Expert View: Consumers can't help us this time

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The Independent Online

The UK has suffered remarkably little from the world economic downturn (itself quite mild by past standards) because it entered the recession with strong public finances and low inflation. The Government was thus able to sustain output by cutting interest rates and increasing public spending. As a result, the growth slowdown has been slight and unemployment has scarcely risen.

The UK has suffered remarkably little from the world economic downturn (itself quite mild by past standards) because it entered the recession with strong public finances and low inflation. The Government was thus able to sustain output by cutting interest rates and increasing public spending. As a result, the growth slowdown has been slight and unemployment has scarcely risen.

These developments were predicted two years ago in this column, which was then distinctly more upbeat than the consensus. But now, as recovery gets under way, I find I am more pessimistic than many observers. The other side of not having much of a recession is that you don't get much of a recovery. Two years of mediocre growth will be followed, in all probability, by a third, because our budget surplus has been spent and it is hard to see where else the demand will now come from.

Export prospects in Europe (our main market) are not particularly bright. Even though the pound has fallen against the euro, the euroland economy (dragged down by Germany) is still in the doldrums. And although the US is a bit stronger, exporting into that market is becoming more difficult as a result of the fall in the dollar.

Consumption has played an important role in sustaining growth over the past two years as the pace of exports and investment has slackened. But this has involved a big increase in borrowing, both public and private. According to our latest estimates, the public finances are in the process of moving from a surplus of 1.7 per cent of GDP in 2000-1 to a projected deficit of 2.1 per cent of GDP (£22bn) in 2002-3. Figures from the British Bankers' Association show households took on a record £68bn of new debt in 2002.

The process cannot continue indefinitely. It is not just that debt has to be repaid. The problem is that the moment the Government, or the consumer, takes on less new debt then there is (other things being equal) less demand. The rate of increase in government borrowing, which has boosted demand by some 1.5 to 2 per cent in 2001 and 2002, will be much slower in 2003 as prudential borrowing limits are approached.

In each of the past three, much deeper, recessions, there was similar pessimism at this point in the cycle. But recovery came because the UK consumer went out and increased spending. What happened on each occasion was that inflation, which had been high as the economy went into recession, fell quite sharply. The fall in inflation was associated with a fall in interest rates and a fall in savings ratios. Consumers felt less need to save, and were more willing to borrow.

That important boost to demand won't happen this time around, for three reasons. First, inflation is only around 2.5 per cent, whereas it was in double digits (or close) in each of the earlier recessions. Second, the same is true of interest rates, which stand at less than 4 per cent today. And third, debt is already at very high levels. Under these circumstances the rate of new borrowing is more likely to fall than to rise.

UK consumers have done a valiant job in staving off recession. But we cannot rely on them to kickstart the recovery as well. Public spending will keep the economy moving along this year, but don't expect it to be much better than last.

And don't forget that there are a couple of big threats out there. A war in Iraq could lead to higher oil prices, while a continuing slide in stock markets will dent City incomes and hence London house prices. So we are looking at a mediocre recovery as a central forecast, with some pretty serious downside risks. It is not a pleasing prospect.

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