After the banking crisis, the Great Recession

Months after the crash, the full impact was becoming clearer

4 March 2009

The world of economics is looking more like it was during the 1970s. There isn’t the inflation and, as yet, the widespread labour unrest that prevailed then, but there has been a similarly massive destruction of wealth. There is also similar pressure on public finances everywhere.

We can see the reality of the shift but the full consequences are much harder to grasp at this stage. People understandably enough have become so mesmerised by the still-deepening recession that they have hardly begun to think about what happens afterwards. However a couple of people have warned of the consequences for the public sector of the shortfall in tax revenues that it faces as growth returns. They deserve to be taken seriously.

One was Steve Bundred, chief executive of the Audit Commission. He warned last week that big cuts in public spending would be needed after the recession was over. He commented on the huge borrowing of the Government and added: “As soon as we see some signs of recovery, in order to maintain overseas confidence, it is inevitable that the government will have to rebalance public finances and that will involve very substantial expenditure cuts.”

The other person was Frank Field, MP for Birkenhead, who warned in this paper two weeks ago: “When the financial market signals that it is not going to accept offloading at £150bn plus of annual government debt into the indefinite future, the real political war will start. The figures are chilling and are still almost unappreciated by our political class.”

Both were focusing on the implications for the public sector of the squeeze ahead. Steve Bundred called for people running government departments and local authorities to start to plan now to avoid “slash and burn cuts later”. Frank Field sought something even more radical: to wean progressive liberalism away from the idea that, “it is the state that ensures social progress. History teaches otherwise. Secure social advance has been achieved by freeing up the basic impulses of human beings to do good…”

In support of Frank Field’s vision that there are other ways of achieving social progress, I give you three facts about Hong Kong. Did you know that Hong Kong’s government spending is only about 15 per cent of GDP? Did you also know that in terms of infant mortality – a good measure of the quality of health care – it ranks in the top three or four countries in the world, far above the UK? And did you know that the performance of its 16-year-olds in the OECD’s latest pupil assessment study was also in the top three or four countries, again well above the UK? I am not saying that the Hong Kong society is perfect but it does show that there are ways of achieving very high welfare outcomes without high public spending.

That is what this financial crisis will do to the public sector. But what about the private sector? Here I think we are only just beginning to get our minds round the consequences of the destruction of wealth that has taken place. We are still in “blame it all on the bankers” mode, which may be understandable but does not do any good. I don’t think most people are aware that somewhere around one-third of the accumulated wealth of the world has been destroyed.

Now it may well be that the financial markets and property prices will recover in the next three to four years – I happen to think they will. I also think the balance of probability is that the economic recovery will be secure by the end of 2010 and that when all is done and dusted we will see that this downturn has been no more serious than that of the 1970s and 1980s (though maybe a bit worse than the 1990s). But even if that is right, and many people would call that optimistic, it could easily be a decade before the wealth that has been lost has been rebuilt. This is a huge global squeeze not just on the rich but on the aspiring middle classes.

This will have a number of consequences. Some are obvious. One will be a fall in government revenues worldwide even if taxes are raised as they will be, increasing the pressure on the public sector. Another will be that people will have to save much more for their pensions, for the loss of wealth has to be offset either directly or indirectly. Another will be social tension between the public and private sectors. Sir Fred has taken huge stick for his pension pot but I expect similar attacks on the pensions of ministers, MPs and senior public sector employees.

Others are less obvious. We can see there will be less money available for charities and foundations that rely on dividend income but it is hard to think through the social and economic implications of that. How can we replace the loss of funds available for scholarships and for much university research? What happens to the funding of the arts? If there is less money available then there will obviously have to be much tougher choices about priorities but, beyond that, I suggest there will be more questioning of values. We are forced to ask ourselves what really matters and what is froth?

Questioning our values may be no bad thing, but if the destruction of wealth is not all bad, it is I am afraid mostly bad. Quite a few people now expect social unrest and they may prove right. That concern is not new. Remember in the late 1970s that the then Chancellor, Denis Healey, warned that there would be rioting in the streets. What actually happened was the “winter of unrest” and the election of Margaret Thatcher. Certainly the next government will have a very difficult task, facing in some ways a situation similar to that of 1979.

But it is surely too narrow to think in terms of what is happening just in terms of British politics or British society. Wealth has been destroyed everywhere but it may be rebuilt more swiftly in the emerging economies than it will be in the established ones. One effect of the downturn is to speed up the shift of power to the “new” economies. China passed Germany last year and may pass Japan to become the world’s second largest economy next. That sort of challenge – the loss of influence of the established economies – was not an issue in the 1970s and I am not at all sure we are prepared for it now.