It is time to stand back a bit, isn't it? The past few days have seen the rumbling concerns about a US recession leading to a more severe global slowdown than was expected and these worries have spooked global equity markets. In fact nothing much new has happened in the past few weeks; what has changed is perception rather than substance. Still, changes in perception matter and it is reasonable to ask how this shift in the global outlook will affect the UK.
As it happens there is quite a bit of new information that has come out in the past few days, some encouraging, some less so. We have just got the first estimate of growth last year at 3.1 per cent. The final quarter showed some signs of slowing, but at 0.6 per cent, which annualised is of course 2.4 per cent, it is nothing to be unduly worried about. As you can see from the first graph, it is services that continue to be the driving force in the economy, with manufacturing output stable, holding at a whisker about its 2003 level.
Will services continue to deliver throughout 2008? The problem is that the word "services" covers such a wide range of activities. Business and financial services unsurprisingly slowed markedly in the final quarter of last year, but the rest cantered along strongly. Consumer demand will be the key, for it accounts for nearly 70 per cent of the economy. We know it will slow this year, partly because of a squeeze on real incomes, partly because of less easy access to credit, partly perhaps because of a desire to rebuild savings. But we don't know by how much.
Will consumer demand fall? It can happen; it happened in the early 1990s for a bit. But this year? Surely not. While employment remains high – it is at an all-time record level at the moment – people will feel they can earn their way out of trouble and most are right to feel that way. I have been looking at some forecasts from Capital Economics and they reckon that real consumer spending growth will dip from its above-trend 3.1 per cent in 2007 to about 2 per cent this year and something like 1.5 per cent in 2009 (see next graph). That is a slowdown but it is a long, long way from recession.
It would also be consistent with my view that 2009 will be the problem year, not 2008. That was the view of Sir Martin Sorrell, head of WPP, on the radio yesterday. He was talking about the global economy rather than the British one but advertising agencies have perhaps a closer feel for global consumer demand than any other institution, since advertising is about the best lead indicator there is.
Translated into overall growth for the UK economy, I suppose allowing for weak or weak-ish exports, we are looking at a number that starts with a one rather than a two: say 1.8 per cent, maybe a bit less. Given the momentum behind the economy at the end of last year and given that there will be further interest rate cuts, presumably with another on the way next month, it is very hard to see the growth number for this year starting with a zero: i.e. less than 1 per cent. Maybe things will slow more seriously in 2009, but that is such a long way off I don't think it makes much sense to talk specific numbers.
There is however another concern, which is our public finances. We probably have the largest annual fiscal deficit relative to GDP of any of Group of Seven economies, though absolute stock of debt is relatively low, even adding the Northern Rock liabilities. We look like being the only G7 country not to have improved our fiscal position between 2003 and 2007, raising the charge that Gordon Brown did not fix the roof during the fine weather.
The latest debt numbers out earlier this week are pretty dreadful for an economy growing at 3.1 per cent a year. As you can see from the next graph, cumulative public borrowing between April and December was nearly £44 billion, far worse than at the same stage in 2006. January is a big tax-gathering month so it will come down for a bit this year, but most economists reckon that the target of £38 billion for the year, already revised upwards, will be missed. The final number will be above £40 billion.
I have been trying to figure out what has gone wrong. The current budget is running a bit worse than last year and net investment is a bit higher, too. Revenues are off a bit from the estimates but not catastrophically so. Debt interest will have nudged up a bit but not dramatically. And the government headcount, which rose at an irresponsibly rapid rate between 2001 and 2005, has actually been shrinking (see final graph).
It is probably – and we will have to wait for the experts to crawl over the final figures – that most of the numbers have gone a little bit in the wrong direction and a number of relatively small problems can have a large cumulative effect.
Remember, these were from Gordon Brown's budget. I have a suspicion, which I cannot prove, that Treasury officials painted a rather more optimistic picture for him than the data warranted.After all, if you have someone who is liable to fly into a rage at bad news you tend to try and dress things up a bit. Now poor Alistair Darling has to try and cope with the mess.
What happens in the next fiscal year, starting in April? The new Chancellor will be facing a potential deficit of more than £40 billion, maybe nearer £50 billion. The more the economy slows the greater the loss of revenue. If inflation stays high – remember the retail price index is up 4 per cent – that will increase public pensions, benefits and index-linked debt charges. He cannot sensibly increase taxation for that would tip the economy into a more serious downturn. Borrowing can stay at present levels a bit longer but it cannot go up much. So what options does he have?
The only possible thing is to do what Gordon Brown failed to do and tackle public spending. It will have to be presented as increases in efficiency delivering higher output, even if inputs are down but this will not be very credible. If I am right and the real problem year is 2009 rather than 2008, then the squeeze will have to tighten further. It is, to put it mildly, a shame that we are heading into a global downturn with a weak fiscal position rather than a strong one. This is exactly the opposite position to the previous cycle, which suggests that we will not come through it in such good shape.Reuse content