Saturday, 17 January 2009


Act 2 then is a story of economic slowdown and recession. Businesses found - and are finding - it hard to get access to finance; house buyers found - and are finding - it difficult, sometimes impossible, to get a mortgage; gradually real economic activity began to slow, and when that happened the deceleration got worse and share prices and house prices fell. When people feel poorer, they spend less, and when they spend less, they make other people poorer.

What has taken me by surprise is the speed of events. When I was first asked to talk to you, in November, the topic was the credit crunch. Barely 4 months later, we are talking now about a global depression similar to the 1930s. All advanced economies are affected, and many less advanced economies. Economies with large financial or banking sectors are badly affected: Iceland, the UK, Scotland.

The policy response in Britain and the US, and to a lesser extent in most European economies, has been twofold. Firstly to lower interest rates, supplemented more recently by direct intervention in the form of ‘quantitative easing’. Secondly, increases in government spending, i.e. fiscal stimulation on quite a massive scale. This itself may cause problems, as the future public finances look distinctly fragile. Some economists who have crunched the numbers have estimated that the UK public debt will not come down to its former levels for a generation; that debt has to be paid off at some point, and other spending ambitions will have to take sacrificed. All this may have the effect of making today’s consumer (who is tomorrow’s taxpayer) even more cautious about spending. There is therefore a vigorous debate amongst economists as to whether more government spending, and thus more government debt, is really the answer. After all, was not too much debt not the problem in the first place?

And this brings me to the big question: how well placed is the UK (and Scotland) to withstand this recession? And what could we have done about it?

Britain is a very open economy, heavily involved in international trade. We export a lot and we import a lot. By itself, that is a good thing. But we are then sensitive to developments abroad, and the slow down in foreign markets will hit us hard. Against that we can set a depreciation of sterling that is making our exports more competitive. But will more foreign tourists come to Edinburgh? It’s good value, but they are poorer.

The UK economy has many peculiarities; one is our obsession with home ownership. Almost uniquely in advanced economies, we are encouraged to get on the property ladder early, and for most this involves getting a mortgage. Until recently, it was quite easy to get a mortgage, as banks were willing to lend large sums, secured not against income but against future price increases. These in turn were assured by buoyant demand and an almost static supply, in part the result of restrictive planning regulations. Combined with the liberalisation of credit and financial markets, we have found it only too easy to borrow money.

But so has the government. When he first became Chancellor, Gordon Brown set down rules for the control of government debt. The Golden Rule was that, on average (i.e. over the economic cycle) the government would not borrow to finance current expenditure, only to finance investment in hospitals etc. But as the government spent more on the doctors, and education, and tax credits, and all these worthy things, it could only meet the Golden Rule by redefining the economic cycle. In effect, it extended the period over which the cycle occurred, giving it leeway to spend more now and repay later. But later never came, and by the time the crisis hit the UK, the public finance were already in poor repair. So just when we need a strong financial position, so that the government can spend to get the economy back on track, we find that we start from a position of high debt.

Of course, if the private sector (consumers and firms) and the government are both borrowing, that means one thing: a large current account deficit. And this is something no one worried about. But it was the symptom of an economy living beyond its means, and borrowing from abroad to finance expenditure in excess of income. When we do that for year after year, then when we really need to borrow, it is that much more difficult, and people start to question our ability to pay it back. This is one reason for the weakness of the pound; some commentators have speculated that the UK may need to borrow from institutions such as the IMF. That would be political death for any government: if Gordon Brown was forced to go to the IMF then that would probably be the end of the Labour Party. So he will do his utmost to avoid it, so expect tough decisions on government spending and taxes in the next budget on 22 April.

So, way are we in this mess? Because as a country, we like to consume too much; we are too prepared to borrow and spend now; our banking sector has been allowed to have a disproportionate influence on the economy, and the quality of banking and financial regulation has been execrable. The government has gradually let the public finances get out of control, has paid too much respect to bankers and financiers, and not asked hard questions of them. Nor have shareholders (including our pension funds). There have been profound failures of corporate governance: why have the non-executive directors of banks been so spineless in protecting shareholder interests? Is it really the case that, in their heart of hearts, the whole board of RBS agreed with Fred Goodwin and thought it a good idea to buy ABN-Amro? Why were they so feeble in resisting his grandiose idiocies? Their negligent behaviour is an interesting area of analysis not just for the economist but also, I would suggest, for the criminal lawyer.

No comments:

Post a Comment