Sean O'Grady: Recession? He simply doesn't know

'In 2001, Mr Brown turned on the public spending taps. All Darling did was wave his Budget box as he drowns'
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The Independent Online

Most independent observers are much more pessimistic about the prospects for the economy than the Government – not so much for this year but about how quickly the economy will bounce back in 2009.

Few economists, if any, agree with the Treasury's forecast of 2.25 to 2.75 per cent growth for next year. Even the Bank of England admits the clear possibility that the economy will briefly shrink during one quarter, perhaps in 2008, more likely in 2009.

Still, even that isn't a recession on the formal definition – of successive two quarters of negative growth – is it? No, which is just as well for the Government, which habitually stands by it. However, that "definition" isn't set in stone anywhere, and the American National Bureau of Economic Research, which pronounces on these matters in the US, says that "a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales".

Sounds familiar. The UK could easily go from 2.9 per cent growth to 1.75 per cent inside a year – and the G-forces of such a violent deceleration will be felt throughout the economy, but will inflict particular discomfort in certain key areas.

The state of the housing market is the most worrying economic concern, for it is here that all the malign influences converge. The US sub-prime crisis and the continuing credit crunch refuse to go away – indeed they are now feeding on each other in a vicious circle. Truly terrifying numbers have been emerging from the UK's property market lately. It's not so much the gradually declining prices, but the record low numbers of surveyors reporting activity, the trickle of new mortgage approvals and the huge overhang of unsold flats and houses.

Such a depressing backdrop will destroy consumer confidence – already at record lows. And when the spending stops, sooner or later the jobs will start to go – the crucial moment when a downturn slides into a slump.

Nor is that all. This time we have record inflation too. Food prices up 50 per cent in a year; oil at over $100 a barrel; the pound down by 17 per cent on the year. These will all damage household budgets. The spectre of stagflation – stagnating output plus inflation – has returned to haunt the economy. And there isn't a thing Mr Darling can do about it.

Last time we had a downturn – after the dotcom collapse in 2000 and the 9/11 attacks a year later – Gordon Brown turned on the public spending taps to keep the economy going, just as the White House is doing today. All Mr Darling did yesterday was to wave his Budget box as he drowns.

Bad as things are, though, a lot hangs on the labour market. This is probably the key between sharp slowdown and a truly nasty slump. It is the difference between now and the past three British recessions. In the downturns of the mid-1970s, the early 1980s and again, to a lesser extent, the early 1990s the British labour market was too rigid, and that made it difficult for businesses to adjust to straitened circumstances. Trade union power was greater in those days.

But there have been more significant changes than that since then. Today the impact of immigration, of older workers coming back into the labour force, of workers afraid of losing their jobs to competition from China or India or Slovakia under the impact of globalisation have all eroded the bargaining power of labour.

Liberalisation and increased competition in product markets have also fed through into a more easily managed workforce. This means that real wages are more susceptible to downward pressure, which should shield employment and investment during any sustained downturn. That is crucial. And, for all the chatter about rampant cost inflation, wages still comprise some 70 per cent of costs. Keep those under control and even the most hard-pressed company ought to be able to protect itself, and its staff, during this economic storm.

Rising unemployment is usually the trigger for a full blown recession, complete with housing slump and blood all over the high street. So far, the survey evidence suggests that employment is doing OK (actually it's at a 30-year high).

Second, one should add, the errors of the Major-Lamont recession of 1990-92 can't be repeated this time because we are not about to crucify the economy on the altar of trying to retain a fixed exchange rate, as we did then (and, further back, as we did at various points in the "stop-go" 1950s and 1960s).

Today, the Bank of England's Monetary Policy Committee sets rates at a level consistent with the internal conditions of the UK economy. So far, they've done a good job. And a falling pound, as in 1992-95, might now help exports and avoid the worst of the world slowdown.

So, perhaps Mr Darling isn't being entirely Micawberish in his hope that something will turn up to save his chancellorship. Not just that though – 2009 should be an election year, and Mr Brown will have to go to the polls by the summer of 2010 so his party's fortunes are riding on this too.

It's enough to turn your hair white ...