Household debt as a proportion of income has doubled over 10 years, and the cost of servicing the debt now takes up much of the money that would normally fuel a recovery. Interest payments now take twice as much of household income as they do in France and five times as much as in Germany.
There is an additional and dangerous twist. This debt is largely secured on family homes, assets that are dropping sharply in price. With property values down 7.5 per cent over the last year, the gloom in the housing market has spread widely through the economy. More than a million home owners now owe more in debt than the value of their homes.
Some are giving up the effort to service their loans, leading to more repossessions, a greater supply of homes on to the market and an even sharper fall in prices. The vicious circle then continues, eroding the confidence even of those with substantial wealth left in their homes.
On top of this home-grown devastation, British businesses are increasingly having to cope with a downturn in our principal export markets. Germany is heading for recession, and the rest of the Continent is suffering the effects of high interest rates. The recovery in the United States has failed to take off. In August alone, British export volume fell by 3 per cent.
The latest indicators all point to a damaging contraction: manufacturing output is falling again; stocks of unsold goods are high, which means further cuts in production to come; there were 51,000 manufacturing job losses in August, the highest monthly total since the recession began.
The Government needs to act urgently to stop the recession sliding into slump. It needs a coherent strategy that goes to the heart of our economic problems. Here is a 10-point programme for a durable recovery.
1. Cut interest rates
to 5 per cent.
This would be a dramatic move which would clearly signal both to consumers and businesses that policy had changed. Parcelling out interest rate cuts in penny pieces merely sows doubt about whether the cuts are sustainable.
There is a risk that sterling will fall sharply because interest rates on pounds would be so much lower than those available on francs or marks; this would in turn raise import prices, and feed through into inflation. With the pound already down some 13 per cent compared with the average level of last year, the Chancellor of the Exchequer cannot afford to ignore the exchange rate.
But no course of action is without risk, and the dangers of a deepening slump with no bottom in sight, of sharply rising unemployment and the destruction of viable businesses are greater than the danger of a renewed sterling crisis.
Moreover, the prospect of a recovery would do much to relieve the markets' fears both about the Government and the economy. The pound's weakness has largely been caused by the perception that the Government could not afford to raise interest rates. A robust recovery would allow both interest rates and sterling to rise again, limiting the inflationary impact of the present devaluation.
2. Push ahead with major road and rail projects.
In order to reflate the economy and, just as important, modernise Britain to enhance its potential as an economic power, the Government should embark on much needed major transport projects. Because personal debt is so high, even sharp interest rate cuts will not guarantee that people will go out and spend: that is the lesson both of the great Depression and of the present experience in the US. So other measures are necessary to stabilise output. And, as Keynes pointed out, if the private sector will not spend, the public sector must. The Government must proceed with projects such as the Midlands Metro, the London Jubilee Line extension and east-west Crossrail, and major road projects. If necessary, planning procedures should be accelerated so that a start can be made in the coming year where projects have not yet begun.
There is no inflation risk here. Construction is one of the most depressed sectors of the economy. Building tender prices are 22 per cent below their peak in 1989, allowing the Government to finance both the building and the extra cost of borrowing with ease.
An increase in borrowing is justified by the depth of the recession. Britain's budget deficit - the excess of spending over taxes - may be pounds 35bn this year, or some 5.5 per cent of national income. An even higher total would not be excessive provided that it is cut when the recovery comes. The average of European countries this year is projected at 4.9 per cent of national income, and they are not yet in full recession.
It is crucial that fiscal policy - both public spending and tax - is not tightened while there is a continued risk of slump conditions. Spending cuts or tax increases merely reduce incomes that might otherwise be spent on goods and services supplied by the private sector. In order to make even more room to increase capital spending, the Government should keep a tight lid on public sector pay. This would also send an important signal to the private sector not to dissipate the competitive gains reaped from devaluation of the pound.
3. Revive the housing market.
First-time buyers who bought at the beginning of this year with the usual 5 per cent deposit will already have lost their life savings. Not surprisingly, other people are reluctant to take the plunge, and a large backlog of potential purchasers is building up. But once the market begins to move, it will gather momentum on its own.
The first task is therefore to encourage first- time buyers to enter the market by offering them incentives that outweigh the perceived risk of losing their deposit. One solution is a one-off tax rebate of perhaps pounds 4,000; this would remain until the market revives but could be ended at any time. Alternatively, the mortgage interest relief that would normally be paid over five years could be rolled up as a lump sum for first-time buyers, while making it clear that relief will be abolished wholly in due course. The initial cost could be financed by a cut in the relief for existing borrowers, who would be more than compensated by interest rate cuts.
The Government also needs to encourage housing associations and institutional investors to buy or manage some repossessed properties. It makes sense to turn home owners who are about to be repossessed into tenants, rather than to evict them. Mortgage lenders (and the insurance companies which insure them against defaults) must take their losses, and accept a rent. The Government should remove all remaining obstacles to lenders which take such houses on to their books.
4. Encourage lending to small businesses.
The banks have been trying to repair their own battered balance sheets at the expense of higher charges to small businesses, which are even less able to sustain the burden. At the same time, small businesses are being denied the finance they need to fund an increase in stocks and work in progress by the operation of the banks' credit rules. Many loans to small businesses are secured on the home of the entrepreneur. Indeed, up to 70 per cent of all loans are secured on property. As house prices have fallen, banks have begun to insist on larger guarantees and higher interest rates.
The Bank of England has considerable influence with the banks, by virtue of its role as their supervisor. The banks in turn rely on the central bank as a guarantor of their solvency in lean times. The Bank must use its position to ensure that the high street clearing banks understand the importance of financing the recovery, and take their responsibilities seriously. Choking off the recovery is in no one's interest, and would merely increase the banks' bad debts. If necessary, they should be given the supervisory and regulatory latitude to enable them to lend more.
5. Make the Bank of England independent.
The Bank of England Act should be amended to make it independent from government and to make it, instead of the Treasury, responsible for monetary policy. Its articles would be amended to give it specific responsibility to achieve broadly stable prices. Exchange rate policy should be consistent with this statutory objective. The Bank of England would have to report monthly to a parliamentary committee in open hearings.
The aim of these changes is threefold. First, to create an additional focal point for financial decision-taking, separate from Whitehall. Second, to correct the inflationary bias in post-war British economic policy. Third, to bring UK practice more into line with that of Germany, as required under the Maastricht blueprint for monetary union. At the moment, the Treasury takes interest rate decisions on the advice of the Bank. While the Chancellor is nominally accountable for policy, no one knows whether mistakes are his own, those of his Treasury advisers or those of the Bank.
Monetary policy at the Bank of England would be developed openly, with a monetary committee voting monthly on policy changes on the lines of the US Federal Reserve's open market committee, or the Bundesbank's council.
To help it focus on its central task, the Bank would get rid of front-line responsibility for banking supervision, which would be passed to a new banking control board. It would still manage operations in financial markets, including foreign exchange intervention, and would retain an overall responsibility for the liquidity of the banking system, which all central banks must have.
6. Reform the Treasury.
The Treasury would go back to its original role of simply running the Government's finances, and no longer be explicitly involved in economic policy. Its sole statutory duty would be to balance the Budget over the economic cycle. This requirement would give it greater freedom to run a deficit when growth was below trend but equally require it to increase taxation or curb spending when growth rose above trend (calculations about the trend of growth would be made by the new independent Economic Forecasting Unit - see below). It would approve public spending and decide on taxation, so that the Chancellor would still determine the budget deficit in any one year. But the Cabinet procedures would be changed so that the entire government approved policy, rather than rubber- stamping the decision of the Chancellor and Prime Minister. The aim of taxation policy would principally be to raise revenue, control public spending and support the supply-side of the economy rather than macroeconomic management.
7. Form a new Economic Forecasting Unit.
The Treasury would give up economic forecasting. A new self-standing agency would be formed, with a charter that guaranteed its independence. The agency would be responsible to Parliament for the accuracy of its forecasts. It would have some statutory responsibilities, such as determining trend growth for fiscal policy, reporting to Parliament on economic performance. It would have a board of outside advisers and would be required to contract a significant part of its work to outside forecasters to ensure that a range of views and analyses were available to Parliament.
8. Create a Department of the Economy.
The principal task of this department would be to co-ordinate the supply-side policies of the Government: in particular in education, training, transport, energy and industrial policy. At the moment, these policies are fixed to suit the interests of individual ministries, but no account is taken of their impact on other aspects of public spending or their wider impact on the economy as a whole. For example, the cost of building a road is lower if it results in fewer construction workers on the dole; but at the moment there is no way of setting one cost against the other. Education policy is fixed without an eye on economic needs, while industrial policy has no clear focus at all. The aim should be to give the new ministry real power, in contrast to the Department of Economic Affairs, which existed briefly in the mid-Sixties, and which was denied any role in policy. To do this, the ministry would be considered one of the four core ministries of state, along with the Treasury, the Foreign Office and the Home Office.
9. Play a central role in Europe.
Although the genesis of Britain's recession lay in the mistakes of the Thatcher-Lawson boom, there are now worrying signs that a worldwide downturn may be overlaid on the domestic forces working for recession. A crucial element of the Government's policy must thus be international: through the European Community and the Group of Seven leading industrial nations.
The Government must be clear about its commitment to link the pound with other EC currencies when British and German interest rates are once again in line, and British growth ensures that the markets find the commitment credible.
10. Make a strong commitment to free trade.
The world seems on the edge of a new global trade deal. In Europe alone, that would be worth more than pounds 19bn in extra wealth every year, much of it coming to Britain. Without that new Gatt deal, world recession will be likelier to become world slump. Britain may be called upon to play a central role in getting the deal, since the country likeliest to hold out against the agreement is France, keen to protect its farmers. Britain, as President of the European Community, could exert real power in marshalling the other EC states against France in the cause of free trade. In trying to break out of recession, no cause is more important.Reuse content