Last week we learned that the UK has fallen into a second recession. Growth over the first three months of this year was -0.2% which followed a contraction of -0.3% in the last quarter of 2011. Two or more consecutive quarters of contraction is the ‘official’ definition of a recession. To misquote Oscar Wilde – to fall into one recession is unfortunate, but to fall into a second is sheer carelessness.
The arrival of the dreaded double-dip, has spurred on the bad news hungry media to make dire comparisons with the UK economy in the 1930s. Some economists have estimated that UK economic output will not return to its pre-first recession level until 2014, that is, they estimate that it will take seven years to get back to where we were in 2007. That’s an awful lot of pain for no gain. So yes, this is now officially the worst economic downturn since the 1930s. But before we start feeling too sorry for ourselves, it could be worse.
In this week’s chart I am trying to satisfy the media’s newly found appetite for looking back a long way into our economic past. The chart shows annual UK real GDP growth going back to 1900 – not long before Queen Victoria’s death. The shaded regions in the chart represent recessionary periods. The double-dip is shown clearly. Cramming two recessions into such a short space of time was a feat we hadn’t really managed before. But as the chart also shows, UK output experienced a much greater contraction at the end of the Great War. With many of its finest slaughtered in the mud-soaked and flea-ridden trenches on the continent, and with the weakened survivors falling victim to the Spanish flu pandemic – which killed around one quarter of a million Britons between 1918 and 1920, and immobilised many others for months – UK output ‘peaked’ in 1918 and did not recover to these levels again until 1934. Now that’s a proper depression! By comparison, for the UK, the 1930s was just an economic blip on the long road to recovery.
I guess the basic message from history then is: “Cheer up, it could be worse.” But unfortunately a “worse” outcome is what the UK’s current fiscal austerity programme threatens to produce.
Being fiscally profligate is clearly not a good thing, and the original decision for putting in place a programme of tax hikes and expenditure cuts was probably the right one. We had a new, coalition government and financial market participants were suddenly taking their role as fiscal policeman seriously again, as they looked to punish fiscally incontinent governments everywhere.
But times have moved on and I think it is now appropriate to review this evangelical commitment to fiscal austerity. I think it is time to think about running a balanced budget for the next couple of years. As long as this change to the fiscal plan is accompanied by credible policies aimed at promoting more growth I don’t see why the UK would be punished by a “run on gilts”. It seems to me that the biggest risk to the UK’s long-term fiscal position now, is the negative impact that fiscal austerity is having on growth. Lower, or negative growth means lower tax revenues, higher welfare expenditure, a worsening fiscal position, etc, etc.
If the plan is announced and executed properly, I see no reason why it would have any impact on gilts yields at all, or the UK’s treasured AAA rating. And besides, as I keep emphasising, there will be a cap on gilt yields anyway. If foreign investors did run from gilts with this policy change – which I doubt – there is massive pent up demand from the UK’s pension industry for gilts and index-linked gilts at even only slightly higher yields than those that currently prevail. While this potential support for the gilt market remains, the UK’s coalition government has nothing to fear from a more growth orientated policy.
A well thought out and credible change in fiscal policy now could prevent a bad situation from getting much, much worse. In my view if the government does not make a more concerted effort to support growth soon, then UK output will still be well below 2007 levels by 2014 … and that really would be down to carelessness.