Despite these encouraging signs, the global economy is projected to falter in the second half of 2022. Several forecasters have recently revised trade and GDP figures downward worldwide.

The war in Ukraine represents a threat to the recovery of the global economy and to the tourism industry itself. Besides causing travel problems and increasing country-risk in Europe, the conflict is also driving up already high oil prices and inflation. It is also causing further disruption to global supply chains.

This may suppress demand through higher costs of travel and accommodation. Indeed, with expanding operations and increasing fuel prices, travel costs will go up in 2022. Prices for kerosene surged to an average of $74.50 (£61.70) per barrel in 2021, and it is anticipated that they will rise to $77.80 (£64.41) per barrel in 2022. As a result, international tourism remains 61% below 2019 levels, based on the latest available (June) UNWTO data. In particular:

• Arrivals in the Americas and Europe are still 46% and 43% below pre-pandemic levels, respectively.

• Although there was significant growth in the Middle East (+132%) and Africa (+96%) in the first quarter of 2022 compared with the same quarter last year, arrivals were still 59% and 61% below 2019 levels, respectively.

• Asia and the Pacific saw the smallest growth among international destinations, remaining 93% lower than in 2019. This is largely because China has still not completely re-opened to international tourism, as well as further virus flare-ups that have required localised lockdowns.

How has international travel been affected by Covid-19?

International tourist arrivals

Between January and October 2020, the pandemic triggered a 70% decline in international tourist arrivals compared with the same period in 2019. This was caused mainly by people not wanting to spend money on flights or not being allowed to fly due to government restrictions.

Although the sector is recovering, tourist arrivals were still below pre-pandemic levels between January and March 2022 (see Figure 1).

Figure 1: Change in international tourist arrivals since 2019 (year-on-year percentage change)

Source: UN World Trade Organization (UNWTO)

As demand in Europe started to rebound, the industry struggled to keep up, particularly in the UK, as airports could not hire enough staff to meet passenger traffic that was higher than expected. While the UK is currently facing a tight labour market with more vacancies than job-seekers in the service sector, the travel industry has been hit particularly hard due to the high number of layoffs during the pandemic.

Number of commercial flights

One significant effect of the removal of travel restrictions has been the increase in the number of commercial flights in 2022. By the end of 2020, commercial flights were down 41.7% compared with 2019, having plunged initially by 74%, according to Flightradar24.

During the first seven months of 2022, flight traffic continued to follow seasonal trends in line with a gradual recovery from the previous years, although commercial flights in July remained about 16% below 2019 levels (see Figure 2). This is higher than the air traffic seen in July 2021, where commercial flights were about 34% lower than pre-pandemic levels.

Figure 2: Number of commercial flights (seven-day moving average)

Source: Flightradar24

Hotel occupancy rates

Hotel occupancy rates (the percentage of occupied rooms at any given time compared to the total number of available rooms) have been recovering steadily. The proportion of people staying in hotels fell dramatically across all regions in 2020, with an average drop of nearly 50%.

Before the war in Ukraine, hotel occupancy rates and room revenue were projected to approach 2019 levels in 2022. Occupancy was projected to hit 63.4%, exceeding the 44% reached in 2020.

As of 11 April 2022, the UK's rolling 28-day occupancy was 87% of what it was in 2019. The next-highest occupancy indexes were recorded by Poland (84.5%) and Ireland (81.3%), according to the STR. In the former case, the increase in occupancy has been, in part, the result of housing refugees during the early stages of the invasion of Ukraine.

Industry profits

After a $51.8 billion (£42.9 billion) loss in 2021, net industry losses are predicted to fall to $11.6 billion (£9.6 billion) in 2022. But while the peak of the crisis has passed, the net industry loss is over $200 billion (£166 billion) from 2020 to 2022 (see Table 1).

Table 1: Travel industry demand, capacity and profits

Source: International Air Transport Association (IATA)

The only region registering positive net profits is North America. Overall, the industry’s capacity and demand remain below pre-pandemic levels, with the highest losses recorded in Africa, the Middle East and the Asia-Pacific region – the last mainly driven by China’s slowdown.

Is a recovery under way?

Revenues

In 2022, revenues from international travel increased by 4% in real terms from 2020. The strongest outcomes were seen in the Middle East and Europe, where earnings increased to almost 50% of pre-pandemic levels. The increase follows a drop of about $1 trillion (£828 billion) in revenue from foreign travel in 2021, on top of the trillion lost during the first year of the pandemic.

Confidence

As long as the virus is contained and destinations continue to relax or lift travel restrictions, 83% of tourism professionals predict better prospects for 2022 compared with 2021. But the prolonged closure of a few significant outbound markets, namely in Asia and the Pacific, as well as the uncertainty brought on by the war, might postpone a full recovery of global tourism this year.

Just under half of UNWTO experts (48%) now see a potential return of international arrivals to 2019 levels next year, while a slightly smaller percentage suggest this could happen in 2024 or later (44%).

Passengers

The rebound in air travel intensified with the start of the summer holiday season in the Northern hemisphere. Compared with May last year, total traffic increased by 83.1%, driven mainly by international traffic, although remaining about 31.3% below pre-pandemic levels. Compared with May 2021, international traffic increased by 325.8% in May this year. In particular, between May 2021 and a year later:

• Traffic on Asia-Pacific airlines increased 453.3%. While the majority of travel restrictions in Asia are being lifted, the main exception remains China. Here, domestic travel plunged by 73.2% from the previous year, as a result of its zero-Covid-19 policy.

• Traffic for Europe increased by 412.3%, although uncertainty and high energy costs due to the war in Ukraine will have a direct influence on certain locations.

• Middle Eastern airlines saw traffic increase by 317.2%.

• Traffic for North America increased by 203.4%.

• Latin American traffic increased 180.5%, with some routes, such as those to and from Europe and North America, performing better than expected.

Drivers of the international recovery

Global demand

Global demand is anticipated to increase to 61% of pre-crisis levels in 2022 – 20 percentage points higher than in 2021. The recovery is being driven by domestic demand, with most countries now imposing fewer travel restrictions.

One of the main components of the global demand for travel will be pent-up savings. But persistently higher inflation globally is resulting in a sizeable hit to household spending in real terms, as incomes fail to keep up with prices. In the UK, the number of households that have run down their savings is set to double by 2024, according to research by the National Institute of Economic and Social Research (NIESR). This suggests that savings-driven demand for travel might be limited or absent for some income brackets due to soaring bills.

Overall, international demand is recovering but at a slower rate than previously forecast. IATA expects that by 2022, global demand for travel will be only 44% of what it was pre-pandemic.

Vaccinations

With a few exceptions, rapid progress in vaccine administration – particularly among advanced economies – has resulted in a gradual re-opening of borders. It will take longer for tourism to be revived fully, particularly in regions where vaccine distribution has been slower, such as in low- and lower-middle income countries. This will also be the case where vaccine efficacy is lower against new variants (such as certain developed economies in the Asia-Pacific region, including China).

What else do we need to know?

The effects of Covid-19 on the travel industry provides an opportunity to reconsider the future of tourism and accelerate longstanding priorities such as addressing climate change and promoting a renewable energy transition (Organisation for Economic Cooperation and Development, OECD, 2021).

Governments must encourage the structural changes required to transform the sector in line with future health and environmental challenges. This should include implementing digital solutions that make it safer and simpler for consumers to travel, such as using artificial intelligence and data-sharing, implementing enhanced harmonised biometric standards for identity verification and travel eligibility, as well as prioritising digital border management through e-visas and e-gates.

At the same time, international cooperation and multilateral agreements should continue to ensure that COVAX-supplied Covishield vaccines are accessible evenly and widely , which will help to avoid double standards that risk penalising low- and low-middle-income countries even further.

In response to the pandemic, the G20 in Rome has issues several recommendations for the future of tourism. These are based around seven interrelated policy areas: safe mobility; crisis management; resilience; inclusiveness; green transformation; digital transition; and investment and infrastructure. Addressing these will require international organisations to use the full extent of their resources to restore travellers’ confidence, while helping the tourism industry to adapt and survive.

Where can I find out more?

• G20 Rome guidelines for the future of tourism.
• Global Economic Outlook – Fraying at the Edges: NIESR’s Global Economic Outlook No. 361, Summer 2022.
• Organisation for Economic Cooperation and Development (OECD): Preparing the tourism workforce for the digital future.
• UNWTO World Tourism Barometer: May 2022.

Who are experts on this question?

• Corrado Macchiarelli (NIESR)
• David Roberts (ONS)
• Dawn Holland (NIESR)
• Donald Houston (University of Portsmouth)
• Simeon Djankov (LSE)

Author: Corrado Macchiarelli

Editor's note: This is an update of an Economics Observatory article originally published on 22 April 2021.

Picture by Heychli on iStock

The post Update: How is Covid-19 affecting international travel and tourism? appeared first on Economics Observatory.

Sports investments work in a similar way. Men's sports often attract investors if there is even a small chance of potential returns. But for women’s sports, investors often seem to focus entirely on past performance.

Unfortunately for women athletes, several structural conditions and underlying biases have limited returns to women's sports in the past. This means they are judged against historic conditions where the odds have been stacked against them.

Consider the story of women playing professional football. On 9 November 2019, 77,768 fans travelled to Wembley to see the England women’s team play Germany. This attendance broke a record set seven years earlier at the same stadium when 70,584 people attended an Olympic match between Great Britain and Brazil.

This latter game also broke an attendance record that had been in place for more than 100 years ago. Back in 1920, 53,000 fans reportedly showed up at Goodison Park to see a match between Dick, Kerr's and St Helens.

Why did it take so long for attendance at women's matches to grow? One obvious reason is that soon after the fixture in 1920, the English Football Association (FA) essentially banned women from professional football. That ban would remain in place until 1971.

Even after it was lifted, women's football teams in the UK – as with other sports globally –  were denied the resources seen in the men’s game. When it comes to sports around the world, we see obvious gender gaps in wages.

The maximum salary in the FA Women’s Super League (WSL) is reportedly $250,000 (or about £210,000). Meanwhile the average salary in the English Premier League (EPL) is £3,090,200. So, the highest paid women in the WSL are paid less than 10% of the average player in the EPL.

Such gaps in pay between the men and women in professional sports are often attributed to differences in revenue. But a study of wages in the National Basketball Association (NBA) and the Women’s National Basketball Association (WNBA) revealed that the women of the WNBA (relative to the men of the NBA) are paid a much lower percentage of league revenue.

The differences don’t just relate to wages. There is also a substantial gap in coverage from the male-dominated sports media. We also see very large gaps in sponsorship spending and in public spending on sports. There is even a difference in the quantity of statistics produced.

All these gaps are important. But perhaps none matter more than the significant disparity in private investment. When it comes to sports, investors (who are often men) seem to have a strong preference for the men’s teams, leagues and competitions.

But why? If we look at past performance, in England, football played by men does substantially better than football played by women in terms of both attendance and revenue. Of course, this is largely because women were banned from elite football for so long. In addition, men’s teams also enjoy significant advantages in media coverage and sponsorship spending.  

For many, this is evidence of gender discrimination in the sport. But some argue that this isn’t the story at all, and instead that men’s football teams are simply ‘better’ to watch. But is there any truth in this?

Recent research indicates that this is not the case. The conclusion that these critics of the women’s game are reaching is not based on the matches they watch. To see this, researchers began by showing football fans (both men and women) videos of professional athletes (again, both men and women) playing the game. In general, viewers rated the male players as better.

The researchers then showed the same fans new videos. This time the sex of the athletes was blurred out. When people were shown the blurred videos, they no longer thought that the men playing football were definitely better than the women.

What this tells us is that the preference men have for watching men play football is not necessarily driven by any real perceptions of quality of play. These preferences are driven by an underlying belief that men are better football players. This bias may be a key factor in why women’s teams and leagues are consistently underfunded in comparison with men’s.

What recent successes has the women’s game had?

Despite this belief, women’s teams can attract impressive audiences. One example is the success of FC Barcelona. On 30 March 2022, 91,553 fans showed up to see Barcelona play Real Madrid, breaking the attendance record at a game between two women’s teams. Just three weeks later (on 22 April), the attendance record was broken again, when 91,648 fans watched Barcelona take on Vfl Wolfsburg. 

These record-breaking spectator numbers may be, in part, due to efforts by FC Barcelona to promote its women’s team (perhaps more so than other clubs have done). At the women’s Champions League final in Turin, between Barcelona and Olympique Lyonnais, there were 32,257 spectators. It is reported that of those who attended this match, at least 13,000 were from Barcelona. In contrast, only around 3,500 fans traveled from France.

This fixture didn’t just attract fans to the stadium. It is reported that 3.6 million people watched the match across all the broadcasting platforms. Despite these viewers, though, the broadcasting deal for the women's Champion’s League remains quite small. It is reported their latest deal is only worth $8 million (or around £6.67 million). To put that in perspective, the EPL’s broadcasting deal is worth more than £5 billion.

Judging by these broadcasting deals, one might think that no one is really interested in matches between women’s teams. But as recent matches have shown, Barcelona and Lyon certainly are attracting an audience. So why are these two teams drawing such a crowd, relative to other women’s teams?

Yara El-Shaboury – a freelance sports journalist – recently wrote about the success of the two teams. Each club has taken a different approach to building a successful team. Lyon has focused primarily on spending money to acquire established stars from around the world, whereas Barcelona has concentrated on developing talent by investing in ‘the best coaches, analysts, and medical staff money could buy’.

Although these approaches appear different, there is something the two clubs have in common. Both Olympique Lyonnais and FC Barcelona have found success by investing in their women’s teams. As El-Shaboury notes, this is not quite the same approach seen elsewhere: ‘for many other women’s soccer clubs, a few bad months can lead to funding drying up, which then results in permanent regression’.

This pattern appears to be a significant problem in women’s sports, where many investors focus on the financial returns being seen right now. It is a very different story in men’s sports. And perhaps nothing illustrates this difference better than the story of Major League Soccer in the United States.

Why are men’s sports teams so well-funded?

Compared with the leagues in England, Spain, Italy, France or Germany (known as ‘the big five’), the MLS is hardly a major football league. Whether we look at revenue or wages, the MLS lags far behind its European counterparts. Most teams in the MLS are not even profitable.

Despite this, investors are lining up to buy teams in the US league. In 2019 an expansion team – a new franchise in the league – sold for $325 million.  This is an enormous value even by global standards. As sports journalist Graham Ruthven argued in 2021, this amount ‘would buy a mid-table club in the Premier League or pretty much any of Europe’s other big five leagues’.

To put this price in perspective, the parent company of Olympique Lyonnais agreed to take a controlling interest in the Seattle Reign of the National Women's Soccer League (NWSL) in 2019 for just over $3 million. Given what was paid, the value of the Reign was put at $3.51 million. Apparently, a top team in women’s professional football is only worth about 1% of an expansion team in minor league men’s football.

Why would investors value these teams so differently? Financiers often say that the MLS, despite a history of losses, has a bright future. So, investors are willing to pump money into the league in the hope that a bright future will be realised.

But whether MLS teams will ever be able to compete with the five established football leagues in Europe is highly uncertain.

What about potential in professional women’s football teams? FC Barcelona is not the only women’s team to see more than 90,000 fans at the gate. The United States women’s national team has also attracted similar numbers to one of their matches. Their players are paid the same wages as the men’s team, and actually generate more revenue for the United States Soccer Federation.

But, for now at least, this proven popularity does not seem to translate to financial investment. No one is offering hundreds of millions for a women’s professional football team. For would-be buyers, past profits don’t seem to justify the investment.

And that is ultimately the difference in men’s and women’s sports. Like managers who are men, men playing sports are consistently evaluated on what investors imagine might happen in the future.

Women in sports – like women in management – are consistently judged on past returns. But because those returns are limited by lack of media coverage, sponsorship spending and public spending, women teams, leagues and competitions continue to suffer from a lack of investment.

Where can I find out more?

• On the story of Barcelona and Lyon
• On the sports media gap
• More on the gender wage gap in basketball

Who are experts on this question?

• Cheryl Cookey
• Nefertiti Walker
• Nola Agha
• Courtney Szto

Author: David Berri

Photo by Chris Leipelt on Unsplash

The post What next for the growth of women’s football? appeared first on Economics Observatory.

Inflation has been rising for several months and has now reached a 40-year high, climbing to 9.4% in the year to June 2022 (see Figure 1). This is due to irregularities and disruptions in demand and supply, and to increasing energy prices. Demand patterns have been inconsistent as the Covid-19 pandemic waxes and wanes, affecting production and distribution, and disrupting global supply chain availability and costs.

In the UK, Brexit has increased costs and difficulties of obtaining labour and of importing and exporting products. It has also had an indirect impact on exchanges rates, with the pound falling against the dollar substantially since 2016. But it is energy prices (mainly internationally priced in dollars) that are driving current inflation. Increasing wholesale gas and electricity prices are feeding into rising domestic and commercial energy bills. The cost of petrol has almost doubled in the UK since May 2020. These issues predate, but have been exacerbated by, the Russian invasion of Ukraine.

Figure 1: Inflation (June 2012 to June 2022)

Source: Office for National Statistics (ONS), 2022
Note: CPIH – consumer price index including owner occupiers’ housing costs; CPI – consumer price index; OOH – owner occupiers’ housing costs

Consumer costs have been rising for some time. Government increases in tax and national insurance, as well as the removal of pandemic-related universal credit and other benefit increases, have exacerbated the escalation. This situation also comes on the back of a decade of austerity and wage restraint for much of the population, which resulted in stagnant incomes and decreased spending power for many. Further, inflation concerns have resulted in the Bank of England raising its base rate from an all-time low of 0.1% (held between March 2020 and December 2021), through five increases to 1.25% in June 2022, impacting the costs of consumer and business borrowing.

How are consumers being affected?

Everyone is hurt by inflation, but the impacts are not felt evenly across society. Low-income consumers are more adversely affected as they spend a larger proportion of their income on food and energy (see Figure 2). The effects of rising energy, housing and transport costs have a differential and significant impact on lower-income consumers, as do food and other consumer goods prices (see Figure 3). There appear to be spatial implications from this, with the Centre for Cities calculating that inflation rates are higher in northern and poorer cities, due to their demographics, infrastructure and economic makeup.

Inflation has resulted in many (but not only) lower-income households cutting spending and/or switching the products they buy, as well as wider use of food banks and greater reliance on debt for regular spending. The problems facing low-income consumers have been highlighted by the food poverty campaigner Jack Monroe, who focuses on both the increasing prices and low availability of products typically consumed.

Figure 2: Inflation rate by income decile

Source: Institute for Fiscal Studies (IFS), 2022

Figure 3: Household spending on food and energy, 2019-2021

Source: House of Commons Library, 2022

These wider impacts on consumers can also be seen through the Growth from Knowledge (GfK) consumer confidence index. The index – which presents changes in sentiment arising from consumers’ views of their finances and the economy now and in the next 12 months – is now at its lowest level since the series began in 1974, with an exceptionally rapid decline in the last year (see Figure 4). It shows that consumers are experiencing their own financial issues but are also concerned about the general economic situation ahead and how this might affect them.

Figure 4: GfK Consumer Confidence Barometer June 2022

Source: GfK, 2022

This has also been identified in the ‘abdrn Financial Fairness Trust/University of Bristol 6^th Coronavirus Financial Impact Tracker Survey’ (June 2022), which showed the largest decrease in financial wellbeing since the study began. An additional 1.6 million households are estimated to be in ‘serious difficulties’, as well as an increase in those ‘struggling’. These impacts are focused on lower income households and describe a precarious financial existence, with reductions in retail spending, including on food, one consequence.

Consumer confidence in the UK is thus very low despite measures by the government to moderate the impact of household energy bills from spring 2022. An initial Council Tax Rebate of £150 for households in A-D Council Tax Bands has been followed by a package of UK Government assistance payments, to come in between spring and autumn 2022. This covers 8 million low-income households on benefits (£650 per household), 6 million individuals on disability benefits (£150), 8 million pensioner households (£300) and £400 for all households through an energy bill payment. More might be needed in the autumn as energy prices are now predicted to rise even further.

How is the retail sector affected?

The retail sector is beginning to see the impacts of these trends. Food products such as pasta, bread and crisps have seen large price increases, but consumers report rises across the entire product range. A particular recent example is the price of Lurpak and other spreadable butters, leading to reports of an increase in security tagging of food products. They also report cutting back on food purchases, switching to cheaper brand products, shopping more frequently for less, switching to discounters and managing budgets closely, even at the checkout tills.

In non-food markets, people are also postponing spending on large items, such as household and white goods or cars. For retailers this may lead to unsold stock accumulating in the supply chain, especially where orders were placed a while ago. There is also some evidence that clothing companies are being affected by consumers returning items, even those that have already been worn. The British Retail Consortium sales data for July 2022 showed a third consecutive month of falling sales, even before inflation was accounted for.

This slowdown in spending is picked up in official retail sales figures. There has been a fall in retail sales volumes, mainly resulting from a decline in fuel and non-food store spending, according to ONS data for Great Britain for June 2022 (see Figure 5). Online sales have continued to decline as a proportion of retail sales but remain above pre-pandemic levels. June saw food and drink sales rise due to the Queen’s platinum Jubilee, but the broad trend is for declining food sales.

These figures show a steady downward trend in retail sales volumes since summer 2021. Affordability is increasingly affecting purchasing decisions, leading consumers to buy fewer food and household items. As more consumers report difficulties in paying bills and a lack of financial resilience and savings, income to spend on retail goods (including essentials) is further squeezed.

Figure 5: Retail sales volumes (2019-2022)

Source: ONS, 2022

The location and type of shops that people use may also be changing. With high transport costs (especially petrol), local stores may benefit from consumers avoiding costly travel. In contrast, larger car-dependent stores may see a decline in footfall and spending.

Increasing costs may also affect how much online retailers charge for delivery, potentially hurting online sales (although consumer perceptions of delivery costs versus petrol prices remain uncertain).

Concerns about the cost of living have led to workers demanding wage increases and some industrial action. Retailers have had to offer staff pay increases – often linked to the minimum and/or living wage or levels above these – and have faced other difficulties in the labour market, where retail vacancies remain high, and labour is in short supply.

Retailers are also affected by rising operating costs. Businesses’ energy costs are rising and are not capped (unlike for consumers). Similarly, purchasing and transporting or delivering products to stores or to consumers is becoming more expensive. Retailers are also vulnerable to other government and administrative costs such as rates, rent and various levies, which compound the pressures on retailers’ outgoings, even at a time that sales are falling.

What is the outlook for retailers?

The Bank of England and the UK government argue that the current cost of living issues (and especially inflation) are temporary. They are hopeful that pressures will ease in 2023, and that inflation will return to its 2% target by 2024.

But international geopolitical tensions – from pandemic-hit supply chains (particularly in the supply powerhouse of China where covid continues to impact production and distribution) to the war in Ukraine (which is affecting food, energy and fertiliser supplies) – do not show signs of easing. As a result, the prices of various commodities and products are predicted to remain high. Energy prices, for example, have been pushed up by the war and a lack of storage and do not yet seem to have stabilised. This means price pressure on consumers is set to continue in the short term, at least.

Figure 6: Anderson’s ‘Agflation’ and UK consumer price index (2015 to 2023)

Source: The Andersons Centre, 2022
Note: Andersons’ Agflation index builds on Department for Environment, Food and Rural Affairs price indices for agricultural inputs and weights each input cost (for example, animal feed) by the overall spend by UK farmers. Andersons then provides a more up-to-date estimate of the price index for each input cost category.

Product prices also look set to remain high or even increase. The Anderson ‘Agflation’ index – which looks at the price of inputs to farming – stands at over 30% and points to the difficulties that farmers and other producers are having in controlling costs (see Figure 6). These issues will inevitably have a knock-on effect on the prices of food in the coming year. Climate change, including record heat in continental Europe, is likely to hinder food supply further.

This is leading to tensions between retailers and manufacturers. Whilst there are always tough price negotiations in these relationships, disagreements are becoming more common and extreme., leading for example to a Kraft Heinz/Tesco public disagreement and refusal to supply by Kraft Heinz. Tesco said they would not pass on ‘unjustifiable price increases’ while Kraft Heinz said they would ‘not compromise on quality’. Supply tensions across retail sectors continue to simmer as retailers and manufacturers are squeezed in turn by reducing consuming spending and increasing input prices.

For consumers (especially those with lower incomes), the situation and outlook are particularly worrying. This is driving changes in shopping behaviour, affecting retailer performance. If current trends continue, an increasing share of the population will be affected, leading to more widespread effects on the retail sector.

But there will be some winners as well as losers. Retailers focused on value and low prices, perhaps through their own private retail brands, can benefit from the switching underway. Those with a local presence, allowing consumers to avoid costly travel, will also stand to gain. While many consumers and retailers are finding life very difficult, others are relatively unaffected, and some groups clearly have money to spend. Ultimately, how long the current inflationary surge lasts will affect how well, or badly, different parts of the retail sector perform.

In the short term, it is going to be tough for consumers and retailers. Worries about inflation and impact of price rises across the economy are leading to reduced spending and personal hardship. Retailers are experiencing this slowdown and until inflation falls and/or consumers see increases in their disposable income, spending will continue to struggle impacting retailers in turn.

Where can I find out more?

• The Office for National Statistics (ONS) publishes regular updates on their data series and a range of analyses of the trends and directions. They are adding to their standard data series with a range of experimental data sets.
• The House of Commons Library contains a range of reports and briefing papers on topics mentioned in this article.
• A wide range of academics, consultants, NGOs and other formal bodies and pressure groups report regularly on the economic background and implications of many of the issues discussed here. These include the Office for Budgetary Responsibility (OBR), the Institute for Fiscal Studies (IFS), the Institute for Government, the Resolution Foundation, the Institute for Public Policy Research (IPPR) and the Trussell Trust.

Who are experts on this question?

• Lotanna Emediegwu
• Michael McMahon
• Leigh Sparks

Author: Leigh Sparks

Photo by Alexey_Fedoren from iStock

The post How is the cost of living crisis affecting retailers and their customers? appeared first on Economics Observatory.

The original deadline for the money to be spent was 30 November 2021, but due to demand and the logistics of issuing cards to 1.4 million people, this was initially extended to 14 December and then subsequently to 19 December.

Figure 1: Northern Ireland’s spend local card

Source: Northern Ireland Executive, 2021

Was the scheme a success?

By the end of the scheme, 1,399,051 residents had been issued with spend local cards, 99.6% of which were activated. This led to £136.5 million (97.6% of total issued) being spent (Department for the Economy, DfE, 2022).

The former economy minister Gordon Lyons (whose department was responsible for the scheme) stated that ‘the purpose of the High Street Scheme is to stimulate local businesses, including retail, hospitality and service sector outlets, which had been hit hardest during the pandemic’ (DfE, 2021).

Of the £118 million spent in retail businesses, 43% was spent in retailers that had not been required to close under the 2020 lockdown regulations. In other words, nearly half of the retail spend went to businesses that had remained open and prospered during lockdowns.

The scheme’s overall effect on the local economy can be determined by how much additional expenditure it generated. This is known as its ‘additionality’.

The scale of this additionality can be measured by the size of what economists call the ‘fiscal multiplier’. This is the mechanism through which government expenditure can have a greater effect than its initial value, due to indirect expenditure.

For example, buying £100 of goods in a shop not only directly pays the wages of the employees there, but these employees will also spend part of the wages they receive on other goods and services, generating further indirect expenditure in the wider economy.

A variety of factors determine the size of this fiscal multiplier, and thus the degree of additionality for Northern Ireland’s spend local scheme. We look at three factors: substitution effects; leakages; and timing.

Substitution effects

Substitution effects lower the fiscal multiplier. While people were each given £100 to spend as they choose, there was no guarantee that it would promote new, additional expenditure. Instead, consumers may have used their card for purchases that they were already planning to make, and either save £100 of their own money, or use this cash to pay off existing debts.

A survey carried out by the Department for the Economy after the launch of the scheme found that 44% of respondents intended to spend or had spent the entire £100 on something that they had been planning to buy anyway (DfE, 2022). Only 22% of respondents stated that that would not use any of the £100 on something they were already intending to buy.

Of the 62% of respondents who planned to spend most or all of the £100 on something that they would have bought anyway, 70% said that this freed up money in their budget. Of these, 15% said that the money freed up would be used to increase their savings and 27% said it would be used to pay off debts or bills.

Expenditure on groceries has a larger substitution effect, as this is regular and planned spending, which in turn will have lowered the fiscal multiplier. The statistical report on the scheme released by the Northern Ireland Statistics and Research Agency (NISRA) does not report the expenditure on groceries and in supermarkets (NISRA, 2022).

Nevertheless, £50.7 million or 43% of the spend on retail was in stores that had been open during the lockdown restrictions of 2020. The vast majority of these were supermarkets. In other words, close to 37% of the scheme’s total spend went to supermarkets. By way of comparison, in its evaluation of Jersey’s spend local scheme, the Jersey Public Accounts Committee was critical that 22% of the spend went to food retailers.

Leakages

Leakages lower the fiscal multiplier. Northern Ireland is a very open economy: around 46% of goods and services purchased by businesses come from outside (NISRA, 2021). Parts of the retail sector also have high representation by UK-wide chains, including supermarkets (Kantar, 2021).

Among survey respondents, 67% stated that they intended to spend all or most of their £100 in small local businesses (DfE, 2022). Unfortunately, the spend data from NISRA do not shed any light on this issue.

Given the high proportion spent in supermarkets, it is very likely that a substantial proportion of extra expenditure by consumers leaked out of the local economy.

Timing

Finally, timing can raise or lower the fiscal multiplier. Retail and hospitality expenditure experiences seasonality. As research commissioned by the Department for the Economy shows, spending on shopping and going to pubs, cafes and restaurants is highest in November and December, and lowest both at the beginning of the year and between August and September.

This means that a scheme operating during this quieter time, and coinciding with the ending of other business support, would have had the greatest additionality, raising the fiscal multiplier.

The positive effects of the Northern Ireland scheme on the fiscal multiplier were dampened by its delayed start and implementation, as well as its continuation through until 19 December.

The data released by the Department for the Economy only show the number of transactions per day during the scheme’s life, shown in Figure 2. The busiest period was during November, with the highest peaks in activity occurring across the four weekends of that month, followed by a peak during the final weekend of the scheme in mid-December.

Figure 2: Number of card transactions per day

Source: DfE, 2021

While a detailed breakdown of expenditure over time has not been published, we can use figures for total expenditure provided in the Department for the Economy’s regular press releases to identify when spending took place.

Approximately 54% of total expenditure occurred during November, with 27% occurring during December, and only 19% in October. The Department’s commissioned research recommended that the scheme should end before the Black Friday weekend, supposedly the start of the Christmas shopping season in late November.

But over one-third (approximately 37%) of the scheme’s total expenditure occurred during the two weeks up to and including the Black Friday weekend – between 15 November and 30 November. Overall, 73% of total expenditure occurred during the two highest months for retail sales annually, therefore lowering the scheme’s fiscal multiplier.

While the spend local scheme was running, it was credited with ensuring Northern Ireland saw a shallower decline in retail footfall relative to the UK average. But evidence from NISRA’s retail sales index suggests that this did not translate into better sales performance.

Indeed, Northern Ireland saw retail output decrease 1.1% over the final quarter (October-December) of 2021, compared with Great Britain, which saw a much smaller decrease of only 0.6%. By the end of 2021, retail output in Northern Ireland remained 4.4% below the pre-pandemic level, while in Great Britain this had recovered to 3.0% above the pre-Covid-19 level.

Together, the evidence on substitution effects, the potential for leakages and the poor timing of the scheme suggest that the spend local scheme’s fiscal multiplier was much lower than was either originally intended or would have been hoped for.

How could the spend local scheme have been improved?

First, it should have been operated from late August through to October – the months that have much lower retail spending than November and December. The delays in implementing the scheme meant that the additionality from the injection of £136.5 million was severely dampened.

Second, the scheme should have been more targeted at businesses that were forced to close by the lockdown requirements of 2020. Businesses – such as supermarkets – that remained open throughout the pandemic should not have been part of the scheme.

Third, there is evidence that a transfer targeted at disadvantaged households provides a stronger boost to overall spending (Andreolli and Surico, 2021). The spend local scheme would have had a greater economic effect if it had been targeted at pensioners and those on income support.

The cost of the scheme, at £145 million, was financed as part of the in-year allocation within the Northern Ireland Executive’s 2021/22 budget. This was partly funded by Covid-19 money carried over from the previous financial year, with the spend local scheme representing 21.1% of the in-year allocation.

Other areas receiving funding as part of this allocation included the economic recovery programme (£130.8 million), education (£64.7 million) and health (£70 million). Expenditure on the spend local scheme represents money not spent on other areas that are priorities for the Northern Ireland Executive.

Therefore, a post-scheme evaluation needs to happen to determine whether this policy experimentation was cost-effective and worth repeating. This will require better data to help policy-makers understand how much was spent in supermarkets and grocery stores, and how much was spent in UK multiples. There also needs to be a survey focused on the extent to which substitution effects occurred.

Where can I find out more?

• Analysis of the Northern Ireland High Street Scheme: NISRA statistical report on the spend local scheme.

Who are experts on this question?

• Esmond Birnie
• Graham Brownlow
• Karen Bonner

Authors: David Jordan and John Turner, Queen’s University Belfast

Photo by William Barton on iStock

The post Update: What effect did Northern Ireland’s spend local scheme have on the economy? appeared first on Economics Observatory.

Northern Ireland’s record on innovation activity is relatively poor compared with England, Scotland and Wales. The nation needs to do better at translating its innovation inputs into innovation outputs and ensuring that the capacity and capability to generate new ideas is strengthened. This will help to support the vision of a 10X Economy set out by the Northern Irish Department for the Economy (DfE) to foster innovation and promote greater prosperity.

What is an innovation ecosystem?

An innovation ecosystem can be defined as a ‘network of individuals, entities, resources, and structures that join forces in a way that catalyses new products, ideas, methods, systems, and even ways of life’ (WeWork, 2020).

As with ecosystems found in nature, the innovation ecosystem does not just refer to its constituent parts. It also includes how they interact with each other in their physical environment, in this case, either to enable or impede innovation.

Although there is a range of contributors within an innovation ecosystem, the main stakeholders can be identified as government, universities and research institutions, financiers and investors, incubators and accelerators, industry, intermediaries, and entrepreneurs and innovators.

The last group comprises the principal actors, exchanging knowledge, skills and ideas within the system to obtain the capital and other resources required to generate innovation and growth.

No one part of the ecosystem operates in isolation. Similarly, the ecosystem itself operates within the prevailing economic and wider framework conditions. These are recognised as the factors external to firms that influence innovation performance and market success. They include the public research base, the business and regulatory environment, physical and digital infrastructure, demand for innovation, and the available human capital (Nesta, 2011).

What does the evidence tell us?

We can measure the success of Northern Ireland’s innovation ecosystem in terms of how it performs in both a UK and wider European perspective. We consider innovation inputs and innovation outputs, as both provide an indication of the effectiveness of the ecosystem.

Innovation inputs are resources devoted to the generation of innovation, such as spending on research and development (R&D) and the supply of skilled workers (or human capital). Innovation outputs represent the new processes, inventions and ideas brought to market.

R&D delivers the knowledge, insight and experimentation used in developing innovations. In Northern Ireland in 2020, £913 million was spent on R&D (NISRA, 2021). Almost three-quarters of this was business expenditure on R&D (BERD), just under a quarter was higher education expenditure on R&D (HERD) and the remaining 3% was government expenditure on R&D (GERD).

In real terms, BERD has performed well over the last decade, increasing by 55% since 2010 (see Figure 1). Similarly, GERD has grown by 49%, although expenditure is at a much lower level. In contrast, HERD grew by just 11% over the decade between 2010 and 2020.

In 2020, in-house BERD accounted for 1.5% of Northern Ireland’s gross value added (GVA) – a measure of the value of goods and services produced. This was similar to the UK average (1.4%) but much lower than the best performing UK region, the East of England, with spending equivalent to 3.5% of GVA.

It is also worth noting that in Northern Ireland R&D activity is highly concentrated; the top ten R&D spending businesses account for one-third of all BERD, while almost two-fifths of BERD spending is in Belfast.

Skilled labour contributes to the absorptive capacity of a firm or region as it relates to the ability of individuals to understand and apply external information, knowledge and technology, thereby enhancing their innovative capabilities.

Northern Ireland’s working age population has a higher share of people with no or low skills relative to other UK regions (Annual Population Survey, 2022). Yet employees in Northern Ireland are actually relatively well qualified, with 37% qualified to national qualifications framework (NQF) level 6 and above (degree, masters or PhD level). This compares with 34% for the UK as a whole (UUEPC, 2022).

In fact, in the UK regional context, Northern Ireland comes second only to London in terms of the proportion of employees qualified to this level (see Figure 2). The share of the Northern Irish population with foundational level essential digital skills also measures up well at 79% compared with 81% in the UK (Lloyds Bank, 2021).

Figure 1: Real expenditure on R&D in Northern Ireland, 2010-20

Source: Northern Ireland Statistics and Research Agency (NISRA)

Figure 2: Proportion of the employed (aged 16-64) qualified to NQF level 6+, 2021Q4

Source: UUEPC based on Office for National Statistics (ONS), Labour Force Survey

Northern Ireland does less well when the focus is on innovation outputs. The most recent UK Innovation survey covering the period 2016-18 shows Northern Ireland to be joint bottom of the UK regional league table in terms of innovation-active businesses (see Figure 3).

Just 32% of Northern Irish (and Scottish) businesses are innovation-active compared with a UK average of 38%. Notably, rates across the UK are lower than those reported in the previous survey for the 2014-16 period.

When broken down further into more specific components, businesses in Northern Ireland are broadly on par with those in the rest of the UK in terms of process innovation – at 12% of businesses compared with 13% in the UK.

But the share engaged in product innovation – in other words, new goods or services – is lower with just 13% in Northern Ireland, compared with 18% in the UK. The gap is still there when assessing the share of product innovators with new-to-market products: just over one-third of innovators in Northern Ireland undertake this more radical type of innovation compared with two-fifths in the UK.

Patenting activity, which gives inventors intellectual property rights in their new ideas, is also low in Northern Ireland. In 2020, there were almost 12,000 patent applications filed in the UK: of those just 153, or 1%, were from Northern Ireland (Intellectual Property Office, 2021).

Likewise, of the 4,500 patents granted, just 65 were from Northern Ireland, again representing 1% of the total. Both trademarking and designs registered there also each account for just 1% of the respective UK totals.

Given that Northern Irish businesses represent around 2% of all UK business activity, shares of 1% in these types of innovation output activities indicate that they are lower than would be expected.

In contrast, university spin-outs – companies that emerge from scientific research – represent a successful element of Northern Ireland’s innovation ecosystem. In 2020, Queen’s University Belfast was ranked first in the UK, and Ulster University 16^th, in terms of their entrepreneurial impact ranking, a metric calculated according to the key indicators that influence spin-out activity at universities (Octopus Ventures, 2020).

Figure 3: Percentage of innovation-active businesses by UK region, 2014-16 and 2016-18

Source: NISRA

Note: Round point = 2014-16 level; bar = 2016-18 level

Figure 3 suggests a relatively poor performance in the UK’s innovation context. But Northern Ireland performs at or above the European Union (EU) average in a small number of innovation-related pursuits, including the above-mentioned product and process innovation activities.

Where Northern Ireland particularly excels is in the collaboration of small and medium-sized enterprises (SMEs) with other enterprises or institutions (see Figure 4). This is a form of open innovation whereby innovation is co-created with external partners.

In Northern Ireland, businesses collaborate for innovation at twice the EU average rate. This collaboration is strongest with suppliers, and private sector clients or customers, although in Northern Ireland, it is mostly undertaken at the local rather than national or international level.

Figure 4: Northern Ireland and EU relative performance in innovation activities, 2019 (EU=100)

Source: European Regional Innovation Scoreboard

How might the innovation ecosystem be improved?

The evidence summarised above suggests that despite the poor outcomes, some components of the Northern Irish innovation ecosystem are performing relatively well. But it is not enough for individual elements of the ecosystem to work.

Indeed, according to the European Commission, a balanced innovation system is needed that performs well across all dimensions. The Commission’s analysis suggests that the most innovative regions are those within innovative countries and those that perform particularly well in terms of their research system and business innovation (European Commission, 2021).

In Northern Ireland, it is encouraging that BERD has increased, but it is concentrated within too few firms and it is regionally unbalanced. And while some parts of the nation’s workforce are well qualified in a UK context, their skills capabilities are not being translated into innovation outputs.

This is particularly the case with new-to-market outputs, suggesting a potential lack of innovation prioritisation among business leaders. This deficiency of innovation activity is subsequently related to the nation’s poor productivity and economic performance.

The most recent economic strategy for Northern Ireland, a 10X Economy (DfE, 2021) emphasises the nation’s ambition for a decade of innovation. Its aim is to focus on innovation in areas of competitive advantage to deliver fundamental change resulting in a ‘ten times better economy’, which benefits all people, businesses and places.

The aim is admirable and undoubtedly there is an improving base from which to work. But the bottlenecks in the existing innovation ecosystem need to be identified and addressed. Without doing so, the ecosystem will not deliver on its potential.

Where can I find out more?

• The Department for the Economy’s 10X strategy sets out the policy aim and focus on innovation for the next decade.
• The European Regional Innovation Scorecard assesses the innovation performance of European regions across a number of metrics.
• The UK Innovation Survey contains sub-regional data on innovation performance across the UK.
• Innovation and the knowledge-base for entrepreneurship: investigating SME innovation across European regions using fsQCA: Using a novel methodology this study looks at the importance of four interlinked conditions for innovation by SMEs across European regions.
• The Enterprise Research Centre website contains a number of reports on the topic of innovation.

Who are the experts on this question?

• Karen Bonner, Ulster University Economic Policy Centre
• Steven Roper, University of Warwick
• Nola Hewitt-Dundas, Queens University Belfast
• Kristel Miller, Ulster University

Author: Karen Bonner, Ulster University

Photo by gorodenkoff from iStock

The post How can Northern Ireland improve its innovation ecosystem? appeared first on Economics Observatory.

web3 promoters

For its advocates, web3 marks an important shift towards the next iteration of the internet. Its predecessor, Web 2.0 – the era of large, powerful social media platforms (such as Facebook) – is said to be characterised by asymmetries and injustices.

Dominated by a small number of Big Tech companies whose founders and investors have amassed unprecedented amounts of wealth and power, Web 2.0 has had consequences that are widely seen as damaging to society and democratic institutions. 

This financial success seems to have been built off the backs of Web 2.0’s users. Professional creators of music, imagery and video receive only a small fraction of the revenues that their content generates for platforms like Spotify and YouTube.

Developers of apps have no option but to pay 15-30% of their revenue to the App Store (Apple) and Play Store (Google/Android) in return for distribution. At the same time, ordinary users supply the posts, engagement and behavioural data that are integral to the advertising-based business models of Instagram, Twitter and TikTok. Despite their role as ‘prosumers’ (producing as well as consuming), they receive no financial compensation. 

By contrast, web3 is said to offer a more egalitarian, peer-to-peer vision of the web, giving all users 'skin in the game'. By using blockchain technology to decentralise the web’s technical, legal and payments infrastructure, web3 supposedly promises to sweep away today’s Big Tech companies, which are seen as abusing their market position as gatekeepers to extract economic rents. 

In their place will be new protocols and platforms, constituted as distributed autonomous organisations (DAOs). According to web3 advocates, DAOs will be governed by their communities, transparent in their operations and immune from capture by narrow financial interests thanks to smart contracts (self-enforcing contracts programmed in computer code). 

Transactions will take place in cryptocurrencies, with non-fungible tokens (NFTs) allowing intellectual property rights to be asserted over digital files, with benefits for creators and markets.

In time, these technologies will supposedly form the basis for a thriving economy in the metaverse – the putative 3D online world in which people will be able to work, socialise and play games in virtual reality. For now, the majority of web3 companies are focused on building the underlying ‘rails’, such as payments (for example, Ripple), technical infrastructure (for example, Aligned) and fraud detection (for example, Chainalysis). 

web3 detractors

Critics of web3 bring a very different perspective. Cryptocurrency sceptics – so-called ‘NoCoiners’ – see web3 as a cynical rebranding exercise. In their view, blockchain is a defunct technology and cryptocurrencies are scams that combine elements of Ponzi, pyramid and multi-level marketing schemes. 

In such schemes, a constant supply of new marks is required to provide earlier investors with liquidity – and the inevitable conclusion is collapse. These critics say that web3 should therefore be understood as a story invented to make cryptocurrency investment appear more attractive to digital creators and those who otherwise dislike Big Tech. 

Some within the crypto movement also have deep reservations about web3 – including former Twitter chief executive officer, Jack Dorsey. Here, the objection relates to the influence of venture capital investors. With more funds at their disposal than there are good investment opportunities, investors like Andreesen Horowitz – a venture capital firm based in Silicon Valley – have been highly active in developing the web3 market, through public relations and government outreach (as well as large investments in web3 companies like the NFT marketplace OpenSea). 

Outsized returns for the same group of investors who have profited from the dominance of today’s Big Tech companies are clearly at odds with the libertarian project of radical decentralisation, to which Jack Dorsey and many other crypto enthusiasts subscribe. 

What are some possible implications for the UK economy?

The criticisms levelled by web3’s detractors seem to be good reasons to reserve judgement on the overall vision for web3. It is also useful to break it down into its component parts, specifically cryptocurrency adoption, tokenisation and virtual economic growth.

Cryptocurrency adoption 

‘Cryptocurrency’ is something of a misnomer. There are very few things that Bitcoin, Ether or DogeCoin can actually be spent on – illegal drugs and NFTs notwithstanding. While cryptocurrency exchanges report billions of dollars’ worth of trading, this is overwhelmingly financial speculation and barely touches the real economy. In fact, it is possible that such speculation is channelling capital away from more productive forms of investment.

Cryptocurrency prices are also extremely volatile. According to the Financial Conduct Authority (FCA), 2.3 million UK consumershave already invested in crypto assets, meaning that a market crash might lead to large losses for retail investors. This would inevitably bring adverse consequences for consumer confidence and spending.

The same goes for fraud, which appears to be endemic to the crypto space. Meanwhile, the anonymity afforded by cryptocurrency significantly increases cybercriminals’ economic incentives to mount ransomware attacks. Affecting three-quarters of UK businesses in 2021, these involve hackers encrypting an organisation’s data and demanding a Bitcoin ransom to decrypt it. 

But UK regulators seem to be more concerned about the risk of financial instability. Most cryptocurrency is held by institutional investors, including hedge funds with leveraged positions. A collapse in crypto asset prices could force investors to sell off other assets to cover losses, reducing liquidity in the financial system and affecting investor sentiment. This could then have potential knock-on consequences for the real economy. 

As such, cryptocurrency markets can be compared to markets for derivatives such as futures and options: they represent a growth opportunity for the financial sector, but a systemic risk to the wider economy. 

But were the Bank of England to launch a central bank digital currency (CBDC), other opportunities might open up. For example, in a future downturn, the government might want to use monetary policy to stimulate economic activity. If it were to issue stimulus payments to individuals and businesses in a CBDC, it could programme in rapid devaluation, creating a strong incentive to spend rather than save, and hence increasing the effectiveness of the policy.

Tokenisation

Rather than issuing shares, web3 organisations issue tokens. These can offer rights of access to the organisation’s products, voting rights on aspects of the organisation’s decision-making, rights over digital property or a combination of all three. 

As tokens are financial assets, they can be traded speculatively in secondary markets. Much commentary has focused on cases where tokens have been instrumentalised in ‘pump-and-dump’ schemes – a form of scam where token-holders hype an asset to drive its price up sharply (pumping), before selling off their holdings (dumping) and precipitating a crash. 

Concerns have also been raised about the tokenisation of loyalty programmes and merchandise by UK football clubs, since it exposes fans to volatile crypto asset markets without obvious benefits over more conventional structures.

But from a purely economic perspective, tokenisation may prove to be an important innovation, in that it provides a new way for organisations to raise capital. The existence of the secondary market means that seed investors in web3 start-ups benefit from much greater liquidity than would be available if they bought equity. 

This can reasonably be expected to increase the pool of capital accessible to early stage tech businesses, with favourable consequences for the development of the tech sector. Given the UK’s strength in financial technology (fintech), decentralised finance (or DeFi) seems like a particular opportunity. 

Similarly, tokenisation could provide small and medium-sized businesses, which are ordinarily subject to banks’ fluctuating appetite for risk, with an alternative source of growth capital. Meanwhile, other types of organisation that typically have limited access to capital markets – including social ventures and community projects – may see issuing tokens as a scalable alternative to grant applications or crowdfunding.

Tokenisation is perhaps most advanced in the creative sector. Before the advent of NFTs, there were few incentives for producing monetisable digital artwork, as files could easily be pirated. By providing more or less immutable records of ownership for digital files, NFTs provide incentives and make it technically possible for artists to receive automatic royalties on re-sales of their work. 

Combined with the ability to sell directly to the public without intermediation by commercial galleries, NFTs seem to be making it easier for creators to develop real businesses (although it is not yet clear whether current levels of demand are sustainable).

In general, if one subscribes to the view that greater supply of capital leads to productive investment, job creation and growth, the potential of tokenisation should be taken seriously. 

Figure 1: UK consumer interest in cryptocurrencies and NFTs during the pandemic period, as measured by internet searches

Source: Google Trends

Virtual economic growth

The idea of a metaverse economy might seem particularly far-fetched, but a substantial virtual economy already exists. Sales of virtual goods inside ‘massively multiplayer online games’ (or MMOs) are estimated – admittedly by gaming industry market intelligence firms – to have amounted to $40-93 billion globally in 2019, and to be growing at a rate of around 15%. 

Many games have native currencies that can be exchanged for skins (virtual goods such as clothes or armour, which alter a player’s in-game appearance). In the video game Elite Dangerous, for example, a currency called ARX can be bought or earned through game-playing and then used to purchase livery for the player’s spacecraft.

Advocates of web3 argue that the development of the wider virtual economy is held back by the absence of property rights. Currently, a dashboard ornament purchased in Elite Dangerous cannot be taken into World of Warcraft: it remains the property of the game’s developer, Frontier Developments, which could, if they wished, confiscate it from a player who had paid for it. 

Replacing native currencies with cryptocurrency and minting skins as NFTs, on the other hand, would provide stronger incentives for third-party developers to create new ranges of virtual goods, and for players to increase their spending on them. This seems at least plausible and much more like real economic activity than cryptocurrency speculation (though it should be noted that many in the gaming community are unconvinced that it would be technically feasible or additive to the game-playing experience). 

What is more certain is the contribution of the UK video gaming industry to the economy: around £1.8 billion towards GDP and around 40,000 jobs in 2018. Larger than any of its European counterparts, it is well-placed to benefit if web3 technologies do indeed drive gaming innovations.

Conclusion

Predicting the economic impact of emerging technologies is notoriously difficult. The biggest benefits from technological change often come from positive spillovers and the biggest risks from unforeseen externalities. Which of the stories about web3 sketched out in this piece will come true is anybody’s guess. 

But increasing amounts of Silicon Valley’s abundance of capital and software engineering talent are being poured into web3 projects. And as the Web 2.0 era has shown, these decisions about where to focus energy will have repercussions for the economy and beyond. 

Where can I find out more?

• Policy Brief: Crypto, web3, and the metaverse: A simple explanation of cryptocurrencies, blockchain, NFTs and the metaverse, together with discussion of web3’s policy implications, by the Bennett Institute for Public Policy.
• web3 policy handbook: US venture capital investors Andreesen Horowitz make a bullish case for web3 and suggest actions that governments should take to encourage its development.
• Line Goes Up – The Problem With NFTs: an entertaining if somewhat polemical video essay that aims to debunk claims that web3 technologies can form the basis of a more equitable internet.
• The Crypto Syllabus: comprehensive reading lists for studying web3 from social, economic and technological perspectives, with short introductory overviews. 

Who are experts on this question?

• Molly White
• Vitalik Buterin
• Edward Ongweso Jr
• Balaji Srinivasan
• Evgeny Morozov

Author: Sam Gilbert

Picture by Antonio Solano

The post What is web3 and what might it mean for the UK economy? appeared first on Economics Observatory.

The response of many governments, most notably in Europe, the United States and other pro-Western countries, has been to impose a range of sanctions on Russia, as well as offers of military and political support to Ukraine. The European Union (EU) and the UK alone account for around 40% of Russia’s trade in goods and services.

The measures are likely to have a significant impact on Russia’s economy. The World Bank forecasts that on the basis of sanctions announced in March 2022, by the end of 2022, Russia’s GDP will be 11% lower, investment 17% lower, inflation will rise to 22%, and exports and imports will fall by 31% and 35% respectively (World Bank, 2022). In addition to this impact on the economy, there should be an effect on Russia’s war effort, not least because a large share of Russian imports is relatively technology-intensive.

But it is not just Russia that will be affected. Apart from the destructive effect of the war on Ukraine, there will be an impact on adjacent countries, especially in Europe. The flow of refugees will place a strain on welfare states in these countries. There will also be effects on trade. The EU, the UK and the United States have all placed restrictions on energy imports from Russia in response to the invasion. The ability of the EU, in particular, to diversify away from dependence on imports from Russia, notably of oil, gas and fertiliser, will take longer.

Of potentially greater long-run significance for Russia is the range of other measures adopted by these countries, including sanctions on financial services and on individuals who are perceived to be close to the Putin regime.

More generally, the Russian economy may suffer from the collapse of technical, scientific and cultural ties with the West. This could lead to a ‘brain drain’ of younger and more outward-looking Russians who do not wish to remain in a country that is rapidly becoming a pariah on the world stage.

Sanctions and trade wars

The imposition of sanctions on Russia is perhaps the most striking illustration of the recent reversal of policies designed to encourage greater trade between countries. These policies emerged following the establishment of a range of multilateral institutions after 1945 and, in particular, the General Agreement of Trade and Tariffs (GATT) in 1947 and its successor, the World Trade Organization (WTO), established in 1995.

The intention of the GATT/WTO was to minimise the threat of ‘trade wars’, whereby trade defence mechanisms such as tariffs, non-tariff barriers and embargoes are imposed for strategic political and economic motives. The desire to avoid trade wars led to measures designed to discourage both one-sided and ‘tit-for-tat’ trade restrictions, and the implementation of mechanisms designed to resolve trade disputes.

It was also implicitly hoped that greater trade co-operation between countries would lead to the liberalisation of political regimes and bring greater emphasis on human rights and individual freedoms. Increasingly in recent years, these hopes have been dashed.

Trade sanctions have been implemented over the years against smaller countries such as Rhodesia (now Zimbabwe) from the mid-1960s through to the 1970s and, more recently, Myanmar in 2021 (Losman, 1978; Poletti and Sicurelli, 2022). These measures have generally been perceived as rather ineffective due to the proximity of those countries to other countries that were prepared to ignore such embargoes and sanctions.

But more recently, the willingness of President Trump to institute trade wars with countries that he perceived to be engaged in ‘unfair’ trade practices against the United States – including China, the EU, the UK and indeed pretty much everyone else – points to the erosion of the mantra of ‘free trade’ as engineering the growth of world output. Indeed, it indicates a move towards more nationalist and protectionist economic policies among some major countries.

The use of trade restrictions against Russia for political reasons is arguably more morally justified – and universally supported – than explicitly protectionist policies. This has been reflected in popular support for the measures.

Social media has played a role in encouraging boycotts of individual firms operating in Russia, the boycott of Russian goods and services and the inclusion of individuals (and their families) on sanctions lists. For example, Nestlé was slow to pull out of Russia until social media called for boycotts of Kit Kats and Nespresso coffee pods (Blitz, 2022). The daughters of Putin and the step-daughter of Russia’s foreign minister Lavrov were called out on social media such as Twitter and Instagram for their lavish lifestyles in the West, and sanctions were placed on them by the UK and US governments.

What sanctions can be imposed and what are their legal implications?

Sanctions against Russia are subject to the rules and mechanisms designed by international institutions to limit protectionist policies. They are also bound by more basic principles of the rule of law, especially when it comes to sanctioning individuals.

A variety of measures have been taken against Russia since the invasion of Ukraine. These include:

• Sanctions against goods, services and finance in Russia.
• Sanctions against individual companies operating in Russia.
• Sanctions against specific individuals associated with Putin.
• Suspension of the ‘most favoured nation’ (MFN) clause in the WTO, which prevents countries from discriminating between their trading partners.

The use of these sanctions raises questions about how trade measures can be used in a political setting and what are the legal and economic consequences. The perceived weakness of the WTO in handling trade disputes has, for example, led the EU to take the lead in strengthening its own trade defence mechanisms, including a proposal for an ‘anti-coercion instrument’. This is a response to coercive tactics taken by third states to threaten or undermine EU policies. The anti-coercion instrument would allow the European Commission to take trade, investment or other restrictive measures towards a non-EU country exerting pressure (European Commission, 2021). The question is whether the events in Ukraine have eclipsed these mechanisms and safeguards.

The objectives of economic sanctions are often compared to the objectives of criminal justice:

• Do they deter bad behaviour?
• Can they be enforced?
• Are their punishments effective?
• Do they lead to changed behaviour by the targeted countries?

Sanctions against goods and services

In 2020, 44% of Russian exports were bound for NATO countries (40% to the EU and the UK, and 3% to the United States). In terms of imports to Russia, 38% come from NATO member states (35% from the EU and just over 4% from the United States).

Given that trade as a share of Russian GDP in recent years is close to 50%, wide-ranging trade sanctions could in principle have a significant effect on economic activity in Russia (Gasiorek and Larbalestier, 2022).

Russia relies heavily on imports for technology, finance, capital and consumer goods. For example, imports of machinery, parts and electrical equipment account for around a third of imports by value, and a large share of them comes from the EU. Further, pharmaceutical products account for only 5% of imports by value to Russia, but two-thirds of these come from the EU.

In due course, Russia may be able to diversify suppliers. Even in the short term, it may be able to obtain some necessary imports by indirect means, such as false invoices or smuggling. But while Russia has land borders with countries, such as Belarus, that are not implementing sanctions, there is unlikely to be scope for the kind of unchecked imports that allowed countries, such as Rhodesia, to evade sanctions in the past.

Economic sanctions against Russia will affect the global economy insofar as they cover exports of wheat, corn, sunflower oil, fertiliser, metals (nickel, copper and iron), neon, palladium (used in microchips) and platinum. Gas and oil are the main commodities where countries applying sanctions will be at their weakest.

Russia has long exploited gas and oil exports as a weapon of trade war in its disputes with Ukraine. Here the EU is vulnerable in the short run: it is estimated that after the winter, European supplies will be at 30% capacity. Within the EU, member states have wanted to keep control over their energy policy choice, especially the mix of energy and when national public interest may be used to divert from the four freedoms (goods, services, capital, establishment).

State aid and competition law may be used to challenge these choices, and indeed to encourage certain choices, for example, the development of green energy. But member states retain sovereignty. The lack of an integrated energy policy for the EU is the Achilles heel that Russia will continue to try to exploit.

Evidence from sanctions after the annexation of Crimea in 2014

There have been some attempts to estimate the impact of current economic sanctions on Russia by looking at the limited sanctions imposed after the 2014 annexation of Crimea. These included financial restrictions on capital for investment, freezing of financial assets, immigration sanctions on particular individuals, prohibitions on technology transfer and technical assistance, and highly targeted trade sanctions. In turn, Russia retaliated with some restrictions on exports of some food products.

Evidence from world trade data suggests that both import and export values fell after 2014 (see Figure 1). But it is important to note that Russian trade values were already on a downward trend before that time, reflecting the weakness of the world oil and gas market. Indeed, as illustrated in Figure 1, the oil price index is a very good predictor of the value of Russian trade.

Figure 1: Russian exports and imports by value and oil price index, 2005-2019

Source: United Nations (UN) International Trade Statistics Database. Note: the dark blue line (oil prices) is an indexed value, rather than a nominal value.

It is estimated that the trade restrictions implemented in 2014 resulted in no more than a 1% reduction in Russian GDP (Korhonen, 2019).

The most significant sanctions are thought to be those that restricted Russian companies’ access to foreign capital, since investors in the EU and the United States were barred from providing capital to five major Russian banks, as well as companies operating in the oil and gas, and military sectors (Korhonen, 2019). Another study also suggests that targeted companies performed significantly worse than other companies engaged in similar activities in Russia (Ahn and Ludema, 2019).

Cutting off external sources of financial support to Russian companies after 2014 had an impact on the viability of their activities. Investors in the EU, the UK and the United States were forbidden to provide financing beyond 30 days to several Russian state banks, oil companies and several firms operating in the military sector. This had two major effects:

• First, foreign investment in Russia fell as a consequence of these sanctions – by one estimate by $700 million per quarter(Korhonen and Koshinen, 2019).
• Second, the foreign debt of Russian banks held abroad fell from a peak of $214 billion to $74 billion in 2019, as these institutions switched to assets held domestically in roubles. The Russian economy has becoming increasingly dependent on capital generated internally, a process that will be exacerbated by the more wide-ranging sanctions introduced in 2022.

What were the legal ramifications of the annexation of Crimea and suspension of Russia’s MFN status?

A further response to Russian aggression in Crimea was the revocation of Russia’s MFN status from the EU, the United States and other G7 countries.

The MFN clause is the foundational principle of the GATT/WTO. It guarantees that each member of the WTO receives the same treatment: the lowest tariffs granted to one member should apply to all members. But there is an ‘essential security’ clause in Article XXI of the GATT, which can be used unilaterally to justify protectionist measures. Reacting to the Russian invasion of Ukraine in February 2022, Canada, the UK, the United States and several other WTO members revoked the MFN from Russia (Collins, 2022). The use of this clause has emerged before in the Russia-Ukraine context.

The political use of trade to sanction a breach of international law is understandably contentious. Resort to trade countermeasures for a breach of international law is seen as undermining the stability of the world trading system. Few disputes have been brought before WTO panels – indeed, the most notable was in relation to Russia’s annexation of Crimea in 2014. Another arose in 2019 when Qatar initiated consultations with Bahrain, Saudi Arabia and the United Arab Emirates concerning sanctions in relation to Qatar’s alleged funding of terrorism.

A WTO panel examined the essential security provision in the dispute brought by Ukraine against Russia after the annexation of Crimea by Russia in 2014. The illegal annexation led to the imposition of economic sanctions by various countries against Russian entities. Russia responded by imposing transit bans and other restrictions preventing the transit of goods from Ukraine to Kazakhstan and other bordering countries.

Ukraine brought a dispute to the WTO claiming this was a breach of the GATT. While Russia asserted that the measures were necessary for the protection of its essential security interests. Russia – backed by the United States – argued that the WTO panel lacked jurisdiction to evaluate its measures. The panel disagreed with this last point and found that it had jurisdiction to review Russia’s use of the essential security justification. But it also found that the situation between Ukraine and Russia since 2014 was an emergency in international relations, and that Russia’s measures had been taken during that emergency.

The panel concluded that every WTO member may define what it considers to be its essential security interests. This discretion is limited by an obligation to interpret and apply the essential security clause in good faith. This involves an obligation ‘to articulate the essential security interests … sufficiently enough to demonstrate their veracity’, and there should be a connection between the essential security interests invoked and the measures taken. Russia could determine the ‘necessity’ of the measures for the protection of its essential security interests.

The panel would not decide on the legality of Russia’s annexation of Crimea under international law. It ruled that it was ‘not relevant’ to its determination whether Russia had ‘any international responsibility for the existence of this situation to which Russia refers’. Russia objected to the panel’s reference to the ‘international community’s’ condemnation of the annexation of Crimea’, leading to the replacement of this term with ‘the UN Resolution’. This indicates the panel’s view of separating out liability under international law and liability under international economic law.

The legal implications of these events for the sanctions imposed on Russia in 2022 are unclear. It might be hard for the countries introducing sanctions – unlike Ukraine itself – to argue that their essential security interests have justified their actions against Russia without arguing that in some more general sense, Russia’s actions in Ukraine threatened a more global conflict.

On the other hand, given the world’s almost unanimous condemnation of the Russian invasion – and growing claims of war crimes committed in Ukraine – it would be ironic at best for Russia to attempt to pursue a dispute at the WTO, arguing that the suspension of the MFN clause was unjustified.

New financial sanctions

The financial sanctions introduced in 2022 are wide-ranging. First, the Russian central bank has been barred from using its ‘emergency reserves’ held in foreign central banks and commercial banks in the form of foreign exchange and securities. By freezing these assets, Russia’s ability to use its foreign exchange reserves to purchase goods and services abroad is severely limited.

In similar vein, the Russian sovereign wealth fund has been targeted and cannot sell assets abroad to finance purchase material. This has an immediate impact on the much-vaunted Russian ‘war chest’ of $600 billion (Cecchetti and Schoenholtz, 2022).

Since these sanctions are internationally co-ordinated and include countries that are normally reluctant to participate in actions of this kind – such as Switzerland – these are potentially powerful constraints on Russian economic activity. They are forcing the economy to rely largely on current receipts from its exports to finance foreign purchases.

Since Russia is running a trade surplus – and has imposed capital controls to limit outflows of foreign exchange through capital flight or purchase of non-essential imports – the immediate effect may be limited. But as countries currently importing from Russia find alternative sources of supply, the constraint on foreign exchange reserves will bite harder.

Russia has responded to the financial effects of these sanctions by demanding that foreign countries pay for their energy supplies in roubles. This could be difficult to enforce, especially since the assets of the Russian central bank abroad are frozen and contracts would have to be legally re-negotiated for changes to occur.

Even if this could happen so that foreign purchasers of Russian oil and gas have to convert their currencies into roubles via the remaining parts of the Russian banking system that are not sanctioned, it is hard to see that this threat is anything other than symbolic.

Russia could try to enforce some sort of multiple exchange rate system by which roubles must be purchased at an artificially high rate, but it is not clear how this would work. Such exchange rate regimes typically collapse or lead to the development of increasingly overt black markets where the local currency is purchased at a cost well below the official rate.

There are also sanctions against Russian commercial banks. SWIFT (the acronym for the Society for Worldwide Interbank Financial Telecommunication) is a messaging system that allows banks around the globe to communicate quickly and securely about cross-border payments. It is a member-owned co-operative based in Belgium, made up of global banks. On 2 March, SWIFT announced that it would cut off seven Russian and three Belarusian banks from its system with effect from 12 March.

The consensus is that this measure will have a limited effect. First, because several Russian banks are not sanctioned; and second, because there are other, albeit more costly, means of communicating bank transactions other than through SWIFT (House of Commons Treasury Committee, 2022).

In similar vein to those imposed on Russia’s central bank, several countries have imposed sanctions on other Russian banks such as Sberbank, VTB Bank, Alfa-bank, Bank Otkritie and Rossiya Bank. Again, this involves freezing assets held abroad and a ban on any bank dealings in these markets.

Other companies and entities, as in the post-2014 sanctions, are limited in the activities that they can undertake abroad – whether purchases (for example, in the case of defence and technology state-owned companies) or raising capital (in the case of oil and gas companies such as Gazprom).

Critics have pointed to the fact that several Russian state-run and commercial banks continue to operate relatively free of sanctions. As the war continues, there will be pressure to widen the reach of the sanctions, but while Russia continues to export products such as oil and gas, it is inevitable that some means of trading with Russia will continue.

The effects of asset freezes on banks on domestic Russian activity is harder to calibrate. Research suggests that after the post-2014 episode, sanctioned Russian banks adjusted their asset and liability structures, moving away from foreign assets and liabilities into the domestic market (Mamonova et al, 2021). They may therefore be more protected from the current sanctions.

Since the Russian central bank can presumably still provide liquidity to the domestic banking system, the Russian financial system is likely to survive, albeit in an increasingly autarkic economic system.

Sanctions against specific individuals

Russian oligarchs or billionaires considered close to Putin were quickly targeted by the EU, the UK and the United States. The personal and corporate assets of these individuals have been frozen and they have also been denied access to maintenance of assets and hiring employees.

Calls for these sanctions have been made since the annexation of Crimea in 2014, justified by arguments that these oligarchs fund major infrastructure projects in Russia, such as the Sochi Olympics or the bridge to Crimea. Crucially, they also fund personal projects for Putin, such as his villa on the Black Sea and private yachts (European Council, 2022).

The oligarchs deny that they have political influence over Putin and that such sanctions are not justified. But do they have any legal recourse in such a case?

After sanctions were imposed following the 9/11 attacks, the EU agreed guidelines on the use of sanctions. Under these, individuals and firms may resort to legal challenges to the sanctions using domestic law – and in the EU with recourse to EU courts, either directly or through the preliminary reference procedure.

EU law provides procedural safeguards, alongside guarantees of adherence to fundamental rights found in EU law, but the EU courts will not interfere in the merits of the case. An attempt by Rosneft – a Russian energy company, 69% of which is owned by the Russian state – to have the underlying EU Regulations annulled when sanctions were imposed on it after the annexation of Crimea was dismissed by the Court of Justice of the European Union (CJEU) in 2017. The Court found that there was a reasonable relationship between the sanctions and the objectives underpinning them:

‘… in so far as that objective is, inter alia, to increase the costs to be borne by the Russian Federation for its actions to undermine Ukraine’s territorial integrity, sovereignty and independence, the approach of targeting a major player in the oil sector, which is moreover predominantly owned by the Russian State, is consistent with that objective and cannot, in any event, be considered to be manifestly inappropriate with respect to the objective pursued’.

Conclusion

The world has responded to the war in Ukraine in an unprecedented way: by using economic sanctions and defensive trade instruments to show political opposition to the Russian invasion. In particular, financial sanctions against Russian banks and other state agencies have had a dramatic impact on Russia’s ability to use foreign exchange and credit lines to bolster its war effort.

This makes the Russian economy more dependent on current revenue flows from its exports of oil, gas and related products. Cutting usage of such products, especially by EU countries, remains a priority. But as Figure 1 shows, any fall in the price of oil will have an adverse effect on Russia’s foreign exchange revenues. Measures to enhance supplies of oil and gas from other producers are therefore a priority, thereby raising total supply while simultaneously allowing countries to divert demand to other producers.

On the legal side, time will tell if the response can have political leverage and force Russia to withdraw from Ukrainian territory. For example, one question, both legal and economic, remains unanswered: how long should the sanctions and revocation of the MFN last, and can Russia successfully appeal any of the dramatic legal and administrative measures taken against it?

A cessation of military activity and withdrawal from Ukrainian territory seems an essential prerequisite before these questions can be answered – and this will only be the first step in what could be protracted negotiations over the future security of Ukraine.

Where can I find out more?

• EU sanctions map: An interactive map showing UN and EU sanctions affecting 33 countries.
• Russia's war on Ukraine: A sanctions timeline.
• Russian sanctions: Some questions and answers: VoxEU article.
• The WTO’s first ruling on national security: What does it mean for the United States? Center for Strategic and International Studies.
• The WTO’s essential security exception and revocation of Russia’s Most Favoured Nation status following the invasion of Ukraine: Article for the City Law Forum by David Collins.
• Kadi and Al Barakaat v. Council of the EU & EC Commission: European Court of Justice quashes a Council of the EU Regulation implementing UN Security Council Resolutions, American Society of International Law.
• The Kadi case – constitutional core values and international law – finding the balance? Article in the European Journal of International Law.
• Ukraine: UK Trade Policy Observatory.
• The Ukraine-Russia crisis and possible trade sanctions: UK Trade Policy Observatory.

Who are experts on this question?

• Stephen Cecchetti
• Adam Cygan
• Richard Disney
• Erkal Ersoy
• Sergei Guriev
• Ben Moll
• Kim Schoenholtz
• Erika Szyszczak

Authors: Adam Cygan, Richard Disney and Erika Szyszczak

Note: An earlier version of some of this material was discussed in a seminar on 29 March 2022 involving some of the authors and participants from the Universities of Kyiv and Lviv.

Photo by Lidia Mukhamadeeva on iStock

The post Sanctions on Russia: what are the ramifications of this new trade war? appeared first on Economics Observatory.

That is because institutions – whether they are regulatory regimes, legal frameworks, fiscal policies, or trade agreements – set the ‘rules of the game’ for business. Firms configure themselves to optimise performance within them. But unlike a single fiscal, legal or regulatory change, a referendum on independence brings the uncertainty of possible wholesale change.

Ultimately, the decisions that business leaders make at an individual firm level – whether to invest, divest, consolidate, grow, and whether to enter or exit a business, market, sector or industry – cumulate and amplify to have a profound impact on local, regional and national economic performance.

How business leaders make sense of such uncertainties, identify the risks and opportunities that they present, and ultimately act at a micro level has implications for short- to medium-term prosperity at a macro level. Establishing how they make decisions under conditions of constitutional uncertainty is therefore critical to understanding wider economic performance and prospects.

How do business leaders make decisions under conditions of uncertainty?

Decision-making under conditions of uncertainty generally, and political uncertainty specifically, has been an area of economic inquiry for many years. Research has often focused on pro-active versus uncertainty avoidance strategies when there is policy or regulatory uncertainty. Depending on whether such decisions are viewed as an opportunity or risk, investments might be delayed or pre-empted (Bernanke, 1983; Bloom et al, 2007).

Evidence from studies of responses to regulatory uncertainty and changes of policy have been mixed (Doh and Pearce, 2004; Dutt and Joseph, 2019). When facing a significant policy or regulatory change, many businesses adopt a ‘wait-and-see’ position (Holburn and Zelner, 2010; López-Gamero et al, 2011; Marcus and Kaufman, 1986; Yang et al, 2004).

But other research indicates that this is not always the case, particularly where decision-makers identify a ‘first-mover-advantage’ – whereby a firm can benefit by acting before its competitors (Aragón-Correa and Sharma, 2003; Carrera et al, 2003; Hoffmann et al, 2009; Marcus et al, 2011). Some businesses may also come under pressure from external parties – such as investors and financial analysts – who pressure decision-makers into addressing uncertainties that may affect future performance (Wiersema and Zhang, 2011).

Some research also shows that strategies to deal with uncertainty will vary depending on whether the uncertainty is likely to yield slow continuous change, rapid high velocity change or uneven, discontinuous change (Doh and Pearce, 2004).

Constitutional uncertainty falls into the last category as it brings the prospect of disruption to multiple institutions simultaneously and change to the rules of the game for business (good or bad).

Suffice to say, there is relatively limited research on the impact of independence movements on business behaviour. Seminal studies of the economics of secession have focused on such issues as the economic determinants of secessionism, the political economy of secessionism and regional economic inequalities (for example, Collier and Hoeffler, 2006; Griffiths, 2014; Horowitz, 1985; Sambanis and Milanovic, 2001; Sorens, 2005).

Studies of business more specifically have tended to focus on voting preferences. They note that large businesses tend to oppose significant constitutional change, while smaller businesses are more inclined to support it (Dion, 1995; Gagnon and Lachapelle, 1996; Lange, 1998; Lynch, 1998; Medina and Molins, 2014).

Yet others have argued that the size of a business is ‘merely a surrogate for several things poorly understood’ (Darnall and Edwards, 2006). For example, research shows that other characteristics, such as ownership structure, may have greater explanatory power of why certain strategies are adopted over others in specific circumstances (Darnall and Edwards, 2006; Mascarenhas, 1989).

The Scottish independence referendum and business

The 2014 referendum on Scottish independence provided an opportunity to investigate how business leaders make sense of the uncertainties created by such votes.

One study – based on interviews with 75 leaders of businesses with a significant economic footprint in Scotland – found that around 90% reported uncertainty associated with the independence debate (MacKay, 2013).

The interviewees represented sectors such as business services, electronics and technology, energy, engineering and manufacturing, financial services, food and drink, and life sciences. They were asked whether they faced any uncertainties related to the constitutional questions, if they perceived the independence referendum to be an opportunity or a threat, and, as a proxy for decision-making, whether they were making contingency plans for different outcomes.

In addition to the reports of overall uncertainty, in 2014, these business leaders were more readily able to identify risks than opportunities. The risks were most pronounced in large, publicly traded companies with head offices in Scotland, and for which trade with the rest of the UK was important.

For these companies, the prospect of being regulated in a jurisdiction outside where most of their business took place, the question of what currency would be used, complexities around tax, employment and access to the European Union (EU) market were most commonly cited.

It was these businesses, often prompted by pressure from shareholders or customers, that were most likely to be putting in place contingency plans (for example, moving their ‘brass plate’ elsewhere or setting up alternative supply chains).

Participants from large and medium-sized companies that were privately owned were also likely to emphasise the risks of independence over opportunities. But without the pressure of being publicly traded, they did express a greater willingness to absorb any short- to medium-term downside risks. Partnerships, given their management structures and diversity of views, were less likely to express strong views either way.

Participants from large subsidiaries of global companies were most likely to emphasise their experience of working across multiple jurisdictions. Such companies were more likely to rely on business continuity plans already in place than to initiate contingency planning specifically related to the independence debate.

For these participants, decisions about whether to invest, divest, consolidate or grow, and whether to enter or exit a business, sector or industry in Scotland were closely connected with the reasons that they were invested in the first place. For these participants, the overall business and trading environment that emerged following a referendum vote was also an important consideration.

Participants from businesses whose customers, labour and supply chains were primarily in Scotland or global were more sanguine about the prospects of independence than those that had significant trade with the rest of the UK.

Even within industries such as financial services, variations in participants’ responses were divided along such lines. For example, a hedge fund headquartered in Scotland but with a global customer base and investment profile may have been less concerned about the risks posed by the prospect of independence than a retail bank or insurer whose customers were primarily in England.

Half of the participants who took part in the study were unable to identify additional opportunities that independence might bring beyond those already available.

Of those participants that did identify opportunities arising from the constitutional debate, only 10% emphasised opportunities over risks. These participants tended to be from medium-sized businesses with a significant proportion of their trade being either in Scotland or global.

Opportunities tended to be more specific to their business, such as the prospect of dispensing with an adverse licensing fee controlled by the UK government or the possibility of greater research and development support from an independent Scottish government, rather than more general opportunities that might arise from an independent Scotland. In these instances, the opportunity to be able to influence government in a smaller country was frequently cited.

The interviews conducted for this study add granularity to survey findings conducted at the same time. Other surveys in 2013 and 2014 – conducted in partnership with the Scottish Chamber of Commerce – found that the main uncertainties listed by the 759 respondents included business and personal taxation, regulation, currency and Scotland’s relationship with the EU (Bell and McGoldrick, 2014).

Half of the participants in the study were able to identify some associated opportunity with independence, including policies more appropriate for Scotland, improved business support from government and close identification with the Scottish brand.

But strikingly, only 4% of respondents identified business growth as an opportunity, and 47% couldn’t identify any opportunities at all. Of the 24% of business that have a risk register, only about half listed the constitutional question, and these businesses tended to have their trade in the rest of the UK or EU.

Indeed, along similar lines, analysis of a longitudinal panel of business investment in 3,589 Scottish firms in the lead-up to the 2014 referendum found that listed firms, firms on the border with England, firms that are financially constrained or whose investments are likely to be irreversible had greater sensitivity to the political and policy uncertainty generated by the independence debate (Azqueta-Gvaldon, 2020).

Echoes of the Scottish independence referendum in the Brexit debate

Findings from the study of business attitudes and perceptions during the Scottish referendum shed light on the responses to industry-led surveys ahead of the referendum on the UK’s membership of the EU in 2016 (see Figure 1).

Surveys of industry bodies with membership drawn from predominantly larger businesses (such as the Confederation of British Industry) tended to find more negative attitudes to leaving the EU than those with membership drawn from smaller firms.

Figure 1: Business attitudes towards the EU referendum, 2016

Source: Surveys conducted by the Confederation of British Industry (March 2016); British Chambers of Commerce (May 2016); Institute of Directors (May 2016); Federation of Small Businesses (September 2015); British American Business (March 2016).

Digging into a survey of 2,231 firms conducted by the British Chambers of Commerce in May 2016 helps to explain why.

Businesses exporting to the EU were much more likely to be in favour of remaining part of it (62.1%), while that figure dropped to 46.7% for those that only export to the rest of the world. Only 30.7% of firms that sell to the EU were biased towards leaving, while that figure increased to 50.1% for those that only export to the rest of the world.

Of non-exporters, 42.8% were inclined to vote to remain in the EU, while a slightly higher 46.4% expressed support for leaving. It was also non-exporters who were most inclined to respond that they didn’t know whether to opt for remain or leave, at 10.2%.

Evidence from the Brexit debate supports the findings reported here: that it is not so much the size of the business that is important, but how they are structured and where they have significant business activity.

What can we learn from Brexit for any future debate on Scottish independence?

In January 2021, the UK exited its transitional membership of the EU’s customs union and single market. While the effects of the Covid-19 pandemic have complicated assessing the impact of Brexit on UK economic growth, exports and imports between the EU and UK fell sharply in 2020: by 14% and 19% respectively. This was even more pronounced between the fourth quarter of 2020 and the first quarter of 2021, with exports falling by 18% and imports by 25% (Ward, 2021).

Evidence from the Bank of England and the National Bureau of Economic Research suggests that the Brexit process, and uncertainty about future outcomes, have also depressed business investment and productivity. This has resulted from, amongst other factors, the culmination of a multitude of firm-level decisions.

The reasons for this drop will become clearer over time, but even with the UK-EU Trade and Cooperation Agreement (TCA) between the EU and UK covering goods (but not services), it has created border frictions.

Indeed, according to analysis by the Office for Budget Responsibility (OBR), in the longer term, both imports and exports will be around 15% lower than had the UK remained an EU member. Similarly, productivity will be about 4% lower due to non-tariff barriers compared with if the UK had remained an EU member.

Given that many new trade agreements between the UK and countries outside the EU largely replicate the agreements that the UK had as an EU member, forecasts suggest that, as with the UK-Japan Comprehensive Economic Partnership, these will be largely immaterial for GDP growth (OBR, 2021). Businesses’ perceptions about the impact of leaving the EU on market access have therefore largely been borne out in practice.

Wider economic performance is based, in part, on business leaders’ perceptions and the decisions that stem from them. The survey findings reported here are largely consistent with research showing that uncertainty can influence business decision-making, as investments are deferred until future outcomes become clearer.

It’s not necessarily all bad news either. Government provision of tax incentives and the need to upgrade assets neglected due to the uncertainty created by the Brexit process has led economists to forecast a strong domestic recovery for business investment following the transition period to a new UK-EU trading relationship (Romei, 2021). This suggests that the deferral of business investment due to political uncertainty can rebound once such uncertainty is resolved.

Yet Brexit also shows that the realities of increased complexity of exporting to European countries, even with goods covered by the TCA – the non-tariff barriers – are likely to dampen exports. This is because the costs for businesses begin to limit the benefits and opportunities of trading in some areas.

With the end of the Brexit transition period, compliance with relevant ‘rules of origin’, EU standards, regulatory checks and differing authorisations between EU countries (which ‘passporting rules’ once circumvented) all add costs to businesses.

As the implementation of the TCA comes into force in 2022, with full border checks in the UK, and businesses have had time to adjust with reconfiguring supply chains and labour, the full impact of the Brexit will become clearer. Some initial surveys of business leaders suggest that in the short term, a third of businesses that trade with the EU have experienced declines in trade (Institute of Directors, 2021).

Indeed, recent data published by the world trade monitor appear to show British exports underperforming the rest of the world (CPB, 2022). This has led the OBR to remark in their economic and fiscal outlook that trade flows of exports and imports were ‘lagging behind the domestic economic recovery’, and they suggest that ‘Brexit may have been a factor’ (OBR, 2022, p. 62).

The experience of Brexit gives an indication of some of the challenges and opportunities that might arise for business and the economy in the event of a Scottish vote for independence from the UK. While the UK is and will continue to be Scotland’s largest trading partner irrespective of independence, the prospect of rejoining the EU presents another complex dimension to the debate.

Conclusion: the past as prologue?

Research looking at business perceptions and decision-making in the lead-up to the referendum on Scottish independence in 2014 shows that factors such as ownership structures, location of key markets, as well as those of labour and supply chains were key determinants in how participants made sense of the uncertainties presented by the constitutional debate (MacKay, 2013). These also contributed to whether they perceived there to be opportunities or risks associated with independence.

With a Scottish population of around 5.5 million people, and a population of approximately 61.5 million in the rest of the UK, large businesses in Scotland were likely to have 80% or more of their UK business outside Scotland. Government data also routinely suggest that 60% or more of Scottish exports at present go to the rest of the UK, largely reflecting the difference in the size of the respective markets.

The factors shaping perceptions of uncertainty, and whether uncertainty presents opportunities or risks are unlikely to be significantly different in a second referendum. Business behaviour and decisions around whether to invest, divest, consolidate or grow, and whether to enter or exit a business, market, sector or industry are clearly more nuanced than simply attributing such outcomes to the size of a business.

Some circumstances in Scotland have clearly changed since 2014, particularly with Brexit, but also in terms of the sectors attracting investment. Given these changed circumstances, how factors shaping perceptions of uncertainty interact might conceivably lead to different perceptions of opportunity and risk in a second referendum.

It is likely that the rest of the UK will continue to be Scotland’s most important trading partner for the foreseeable future. The UK economy, it is important to emphasise, is highly integrated. The impact that Brexit may have on business attitudes towards the opportunities and risks posed by the prospects of a second referendum remains to be seen. It is likely that patterns would not be significantly different.

In the short term, listed firms and firms with significant trade in the rest of the UK will be most anxious and prone to defer investment or move part or all of their operations in the event of a ‘yes’ vote. Subsidiaries of multinational companies, privately held firms with the majority of their trade in Scotland, firms with global markets or those that see growth opportunities in Europe might be comparatively more relaxed.

The lessons from the Brexit negotiations and the challenges and opportunities we have experienced throughout the process will also undoubtedly play an important role in shaping the views of business.

Where can I find out more?

• Centre on Constitutional Change.
• Brexit analysis: Office for Budget Responsibility.
• Brexit uncertainty is taking a toll on the British economy: National Bureau of Economic Research.

Who are experts on this question?

• John Vickers, University of Oxford 
• Nicholas Bloom, Stanford University
• John Van Reenen, London School of Economics
• Ronald MacDonald, University of Glasgow

Author: Brad MacKay

Editors' note: This article is part of our series on Scottish independence - read more about the economic issues and the aims of this series here.

Photo by Travelling Light on iStock

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What has been the impact of Covid-19 on sales, employment and investment?

The spread of Covid-19 and measures to contain it led to a large fall in sales. Looking back, between April and June 2020 (Q2) businesses estimated that their sales were around 30% lower than they otherwise would have been (see Figure 1). Crucially, this was when the UK was in its first country-wide lockdown.

Sales have recovered gradually since then. But there have been further, smaller dips, including in the first quarter of 2021, when the country was again subject to restrictions introduced to contain the Delta variant, and again more recently, as a consequence of the Omicron wave.

The estimated impact of Covid-19 on sales worsened from -4% in 2021Q3 to -6% in 2021Q4 and -7% in 2022Q1.This is likely to be related to the effects of the Omicron variant. But this was a somewhat small change relative to the effects on sales seen earlier in the crisis.

The pandemic has not affected all firms and industries equally. Industries that rely on personal interactions or travel, such as airlines or hotels, have been hit hardest. Indeed, the estimated falls in sales in the early part of the pandemic were largest in accommodation and food and recreational services. These industries continue to be among the most affected in the latest data (Anayi et al, 2021).

Looking ahead, respondents to the February 2022 DMP survey expect the effects of Covid-19 on sales to continue to ease during 2022. The group expect sales growth to go from -7% in 2022Q1 to -4% in 2022Q2 and move up to approximately 0% by 2022Q3. Beyond this, they expect the impact to rise to around 1% over the medium term (2023 and beyond).

This represents only a slightly slower recovery compared with firms’ pre-Omicron expectations. This is most likely to be the case as the new variant was revealed to be milder than originally expected, requiring less stringent containment measures.

By the second half of next year, UK businesses expect Covid-19 to be having little effect on their sales, on average. But within these figures, around 15% of firms expect sales to be higher than they would have been otherwise, with 20% predicting sales will be lower.

There was also a large fall in employment during the pandemic. Employment is estimated to have fallen more slowly than sales, with the impact of Covid-19 estimated to have peaked at -9% in 2020Q3. Falls in employment were smaller than those in sales, in large part due to government support programmes, such as the Coronavirus Job Retention Scheme (CJRS) which at its peak protected almost nine million jobs.

The proportion of employees on furlough gradually declined after February 2021, and the CJRS officially ended in September 2021 (see Figure 2). In the February 2022 DMP survey, the impact of Covid-19 on employment in 2022Q1 was estimated to be -4%, marginally worse than in 2021Q4 (see Figure 1). The effect was expected to ease to -2% in 2022Q2, and -1% by 2022Q3.

Lastly, Covid-19 has also led to a large fall in investment. This fell initially by more than sales in the early part of the pandemic and remained weaker until the end of 2021. But it appears to have been less affected by the Omicron variant compared with sales. In 2022Q1, the impact of Covid-19 on investment was estimated to be -6%, compared with -7% for sales.

The effects on investment are also expected to wane over the coming quarters, and at a slightly faster pace than for both sales and employment. In the February 2022 DMP survey, the impact of the pandemic on investment was expected to ease from -6% in 2022Q1 to -1% in 2022Q2 and be approximately zero in 2022Q3 (see Figure 1).

Investment was expected to be around 1% higher compared with what it would have been without Covid-19 over the medium term (beyond 2023). The pandemic is also expected to lead to long-term structural changes in the economy that will affect the types of investments firms make. For example, firms are expected to invest less in land and buildings but more in information technologies and software in future years (Anayi et al, 2021).

Figure 1: Expected impact of Covid-19 on sales, employment and investment

Source: DMP

Note: (a) The results are based on the questions: ‘Relative to what would otherwise have happened, what is your best estimate for the impact of the spread of Covid on the sales/employment/capital expenditure of your business in each of the following periods?’. Data for 2020 Q2 are from the July 2020 DMP survey, data for 2020 Q3 are from the October 2020 DMP survey, data for 2020 Q4 are from the January DMP survey, data for 2021 Q1 are from the April 2021 DMP survey, data for 2021 Q2 are from the July 2021 survey, data for 2021 Q3 are from the October 2021 DMP survey, and data from 2021 Q4 are from the January 2022 DMP survey. Data for 2022 Q1, 2022 Q2, 2022 Q3, and 2023+ are from the February 2022 DMP survey. Data shown for 2020 Q1 are percentage changes in aggregate ONS data for private sector output and private sector employment between December 2019 and March 2020.

What about working arrangements?

Working from home became much more common during the pandemic (see Figure 2). In 2019, DMP respondents estimated that around 7% of the hours that their employees worked were done so from home (Anayi et al, 2021).

In April 2020, just under two-thirds (61%) of employees were actively working (that is, excluding those on furlough, those who were employed but had zero hours, and those unable to work). More than a third (36%) of employees were working from home (see Figure 2).

During most of 2021, the proportion of employees working from home gradually declined with more people returning to business premises. But government guidance to work from home where possible in response to the spread of the Omicron variant increased the proportion of employees working from home from 25% in November 2021 to 30% in December 2021 and January 2022.

By February 2022, as this guidance was removed, the numbers had returned to November 2021 levels. By this stage, around 24% of people were working from home, 4% were unable to work and 72% were working on business premises. This indicates that a larger proportion of the workforce is currently working from home than was the case before the pandemic.

Looking ahead, firms’ responses to the DMP also suggest a gradual return to business premises is anticipated. Nevertheless, working from home is predicted to remain significantly above pre-pandemic levels over the medium term, with around 17% of hours to be worked from home in 2023 and beyond. That is around two and a half times more than before the pandemic.

Figure 2: Percentage of employees working on business premises, working from home and unable to work

Source: DMP

Note: (a) The results are based on the question ‘Approximately what percentage of your employees do you expect to fall into the following categories in each of the following periods?’. Respondents could assign their employees to the following categories: (i) Still employed but not required to work any hours (eg. ‘on furlough’), (ii) Unable to work (eg. due to sickness, self-isolation, childcare etc), (iii) Continuing to work on business premises, and (iv) Continuing to work from home. Firms are asked to include only employees of UK-based businesses and not from any overseas part of the group, and to treat employees working some hours as continuing to work if they have been partially furloughed. Where employees spend some time working on businesses premises and some time working from home, firms are asked to answer based on the approximate proportion of hours worked from each location. Not all bars sum exactly to 100 exactly due to rounding.

How has business uncertainty evolved over the past two years?

As well as a large fall in sales, there was a sharp increase in uncertainty as the scale of the pandemic became clear during early 2020. Measures of uncertainty can be constructed using year-ahead expectations data in the DMP (since the survey asks about the distribution of expectations, not just for point estimates).

Figure 3 shows a big increase in uncertainty about both future sales and employment in the spring of 2020. Sales uncertainty remained high throughout 2020 but has since declined. Even in February 2022, it remains above pre-pandemic levels.

Employment uncertainty declined more quickly and is now only marginally above its 2019 average. Meanwhile, uncertainty about future inflation initially rose by less than sales and employment uncertainty. But it has been on an upward trend over the last year and is currently the highest of all three measures in relation to their 2019 averages.

Figure 3: Sales, employment and inflation uncertainty

Source: DMP

Note: : (a) The sales uncertainty index is constructed using the standard deviation of expected firm-level sales growth a year ahead. The employment uncertainty index is constructed using the standard deviation of expected firm-level employment growth over the next 12 months. The inflation uncertainty index is constructed using the standard deviations of expected firm-level price growth over the next 12 months. All three indices are normalised to their respective average values during 2019. A three-month moving average is then constructed to create the final series.

What about inflation?

During the first year of the pandemic, there was a modest fall in economy-wide price inflation reported in the DMP. This was similar to what was seen in aggregate consumer price index (CPI) inflation.

During 2021, inflation picked up sharply. DMP respondents reported that inflation in the prices that they charge has been increasing in recent months, reaching 5.4% on average in the three months to February 2022 (see Figure 4). This is up from 4.9% in the three months to November 2021.

These figures refer to prices charged by businesses across the whole economy, including businesses that sell to other businesses (rather than just by those businesses that sell directly to consumers). Price growth was particularly elevated in the manufacturing, wholesale and retail sectors, as well as in accommodation and food industries.

The rise in inflation is likely to reflect a number of factors, including the recovery in demand, supply and labour shortages, and higher energy prices.

As well as increases in reported inflation, expected year-ahead price inflation has also been increasing over the last year. It reached 4.8% in the three months to February 2022, up from 4.2% in the three months to November 2021 (see Figure 4).

This implies that businesses believe that inflation is likely to remain high over the next year, although the expectations have fallen back a little from current levels. But as described above, uncertainty around these expectations for inflation is currently higher than normal.

It should also be noted that the latest data were collected up to the middle of February 2022 and so will not take account of how businesses expect prices to be affected by the war in Ukraine.

Figure 4: Realised and expected annual price inflation

Source: DMP

Note: (a) Realised price growth results are based on the question ‘Looking back, from 12 months ago to now, what was the approximate % change in the average price you charge, considering all products and services?’. Expected price growth results are based on the question: ‘Looking ahead, from now to 12 months from now, what approximate % change in your average price would you expect in each of the following scenarios: lowest, low, middle, high and highest?’ and respondents were asked to assign a probability to each scenario.

How have supply and labour shortages affected UK businesses?

As reported in November 2021, there continues to be a strong positive relationship between both recruitment difficulties and non-labour disruptions (such as supply chain delays and shortages of raw materials) on the one hand, and realised and expected output price growth on the other. The emergence of these shortages is another important feature of the post-pandemic recovery challenge.

In February 2022, businesses estimated that around 13% of their non-labour costs had been disrupted on average, a gradual decline relative to previous months (see Figure 5, panel A). These disruptions are widespread, with around two-thirds of businesses reporting some disruption in February. Manufacturing and accommodation and food industries were most acutely affected, with over 20% of their non-labour costs disrupted.

Over the past few months, businesses have also been asked about the level of difficulty in recruiting new employees. The results suggest that recruitment difficulties continue to be pervasive among businesses in the DMP. Over half (59%) of firms report finding it ‘much harder’ to recruit new employees compared with normal times. This figure is broadly in line with the levels seen since October 2021 (see Figure 5, panel B).

Businesses in the transport and storage, wholesale and retail, and information and communications industries report the highest levels of recruitment difficulties.

Figure 5: Percentage of non-labour inputs disrupted (panel A) and percentage of businesses currently finding it much harder than normal to recruit (panel B)

Panel A

Panel B

Source: DMP

Note: (a) Results on availability of non-labour inputs are based on the question ‘Over the past month, has the availability of the non-labour inputs that your business uses been disrupted?’. Respondents provided a percentage impact figure. (b) Results on recruitment difficulties are based on the question ‘Are you finding it easier or harder than normal to recruit new employees at the moment?’. Respondents could select from one of the following options: (i) Much easier, (ii) A little easier, (iii) About normal, (iv) A little harder, (v) Much harder, (vi) Not applicable – not recruiting at the moment.

Conclusions

Covid-19 has had a significant impact on UK firms, affecting almost every aspect of everyday business. This article analyses the main developments over the past two years using data from the monthly Decision Maker Panel survey.

The sharp drops in sales, employment and investment experienced in 2020 have now waned. Nevertheless, risks remain, mainly around higher price growth, elevated uncertainty and persistent supply disruptions.

In addition, structural changes are also expected across UK firms, with working from home remaining much more common than before the pandemic.

Where can I find out more?

• The Decision Maker Panel website.
• This article from the Bank of England summarises and analyses some of the key findings from the latest DMP survey data.

Who are experts on this question?

• Lena Anayi
• Nicholas Bloom
• Paul Mizen
• Gregory Thwaites

Authors: Paul Mizen, Philip Bunn, Ivan Yotzov, Lena Anayi, Nicholas Bloom and Gregory Thwaites

Picture by Nito100 on iStock

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