In These New Times

A new paradigm for a post-imperial world

Grim prospects for UK economy

Posted by smeddum on August 24, 2008

By Seasn O’Grady
Sunday, 24 August 2008 Independent

All agree we’re close to recession. The revised GDP figures released last Friday pretty much confirmed that two successive quarters of negative growth – where the economy shrinks, which is the conventional definition of “recession” – cannot be far away. In case you hadn’t noticed, the economy ground to a halt in the second quarter of the year, and almost every leading indicator suggests that activity will slow further over the next year. But how bad will things get? And what will be the consequences?

Things don’t look great, but we needn’t get too apocalyptic either. Let’s take a peak at the dark side first. While household spending fell last quarter, by 0.1 per cent, by far the biggest drag on the economy is the decline in investment. In the first three months of 2008 it was down by 1.5 per cent on the last quarter of 2007; it has now dropped by another 5.3 per cent. That magical, elusive ingredient – confidence in the future – seems to be ebbing away.

There is a further point worth making here: cuts in investment – buying new kit for offices, factories, design studios, farms and the public services – will reduce economic growth way into the future. As we spend less on renewing the productive capacity of the economy, so we reduce our ability to create wealth in the months and years ahead. In particular, we will suffer from the sharp decline in construction; the long-term housing shortage in the UK is about to get a little bit worse. This slump in investment will damage, permanently, the productive capacity of the economy and reduce its long-term rate of growth. The recession of 2008-09, even if it turns out to be short and shallow, will cast a long shadow.

So far, so miserable. The brighter news is that we are at last getting some benefit from the pound’s 12 per cent devaluation since last summer. Exports are down, in truth, because of the general slowdown in the world economy, and especially in the eurozone, our largest trading partner and itself not far from recession. But imports are down even more. The sad thing is that we’re not selling as many of our wonderful Minis, bottles of Scotch and Norman Foster buildings abroad as we would like, but the situation would, we can safely conclude, be an awful lot worse if it hadn’t been for sterling’s tumble. So the weak pound is doing us good, and pushing the UK economy towards a much needed rebalancing in favour of exports and manufacturing.

Leaving the export/import side of things to one side, the UK’s “domestic” economy is already in recession, having seen two quarters where the positive contribution from net trade exceeded the negative impact of lower domestic demand.

The UK’s trading performance is becoming a source of relative strength rather than weakness. Maybe that shouldn’t be such a surprise. Historically, the traditional route for the UK economy out of recession has been through trade. The awful conditions of 1973-74 (oil was dear then too) were followed by the great depreciation of 1976 and an impressive (for the time) recovery; the recession of 1979-81 was accompanied by an absurdly high exchange rate (around $2.50 to £1), and sterling’s subsequent decline to dollar/pound parity helped fuel the boom of the later 1980s; and our ejection from the Exchange Rate Mechanism in 1992 paved the way for the glorious 63 successive quarters of growth, which have just ended. It’s a compelling pattern – and one that it would not now be possible to repeat had we joined the euro a few years ago. Sadly, the Italians, Europe’s other great devaluers, no longer have that option and endure economic misery as a result.

But what of the future? By far the best forward facing set of statistics are supplied by the Chartered Institute of Purchasing and Supply. Every month it polls thousands of managers at the sharp end of British business, tracking confidence, pricing, recruitment intentions and, crucially, forward orders. The data gives us an excellent idea as to what will soon be happening “out there”. The Bank of England certainly takes CIPS surveys seriously, and so should we. All the indicators are pointing firmly downwards, and some of the other survey evidence is even more frightening.

Comparing the current crop of numbers with those from the last recession, from 1989 to 1992, is a scary exercise. We see that almost all of the figures are lower now, some markedly so. The most startling, if understandable, difference comes from the credit crunch and the crisis facing the banks, which has pushed confidence levels in the financial services sector to record lows. It has been the engine of growth; now it has overheated and exploded.

Thus, the consensus among economists is that growth this year will average 1.4 per cent, well below recent trends, and in 2009 will slow to 0.9 per cent. This points to a couple of quarters of contraction. The Bank of England predicts “broadly flat” growth and concedes the possibility of outright recession. Strong growth will return some time in 2010, maybe just in time for a general election, maybe not.

In any case, as the Governor of the Bank, Mervyn King, memorably put it recently, we are in for a “difficult and painful” year. Living standards may fall, a product of high inflation and slow wage growth. The depreciation of sterling that will help keep the economy from the worst ravages of a slump will cut the real value of your salary. These factors, incidentally, will help keep rises in unemployment to a minimum, and the UK’s flexible labour market will turn out to be its one great strength. Indeed, a market so flexible that excess labour simply gets on a coach back to Poland and Lithuania is nothing short of an economic miracle. The public finances will remain a messy but positive contribution to growth.

Nonetheless, jobs will go, homes will be repossessed and there will be forced selling of houses worth less than the mortgages on them. For an unlucky minority, nothing less than homelessness and bankruptcy lies ahead. That, I am afraid, is how bad things are going to get.

Sean O’Grady is economics editor of ‘The Independent

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