Bill Jamieson: Come clean on crisis

Published on Saturday 25 July 2009 14:25

MISERABLE economic performance but stronger retail sales; dire forecasts on our prospects but the UK stock market having its best run for years: what is going on?

Figures last Friday showing the UK economy contracting by 0.8 per cent in the second quarter, more than double the figure economists had expected, take the annual rate of decline to 5.6 per cent. It's the biggest fall since records began in 1955. Yet the FTSE 100 Index brushed these figures aside and went on to enjoy its tenth consecutive trading day of gains.

Two statements can be made with some certainty. One is that, disappointing though the second-quarter GDP numbers are, we are past the worst of this recession. A return to the black pessimism of the early months of this year looks unlikely.

The April-June quarter should turn out to be the last quarter of recession – that is falling GDP. But after a financial crisis as severe as the one experienced, only a slow recovery can be looked for. The economy will be held back by high private debts and (with inadequate bank capital) poor credit availability – and deepening unemployment. It took 14 quarters for GDP to regain the pre-recession peak after the mid-1970s recession, and 13 quarters after the recessions of both the early 1980s and early 1990s.

This time, Citigroup economist Michael Saunders expects it will take about 20 quarters (that is, until the first quarter of 2013) before GDP regains the pre-recession peak (2008 Q1). He adds that it will be many years before the UK returns to a well-balanced and sustainable mix of low unemployment, low fiscal deficit and low public debts, decent economic growth and low inflation.

Depressing though this is, it is not far out of line with the warning from the National Institute for Economic and Social Research last week. It predicted that it may take another five years for income per head to return to the level it was before the recession hit in early 2008. It sees total UK GDP falling 4.3 per cent in 2009, before growing 1 per cent in 2010 and 1.8 per cent in 2011.

The second clear signal is that the biggest obstacle to a recovery in confidence now is what the government intends to do (or not) with the worsening budget deficit.

The key implication of those second-quarter GDP figures is that Chancellor Alistair Darling's 2009 forecasts, set out in the April Budget, now look impossible. The Treasury forecast that the economy would contract by 3.25-3.75 per cent this year. For this to now happen would require a remarkable bounce back in the second half of the year with growth of around 1.5 per cent in each of the remaining two quarters. That is most unlikely to happen.

Weaker than forecast growth means that public sector net borrowing will exceed the already horrific 175 billion projected for the 2009-10 financial year. That implies deeper spending cuts and/or sharper tax increases will be needed for the Chancellor – or his successor – to balance the books.

Prime Minister Gordon Brown has consistently denied that public expenditure will fall, determined to portray the choice for voters as one between investment with Labour and cuts with the Conservatives. A government still in denial about the need for action to bring down public spending is one that could be riding for a fall this autumn.

There is nothing that business and markets would more like to see now than the semblance of a plan to bear down on a budget deficit as soon as possible – for the longer the delay, the more bitter the final medicine will prove. Without some sense of direction both the currency and financial markets are vulnerable to a flight of confidence if the impression sets in that matters will effectively be allowed to drift until a general election next May.

This is of critical relevance to Scotland, with its higher relative dependence on public spending. According to a paper last week from the Centre for Economics and Business Research, this could act as a brake on our recovery performance over the years 2010-13.

Labour can argue somewhat disingenuously that because of higher unemployment and welfare benefits, public spending in Scotland will hold up. But for the SNP administration it will be a different story, with sharp cuts likely in the budget covering those devolved sectors for which it is responsible.

Little wonder finance minister John Swinney is gearing up for a rearguard action against "Westminster spending cuts". But it is hard to see how Scotland's 30bn-plus budget can be immune. The roll-out of vote-buying "free" services such as care for the elderly and university tuition fees that characterised the first decade of devolution has come to an end.

But the Scottish government too seems to be in denial of the scale of the debt and borrowing crisis and what resolving it is likely to involve. The First Minister may be salivating at the thought of yet another battleground opening up between Scotland and Westminster. But the political class north and south of the Border need to come clean with the voters.

Last week also brought worrying weak spots in Scotland's economic statistics to the fore. There are some inexplicable "black holes" in areas such as financial services and hotels and tourism – discrepancies which this column has long pointed out.

For example, the non-bank financial sector in the first quarter is shown on the latest official numbers to have suffered a slump of 25 per cent on a year ago – a finding that runs directly counter to evidence of a relatively more resilient performance in areas such as fund management vis--vis the banking sector.

An improvement in the range, quality and timeliness of Scottish economic data really now needs to be put in hand before there is further talk of Calman, fiscal autonomy and "more powers". On current data this would be akin to strapping on motorised roller skates to a blindfolded parliament.

So where are there grounds for hope? Looking to the bigger picture, the main factors behind the continuing lift in stock markets last week were better than expected news from US companies, not just banks, and markedly more positive figures from the US housing market – source of the sub-prime catastrophe.

The National Association of Realtors, the US-wide estate agency organisation, reported that home sales rose by 3.6 per cent last month – the third straight monthly increase. Investors can now see a prospect of a gathering recovery in the US that will feed through to the rest of the world. On the premise that a rising tide lifts all boats, both the UK and Scottish economies should be beneficiaries of this improvement in export prospects and in confidence. An improving appetite for equities should also help companies raise more equity capital – critical when bank lending is so constrained.

Might the latest UK retail sales figures be part of this brightening picture? Retail sales volumes rose by 1.2 per cent month on month in June, the highest such gain this year and well above independent forecasts. However, this looks more like a summer clothing sales blip brought on by the hot June spell. Sales by clothing retailers were up 4.7 per cent on the month – an unusually large gain.

Household spending overall is set to contract by 3.2 per cent in the current year, followed by a further decline of 0.8 per cent in 2010. Looking at quarterly trends, the peak-to-trough fall in consumption during this cycle is likely to be close to five per cent.

With rising unemployment, tax rises looming and only a glacial improvement in bank lending to business, we look set for a long, slow haul. But it is time we looked beyond those gloomy figures to tackling the problems ahead.