Bill Jamieson: It's touch and go on return to recession

Published on Thursday 14 October 2010 16:02

BARELY will the ink be dry on the anxiously awaited Comprehensive Spending Review on Wednesday than attention will swing to prospects for 2011 and beyond. How close will we come to a return to recession? Are we really through the worst of the global crisis as Prime Minister David Cameron asserted recently? Or are we still, as former chancellor Kenneth Clarke warned us last week, still in a period of maximum danger?

First, a dash of cold water on some of the hyperbole that has taken hold on commentary about the spending cuts. It is almost impossible to encounter coverage on television and in the press without the words "massive", "savage" and "Draconian". Such is the scene-setting, nothing less than mass hand-wringing in public squares can be expected.

In truth, though lower in inflation-adjusted terms, public spending will be higher in cash terms this year, next year and the year after. Welfare and social security spending will continue to grow. The focus of attention on Wednesday will be reductions to departmental spending - tougher as the NHS has been ring-fenced.

I am indebted to Tim Morgan, global head of research at broker Tullett Prebon, for an excellent paper this weekend entitled A Shower, Not A Hurricane. The cuts planned by the coalition only involve reversing, over five years, a small part of the enormous real-terms increase which took place over the preceding decade.

In 1999-2000 UK government spending was 343 billion, a figure which would, had it simply moved in line with inflation, have reached about 450bn by 2009-10. Actual spending in that year had risen to 669bn - a massive increase in real terms of 53 per cent.

The spending cuts outlined in the 2010 June Budget reduce real-terms outlays from a projected 697bn this year to 686bn in 2015-16. Spending then will actually be higher than it was in 2009 - hardly a year of biblical misery and famine. But the reductions will still be a major culture shock given that they follow the political "I-want-it-all-and-I-want-it-now" boom of the past decade.

Interest payments and the political decision to maintain health and foreign aid budgets mean that spending by unprotected departments will fall in real terms. But the fall is just 7 per cent - from 525bn this year to 485bn by 2015-16. This level of cuts is, says Morgan, "neither excessive nor 'savage'. But it is imperative, for the alternatives are all far worse."

It is doubtful these statistics will get much of an airing in the hand-wringing hysteria over the coming week.But reality has finally caught up with a political class that has for far too long approached elections as a glorified auction of "free" benefits with no regard to cost or consequence.

You can have a fully resourced NHS, impressive infrastructure projects, a nationwide school rebuilding programme, fight two wars and keep the military supplied with toys, and pay out ever more "free" universal benefits. What you cannot have is all of these things at once. The truth has dawned that "to govern is to choose".

Unfortunately, in Scotland, reality denial is set to continue well into next year. The campaign for the Holyrood elections next May has already started. The public sector vote is very large in Scotland. Labour has already signalled it will scrap the council tax freeze and allow councils to raise more money from businesses and homeowners. And there is growing speculation of the SNP resorting to the tax-varying powers allowed under the Scotland Act to raise income tax by a maximum 3p in the pound. It has already imposed an extra 150 million in business rates this year.

The major parties will be in denial till the end - and even then I would not rule out a stand-off between the coalition government and a Scottish administration refusing to implement cuts. The chances of a thoughtful, considered appraisal of government restructuring and reform looks remote. If there are reasons to be apprehensive about economic recovery in Scotland, look no further than here. We will have a flat-pack boom - as in flat-pack up and go.

What of prospects in the real economy? We are close to a tipping point. Indicators such as employment numbers and chambers of commerce surveys point to a glacial recovery.

In America, too, worries about a "double dip" have risen. This combination of sluggish growth and persistent unemployment has caused Barclays Wealth economist Michael Dicks to describe prospects for next year as a "growth recession". Growth in the UK, he warns, will be feeble due to fiscal tightening and the Bank of England looks set to embark on another bout of quantitative easing by the end of the year. He sees GDP growth edging back from 1.3 per cent this year to 1 per cent next, down from a previous forecast for 2011 of 1.8 per cent.

The big question mark is over how resilient the UK economy will prove as the VAT rise and spending cutbacks begin to bite. "We judge that the majority of economists," he writes, "are overly optimistic about the ability of the economy to weather next year's fiscal tightening."

At the Centre for Economics and Business Research, Douglas McWilliams is forecasting a real touch-and-go brush with recession next year. He sees growth of just 1.3 per cent in 2011, with a one in ten chance of recession, and 1.4 per cent in 2012. And its central forecast for the first quarter of next year is just 0.1 per cent - implying a nearly 50 per cent chance of negative growth for that quarter.The forecast includes an additional 100bn in quantitative easing, base rates remaining at 0.5 per cent till late 2012 at least and ten-year gilt yields in the 2.5 to 2.75 per cent range till end 2013.

One positive point amid the gloom is that private sector companies have seen a strengthening of their balance sheets as costs have been cut back and borrowings brought down. "To put it bluntly," says Bill McQuaker, head of equities at Henderson Global Investors, "US businesses are flush with cash... the available cash flow of US companies as a proportion of GDP hasn't been at this level in more than 40 years."

The picture is similar in the UK. Figures earlier this month from the Office for National Statistics showed the net rate of return on capital for the UK non-financial corporate sector rose from 11 per cent in the first quarter to 11.6 per cent in the second.

As for investment intentions, surveys show an improvement. Business investment is likely to be up by between 9 and 10 per cent in the final quarter of this year, compared with a 23 per cent slump year on year in the fourth quarter of last year.

"The financial incentives for firms to invest are now quite high," says Citigroup UK economist Michael Saunders. "The rate of return on capital is more than 3 per cent above the earnings yields on UK equities and extremely high compared to returns on deposits."

This gives some hope. But in the near term at least, it seems that even if we escape recession, it will to all intents and purposes feel like one.