Hamish McRae: Will services provide our salvation?

The UK could end up with less loss of output than Germany or Japan
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The Independent Online

It is the sign of our recessionary age. BMW is sacking 850 workers at Cowley because of falling demand for the Mini. And Domino’s Pizza is taking on an extra 1,500 people because of rising demand for its meals. You can get away without changing the car for a year or so but you have to have something for your supper.

Of course, it is not a fair comparison. The jobs that are being lost are almost certainly better paid than those that are being created, though the hours may be better for it is the night shift at Cowley that is being stopped. Overall, the country is losing many more jobs than it is creating. And the enviable success of Domino’s is a reaction to recession as people are trading down from more expensive meals. Nevertheless, this sort of reaction to recession does raise the possibility that our service-heavy economy may be more resilient to the global pressures than the manufacturing-heavy economies such as Germany and Japan.

Both those countries entered recession a little earlier than we did and have slowed more rapidly. What is happening in the UK is nothing to be proud of. We are going to have a serious recession, maybe worse than the early 1990s and possibly worse even the early 1980s. But in relative terms we may not do too badly, contrary to the official forecasts such as those from the International Monetary Fund, which puts us bottom of the pack. For what it is worth, not a lot, my instinct is that in three or four years’ time, when the sums are finally known, we may be seen to have come though the downturn with less loss of output than Germany or Japan.

There is an even bigger question than the “How well will we come through this recession?” one, to which the only completely honest answer anyone can give is “we cannot yet know”. This is, “How do we earn our living once the recession is over?” Given what has happened to our strongest industry, financial services, we have to ponder quite how we are fill the gap. Domino’s pizzas may be wonderful but I can’t see them earning a lot of foreign exchange. The Mini plant, by contrast, has been a huge export earner, with BMW able to justify its high cost base by the up-market nature of the product, by working the plant 23 hours a day and by benefiting from its skilled and flexible workforce. Maybe we are more resilient in the downturn but we cannot run a country by, so to speak, taking in each other’s washing.

A lot of people, quite rightly, are worried about the devastation that the recession will do to what remains of our manufacturing base but it is important not to see this in too stark terms. President Nicolas Sarkozy recently attacked British economic policy, to the effect that our cut in VAT was a waste of money and that we had shut down all our industry and made a huge bet on financial services that had now gone wrong. The French President may have had a point on the VAT cut but on the manufacturing/services issue he was mostly wrong.

In fact our manufacturing is almost as big as that of France (14 per cent of GDP instead of 16 per cent) and thanks to the devaluation of sterling has become much more competitive vis-à-vis not just France but the entire euro area. And while there are serious job losses taking place in financial services worldwide, they are probably less marked than the job losses in manufacturing. Even in recession the world needs banking services, as the government recognises, and if we can pay a bit less for these by their providers having smaller bonuses, I am sure we can live with that.

Actually, I do think the UK has a very serious problem that arises out of its heavy dependence on financial services but it is not that we are going to have a more serious downturn than other countries. The problem is the extent to which we have relied on finance, broadly defined, for government revenue. Economic growth over the next five years will come from a variety of drivers, including manufacturing. As growth picks up, the various service industries, finance excepted, will continue to generate decent profits and will resume hiring. But finance in general and banking in particular will remain under great pressure. Profits will be thin; bad debts have to be worked off over several years; pay will be lower.

So yes, there will be growth, but it will not be driven by financial services, and that will ripple out through London and the home countries to the rest of the country. But London, the South-east and East Anglia are the only parts of the UK that make a net contribution to public finances. All the other regions take out more in services than they contribute in taxation. Government revenue is already running well below last year and the recession has only just begun. Why have Gordon Brown and Tony Blair before him seemed so in thrall to the City? Because the financial services industry was the main driver of growth in the London economy and therefore picked up a disproportionate amount of the tab for their spending.

It is going to be different from now on. We will get growth but the Government won’t get revenue. Our public finances are in a catastrophic state, with a deficit nudging towards 10 per cent of GDP. Of course this is not really a problem for this Government, for time is running out. It will be a problem – the defining problem – for the next one, and I am afraid, the one after that.

If that comment sounds unduly dispiriting, two points to soften it. The first is that the public debt burden, even on unfavourable assumptions, will be nothing like as great as after the two world wars and those debts were eventually, if painfully, cleared. The second is that all economies are, unless economic policy is really disastrous, self-healing. Things recover. That happens in manufacturing, for if you think about, people can put off buying the new Mini (or whatever) for a year or more, but eventually they do need another car and it makes economic sense to get a more efficient one.

Meanwhile, we have to go on with our daily lives and that involves spending some money. As far as I can see, consumption in the UK has never fallen for more than one year on the trot during peacetime. We trade down to a pizza (or whatever) for a while but then, hey, it’s time for a steak.

h.mcrae@independent.co.uk

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