An economy on the brink

Britain stands on the brink of one of the deepest recessions since the end of World War Two. Real GDP in the UK fell by its highest amount for eighteen years in the 3rd quarter of 2008 and this marks only the early stages of the downward slide. Most of the really bad economic news - such as the banking collapses and the carnage on the high street in the weeks before Christmas - happened in the final quarter.

2009 will be the first downturn that the vast majority of students will ever have experienced and for many, the direct consequences of a sharp fall in output, profits, jobs and spending will be clear to see.

Naturally for economics students and teachers, the fall out from the global credit crunch and financial crisis will be an incredibly interesting time - the era of the Great Stability has come abruptly to an end and all bets seem to be off regarding the extent and depth of the next stage of the economic cycle. Expect the word recession to be increasingly replaced by the word slump as the forthcoming year unfolds. Indeed the R word may be swapped for the D word if the contraction becomes embedded.

Official data lags what is actually happening in the real economy - the GDP figures tell us that the British economy started to contract in the middle of 2008 but we won’t be in an official recession until the 4th quarter data is released sometime in the spring of 2009. Don’t be fooled by this - the recession started many months ago and is picked up more accurately by the survey evidence.

There will be lots of articles written about businesses and industries that seem to be recession proof - the focus in recent weeks has been on the rise of the discount retailers such as Aldi and Lidl. The reality is that no business is recession proof - but the genuinely interesting stories are on those businesses that show the adaptability, nous and acumen to seek out the opportunities that economic downturns provide. The nature of the credit crunch is that many viable businesses will go to the wall and some mediocre operators will hang on until the recovery appears. But the true test of competitiveness is to be able to survive a downturn and get into shape to prosper when the green shoots start to emerge.

One of the key indicators to keep a close eye on will be business sector investment. Although the government is fast-forwarding some public sector capital projects, keep in mind that private sector investment spending accounts for three quarters of the total so there is only so much that state-led capital spending can do to offset what is likely to be a severe downturn in spending on new IT equipment, buildings and plant and machinery.

Making policy - groping in the dark?

This is a fascinating time to watch how macroeconomic policy-making is conducted both here in the UK and in a European and global context.
1. Will the deep cut in policy interest rates work or has the Bank of England become powerless and impotent?
2. How many central banks will resort to direct expansion of the money supply through quantitative easing?
3. Will countries in charge of their own exchange rates look to engage in competitive devaluations to boost their export industries?
4. How strong will be the pressures for protectionism?
5. Can fiscal policy measures prove to be more effecting than monetary policy in limiting the extent of the downturn?
6. Will national governments be able to finance a huge rise in sovereign debt as their budget deficits balloon ever higher?
7. Are economic policy makers both in the Treasury and at the Bank of England making sensible decisions about how best to ‘manage’ this downturn?
8. To what extent are they now powerless because of the fragility of the banking system? (It doesn’t really matter what the rate of interest is if a lender is not prepared to lend).
Shock waves

Given the size and severity of the external and domestic shocks that have hit the economy over the last year and a half, this is not an easy time to be making policy decisions. The Bank of England was being criticized this summer for ‘falling behind the curve’ in underestimating the scale of the likely slump in demand and jobs. Gordon Brown and Alastair Darling face ridicule - the former for claiming to have saved the world and the latter for continuing to publish Treasury forecasts that, like the incurable romantic, look to be hopelessly over-optimistic.

My instinct is that the next three months will be stunningly bad for the British economy. Hundreds of thousands of jobs will go from retailing to banking and a myriad of supply-chain industries covering both manufacturing and services. There is a mountain of corporate debt that must be repaid in the first half of 2008 and many well run companies will struggle to do this; their response will be to shed jobs, cancel investment projects and look to preserve cash-flow by trying to cut as many overheads from their business as they can.

The lower pound will help but the effects are muted by weakness in demand in the global economy. Commodity prices continue to fall away and cheaper energy bills and fuel prices will provide a soothing balm to hard-pressed consumers.

But 2009 will be a year when the household savings ratio climbs quickly. The emphasis will be on paring back corporate and consumer debt.

Suggestions for further reading

UK Recession will be worst since 1947

Recession will ‘set British economy back five years’

Who was to blame for UK slowdown? - Nils Blythe, Business correspondent, BBC News