Hamish McRae: The figures are shocking, the cures are not working – but it isn't all that bad

Economic view

Sunday 25 October 2009 00:00

So we are not yet out of recession after all. Those of us who have long warned that 2009 would be the bad year have been proved more right than we would have liked. But even the most gloomy of us will have been upset by these numbers, for this is worse by a fair margin than we have expected. All those headlines that the recession had ended in September? They were wrong.

The GDP figures on Friday, showing that the economy was still contracting during the third quarter of this year, were shocking for three reasons. They were shocking in themselves because by now there ought, on the pattern of previous cycles, to be some modest bounce starting to happen. They were shocking because they run counter to the evidence that seemed to be coming from the real economy, which showed that at worst things were flat. And they were shocking because they suggest that the huge (and expensive) efforts the authorities are making to boost the economy have, so far at least, failed. A word about each.

You can see this cycle compared with that of several previous ones, including the 1930s, in the chart. It shows the National Institute of Economic and Social Research monthly estimates of economic activity, updated with the latest estimates from the Office for National Statistics.

Assuming these new official figures are right, this downturn looks like being worse than that of the early 1980s, in depth if not yet in duration, as measured by the time taken to get back to the previous peak. That calls for some serious rethinking because the numbers simply don't square with everything else. Compared with the 1980s, unemployment is not as bad and inflation is not nearly as bad, while house prices have not fallen by as much as they did in the early 1990s. As for current data, retail sales have been flat rather than down in the past few months, and year-on-year they are up. Business surveys have turned sharply up, suggesting that growth is not far off, and the financial markets are signalling a much better year ahead. But whatever excuses you make you cannot magic away such dismal numbers, particularly since they seem to be worse than those of our main European and North American competitors. We don't have figures yet but it looks as though the Eurozone, the US and Canada will all report growth this quarter.

But can these figures be right? The largest element of output, that of the service industries, is extremely difficult to calculate and the initial GDP figures are almost always revised, often several times. The last lot have already been revised upwards, though not by nearly as much as I expected. And, as a general rule, when economic statistics "feel wrong" they usually are. There is no point in attacking the statisticians, who are doubtless doing their best, but two or three years from now when we can look back on all this, I am pretty sure that the downturn will not prove to have been quite as deep as it appears.

If all this is disturbing for us as citizens, it is disturbing for the authorities too. All those billions the Government is borrowing, all that stimulus – near-zero interest rates, the money the Bank of England is printing, the boost from the car-scrapping scheme, the soon-to-be-reversed cut in VAT and the help from a devalued sterling – it does not seem to have worked, does it?

There are several responses to that. One is to say that if the policy is not working you have to do more. The argument against that is that if a budget deficit of 12 per cent of GDP does not boost the economy, what makes anyone think that a budget of 14 per cent would? It may be that we have reached a point where policy stops being effective or credible because we all know it cannot continue much longer. People feel they are not being told the truth about public finances and are preparing for a change in leadership next year by getting their own finances straight now.

That leads to a second response. If the policy is not working we had better think of something else. That need not be a "slash and burn" approach to public spending or an early rise in interest rates, but it does mean a credible plan to get public finances under control. Were Gordon Brown coming into office now he would be castigating the government for its irresponsibility and he would be setting out a medium-term plan to restore faith in the UK's ability to manage its finances soundly. That was what he was saying in 1997. Something like this is needed to reassure not just our foreign creditors but also opinion at home. We need a "golden rule" that the Government will only borrow for investment, not current spending, and we need a plan to get overall borrowing to 40 per cent of GDP. Familiar, eh? But we also need some way of making sure that the next Chancellor is genuinely constrained by these rules rather than able to bully his way past them.

There is a third response, which is to accept that the Government cannot help much. So, instead, we have to look at the detail of what is going wrong and see what can be done by the private sector to mitigate the impact of the downturn. A lot is happening already. I am impressed by the efforts made by mortgage lenders to keep borrowers going by renegotiating terms rather than shutting them down. But in the corporate world, particularly among smaller businesses, there are more disturbing reports about perfectly viable businesses being unable to keep going because they cannot get working capital. There will always be tension between companies and their bankers, and it always mounts in a recession, but banks would be wise to remember that banking used to be about long-term relationships.

There is a final and, in a way, more hopeful response. That is to say that the downswing of any economic cycle takes a long time to turn up. Look at the early 1980s, which I still think will prove the best template for what will happen. It is not realistic to expect much growth next year, though I still expect a bit. There will be slightly better growth in 2011, and by 2012 we should be starting to make up some of the lost ground. Eventually, economic cycles do correct themselves even if it is hard to remember that in the middle of a serious recession. And, for all its difficulties, that early 1980s cycle did create the conditions for the considerable, if far too bumpy, growth performance of the UK through to last year.

I have mentioned before the "brick on elastic" analogy favoured by economists when trying to explain why it takes a long time for expansionist policies to take effect. You try pulling a brick with a piece of elastic. For a long time nothing happens, then it starts to move, and, when it does, the brick moves quite suddenly.

Hooray for common sense, it'll help you keep your most valued staff

If you can't pay people big bonuses, how do you stop them going off and working for someone else? That does, of course, presuppose that there are other opportunities – still, the fact remains that mainstream banks are losing people they would rather keep. But this is not just about banking, for many firms are finding it hard to retain talented people in a downturn.

Some clues of what to do have been set out in a new book from Harvard Business Press, Top Talent: Keeping Performance Up When Business is Down, by Sylvia Ann Hewlett. She finds that, compared with a year ago, the percentage of talented employees who feel loyal to their firms has dropped from 95 per cent to 53 per cent; that 90 per cent of talented people feel their workload has increased; and that when firms cut staff sharply they are particularly vulnerable to losing the people they don't want to go.

So what to do? There are a number of things, but here are three. One is to make sure you restructure with care. You allow people who are leaving to say goodbye properly to colleagues and you try to make sure that they are helped into their next job or career change. A second is to have a "no-spin" zone of communication. You explain everything as openly as possible. And a third is to use time as a currency – cut costs by more flexible working, by mini-sabbaticals, home-working and so on.

If all this sounds like common sense, then it is. No wise company wants to pay more for its talent that it needs to, and one of the problems of the financial-services industry has been that a good idea – varying pay according to the income people bring in – has somehow become corrupted into bonuses being a way of keeping the score. But in reality, most financial-services employees would rather have somewhat lower pay in exchange for greater security and better working conditions. There is a circle to be squared here and Top Talent carries a message that goes beyond the recession. You do, after all, want to retain your best people in the good times as well as the bad.

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