The global economy is currently going through a period of unusually severe and complex economic threats and opportunities. The debt and respective fiscal discipline ‘hangovers’ from the worst financial crisis (2007-09) since the Great Depression will continue for some considerable time. More stringent banking regulations and reforms have been unleashed, both nationally (like the UK Vicker’s proposals to ring-fence retail and investment banking) and internationally (led by the new Basel 3 regulations on banking risks).
At the same time, recent banking ‘scandals’ have aroused renewed public fury that post-crisis banking is simply a repeat of the practices and excesses that allegedly characterised the build -up to the 2007-09 ‘credit crunch’. Within this difficult scenario, the eurozone crisis continues to threaten some of the hard-won economic recovery gains.
For a short time at least, though, the outstandingly successful London 2012 Olympics have been a reminder of what ‘Team GB’ is capable of delivering with the right talent, backing and teamwork. It has been a good reminder of what Britain can do when put to the test. The Olympics have produced a ‘feel good’ ethos across the country and elicited worldwide acclaim for a job spectacularly well done. It is hoped by many that the Olympics may also help ‘nudge’ the struggling UK economic recovery along the required trajectory.
The present economic scenario is ‘mixed’ and ‘weak’ in the West at best, and threatening and uncertain at worst. The UK’s ‘double dip’ recession and the prospects of even a ‘triple dip’ next year if the eurozone crisis worsens are not reassuring possibilities. Any Olympics-fuelled UK recovery may prove to be small, short-lived and unsustainable if the eurozone problems erupt into a full blown crisis during the next year..
In the present two-speed global economy, even the Chinese economy is beginning to cool. The eurozone continues to lurch from one piece of alarming news to another – the latest concern being the recurring problem of Spain’s sovereign risk exposure. At the same time, the US economy is stagnating and the latest UK growth data are weak. Both the US and UK are still only around halfway along the needed post-crisis de-leveraging (or debt reduction) within their respective economies. With the present high uncertainties, many investors and big companies are sitting on high cash balances that they are not yet prepared to invest longer term.
The present UK recession is now the longest recorded. The latest official statistics on GDP record the sharpest quarterly decline since the first quarter of 2009. The latest figures were unexpectedly severe to some economists. In this context, The Economist (July 28) cautions that ‘The economy is struggling, but not as hard as the official GDP figures suggest’. They point out that those who are sceptical at the apparent severity of these latest figures have a stronger case for some scepticism than is usual. They suggest that the biggest reason to mistrust these latest GDP figures is the apparent health of the UK jobs market.
The UK remains one of the worst post-crisis economic performers amongst the developed countries. Even in the struggling eurozone, German and French economic performances appear stronger than that of the UK. The UK Chancellor’s strong deficit-reduction strategy continues to attract greater calls for stronger measures to stimulate growth. A recent (29 July) Sunday Times survey found that only a quarter of those surveyed feel that the Government is tackling the present economic stagnation well.
The IMF’s assessment of the UK economy (imf.org) revised expected growth downwards to 0.2%, effectively a flat economic growth trajectory for the rest of the year. Important factors that helped support this IMF downward projection included the eurozone crisis, the UK’s tough fiscal discipline, weak credit growth and an inflation squeeze on real incomes. These forces conspire to produce a difficult economic climate for growth. The latest (August) Bank of England forecasts for the year are for ‘zero’ growth.
Despite the apparent ‘gloom and doom’, though, there are some positive signs. For one thing, many economists (and they don’t always get it wrong!) believe that the present gloom is being overdone. Analysts at the Ernst & Young Item Club, for example, believe that UK output can grow more than 1% in the third quarter and reach 1.5% in 2013 (assuming no major escalation of the eurozone crisis).
Since the present double-dip recession began (in the early autumn of 2011) a quarter of a million jobs have been added within the UK economy and unemployment has reduced by 100,000 (to 8.1%). The number of people in employment rose by 166,000 in the first quarter of the year. Most of these jobs have been full-time and the average working week is extending. These data are not apparently consistent with the latest UK GDP figures. Inflation has also fallen to its lowest level for two years and (according to Deloitte Consumer Tracker) household optimism has improved over the past quarter.
The UK Government is also responding to the present challenges, whilst having to recognise the Chancellor’s dilemma – if he relaxes his strong deficit-reduction strategy, he risks losing the country’s triple- A credit rating. There is a temptation to delay or lengthen the period of the present tight fiscal stance of the UK (and thereby put more spending back and more quickly into the economy), but this carries with it the real risk (amongst others) of a loss in the UK’s credit rating.
A basic problem with the UK (and wider Western) economic recovery is the apparent lack of credit, especially bank lending. The new UK ‘Funding for Lending’ scheme (launched in August) is a welcome and much needed move. This £80bn scheme will provide cheap funding to the banks on the condition that they maintain or increase their lending. Nevertheless, there are those who believe it is around four years late (Sunday Times, 29 July) and its impact and contribution to sustaining bank lending will be difficult to assess. But it is certainly a good move.
The more fundamental challenge is to increase bank lending (and the new Funding for Lending scheme will help this) and to sustain it. Earlier in the year (February 15) the Governor of the Bank of England talked about the ‘harsh treatment’ by banks of small businesses. The Governor referred to the ‘market failures’ arising from the lack of bank lending to businesses who were consequently unable to grow and help drive the economic recovery.
There is no shortage of ‘big ideas’ (like that of a British Investment Bank) and failed initiatives (like the much vaunted ‘Project Merlin under which the banks agreed targets for increased lending to smaller businesses). In this context, the recent (March, 2012) UK BIS Taskforce Report ‘Boosting Finance Options’, led by Tim Breedon (CEO of Legal and General and Chairman of the Association of British Insurers), has been enthusiastically received. This study argues that UK businesses rely too heavily on bank finance (which apparently fails to match demand) and it advances strong arguments for alternative forms of finance and other changes. They estimate the ‘funding gap’ faced by smaller business to be of the order of £84bn to £191bn over the next five years.
The latest UK figures show that bank lending remains a serious problem. Bank lending to smaller (and other) UK companies in June has fallen again – this is more than 25% below a 2008 peak. It is true that there is a demand –side problem (many businesses are concerned about the economic scenario and are unwilling to borrow and expand at this time), but there is strong evidence that there is supply-side ‘gap’. Bank credit is apparently ‘rationed’, comparatively expensive and it is likely to become more expensive with new, tighter bank capital and liquidity regulations.
The new Basel 3 capital regulations are a response to the last financial crisis. As such, they are tough and require banks to increase substantially their own capital and liquidity resources. This operates to raise the cost of bank lending and to constrain its supply. The new rules recognise the need to increase bank capital in good times so that banks can continue to lend during economic downturns in order to help ‘fire up’ economic recovery. The problem is that these new rules have been implemented (and it will take several years for them to be fully implemented) at a time of Western economic recession. If that wasn’t challenging enough, banks have also been required to increases their capital cushions in advance of a possible increased eurozone and sovereign risk crisis.
So no easy solutions to UK economic recovery. Many problems, some serious threats and considerable policy challenges have to be faced. The Government appears resolute to a strong fiscal stance (which is necessary and will be beneficial in the longer term), but it also must recognise the urgent need for greater credit availability now.
Solving the eurozone crisis, reducing sovereign risk, restoring bank lending and a stronger US economic recovery appear to be amongst the necessary conditions for a strong and sustained UK economic recovery. But, as we have suggested, excessive gloom is not warranted. There are some positive signs of a (albeit still low and struggling) economic recovery. Now is the time to exploit the Olympic ‘feel good’ ethos and talk up Team GB’s economic prospects.
Professor Ted Gardener
