Jeremy Warner: Recession may be over but not the pain

Thursday 10 April 2014 02:26

Outlook All of a sudden, the green shoots of economic spring seem all around us. Some of them may even be turning into smallish shrubs, if not quite yet fully grown bushes. According to estimates published last night by the National Institute of Economic and Social Research, which is second to none in the accuracy of its forecasts for the UK economy, March marked the trough of the recession, with the economy actually growing in April and May.

If these estimates are right, then the second quarter will have been one of positive growth, albeit not by much and following one of the most violent contractions ever recorded for the preceding three quarters. Only the Great Depression has witnessed a more precipitous lurch into the abyss.

Still, let's not be churlish. If this is indeed the trough, the scale of the contraction will have been smaller than that of the recession of the early 1980s. Somewhat unbelievably, given the near death experience of the banking system, this won't have been the worst economic contraction since the Second World War.

In any case, the recession seems to be over for now and Alistair Darling's Budget forecast that the economy would be growing by the end of the year, widely condemned as delusional at the time it was made, looks as if it will turn out to be correct.

Incumbent governments will always attempt to harmonise the economic cycle with the electoral one in the belief, possibly misguided, that if voters think things are getting better, then they are more likely to opt for the status quo.

The evidence for this is actually fairly patchy, and certainly the correlation works much better in the US than it does here. John Major managed to win an election in the depths of a recession but then lost the next one even though the economic recovery was by then well established.

Yet famously in the US, James Carville, Bill Clinton's campaign strategist in the run up to the 1992 presidential election, hung a sign in the presidential hopeful's Little Rock campaign headquarters that read "it's the economy stupid". This was meant as a reminder to his candidate that despite the achievements of the incumbent, President George Bush senior, in presiding over the end of the Cold War and apparent victory in the Gulf, the economy was a clear Achilles heal.

Bush senior later roundly blamed Alan Greenspan, then chairman of the US Federal Reserve, for scuppering his chances of a second term by not cutting interest rates sharply enough ahead of the election.

It was a mistake that his son, George W, did not intend to repeat. The US economy was shamelessly pump primed ahead of the 2004 election and George W staggered back into power despite the by then already manifest mistake of the Iraq invasion.

So is it remotely possible that Gordon Brown, universally declared electorally dead and buried as recently as a few days ago, has pulled off the trick of fine-tuning the economic recovery to coincide with going to the polls? Politics is an unpredictable old business, and certainly our beleaguered PM must be feeling a bit happier with life this morning than he was in the immediate aftermath of the European elections.

This in any case wasn't as bad a result for Labour as generally thought, as it failed to give the Opposition the overwhelming vote needed to be sure of a big majority in a general election. Rather, support frittered away to the fringe parties. The attempted putsch has been seen off and now the economy is improving. This must give the PM renewed hope that he can still win a general election, however unrealistic it might be.

No wonder that senior Tories sometimes refer to him as "Terminator". It seems impossible entirely to kill him off. Battered and bruised, minus a couple of limbs and stripped down to his metallic innards, the red eyes still stare out, even as he is lowered on a chain into a vat of boiling lead.

Yet even one as willing to clutch at straws as Mr Brown cannot be counting on the economy to bail him out. People's memory of a downturn is long, and voters don't quickly forgive. Nobody believes Mr Brown's insistence that this was an economic calamity which sprung entirely from the excesses of the American housing market, with the UK caught up in it all as some kind of innocent bystander. Still less are they inclined to give him credit for the policy response, which rightly or wrongly is quite widely regarded as chaotic, dithering and inept. In any case, it is the crisis, not the crisis management that people tend to remember.

But the more serious fly in the ointment is that to the extent that there is an economic recovery going on, it rests on extremely shaky foundations and may not last very long. Sir Martin Sorrell, chief executive of the advertising giant WPP, says bluntly that he's observed no recovery at all. It's not hard to see why to many recovery looks like a mirage.

The main reason why the economy has stopped contracting is that business has stopped de-stocking. In the first quarter alone, British businesses cut their stocks by some £6bn. Such a fierce inventory adjustment cannot go on indefinitely.

If the destocking sinks to zero, as it might have done for the second quarter, then that in itself will cause production and activity to rebound quite sharply as a more normal pattern of orders and supply re-establishes itself. The pickup in industrial production reported yesterday seems to confirm this analysis.

Yet if consumption and investment continue to decline, the inventory effect may turn out to be no more than a one-off boost. Unless business starts actively to restore stocks to pre-bust levels, as opposed to simply not cutting stocks any further, eventually these more negative forces will reassert themselves and the economy will begin contracting again.

That's why everyone is still so cautious about calling the end of the downturn. Any recovery that is taking place is still a long way from being self sustaining.

A number of City economists reckon that consumption is about to pick up too. Certainly the rise in disposable incomes caused by rock bottom mortgage rates gives good reason to think it might do. Unfortunately, any such revival is the very reverse of what's necessary to deal with the structural problem at the heart of the UK economy.

Over the last 20 years, the UK has had the lowest savings rate of any OECD nation, knocking even the US into second place. In this "spend now, worry about the consequences later" world, Britain's economy prosperity has come to rely disproportionately on consumption and the boom in house prices. Investment in the future has gone by the wayside, which for an ageing society creates a potentially devastating deficit for the future.

The savings deficit is one thing; alongside it runs a now burgeoning fiscal deficit which also has to be addressed urgently. The renewed row that broke out in Parliament yesterday about who is going to cut how much out of which departmental budget is all so much political noise.

The only thing we know for sure is that whoever occupies Number 10 after the next election is going to have to make deep cuts across the board. Even the marginal increases pencilled in by Labour in nominal terms will mean real cuts once inflation is taken into account. That too is hardly conducive to a robust, long term economic recovery. Neither of the two main political parties yet seem prepared to admit the scale of the challenge faced.

Green shoots or none, it's an austere future that beckons.

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