Monday 10 January 2011
By Larry Elliott
History suggests 2011 will be a year of living frugally
The three downturns in 1981, 1991 and 2001 were triggered by tightening policy to cut inflation or deflate asset-price bubbles
If history is anything to go by, 2011 will be a stinker. In 1981, unemployment was rising towards three million in what was, until then, the deepest post-war recession. In 1991, Britain was wallowing in a sea of bankruptcy and negative equity amid the collapse of the 1980s housing bubble.
And in 2001, the global economy tanked during the brief interlude between the dotcom mania of the late 1990s and the US property boom of the mid-2000s.
With high commodity prices and the eurozone gripped by what appears to be an existential crisis, it is little wonder that there is a degree of trepidation about the year ahead that ends in a 1.
Those who take a more upbeat view would argue that there were specific reasons for the recessions of 1981, 1991 and 2001 that do not apply to the current situation. In each of the three decades, the downturns were the consequence of a tightening of policy deliberately designed to reduce inflation or deflate asset-price bubbles.
But even a starry-eyed optimist would struggle to make a case for 2011 being a vintage year for the UK. Taxes are rising and spending is being curbed; wages are being pegged at a time when inflation is going up. Even assuming the Bank of England is right that upward pressures on the cost of living will abate this year, for the first half of 2011 at least there is going to be a severe squeeze on personal incomes. Most households will be faced with the choice of cutting their spending or borrowing more to maintain the same level of consumption. A backdrop of rising unemployment and weak house prices will mean that most, if they are sensible, will be prudent rather than reckless.
There are already signs of belt-tightening taking place, despite the reports of high street spending bonanzas late last month. New car registrations last month were 18% lower than in the same month of 2009, with private buyers especially thin on the ground. To be sure, the December 2009 total was flattered by the car scrappage scheme, but there was no sign last month of the expected rush to beat the VAT rise.
The message from the CIPS/Markit survey of the service sector was similar. Even allowing for the weather, activity was weak in December, continuing the trend for the second half of 2010. Consumers were facing the prospect of higher domestic fuel bills, dearer rail fares and rising petrol prices even before VAT went up. You don't need to be Adam Smith or Maynard Keynes to work out that the first six months of 2011 look pretty nasty.
Single and looking. Email me
But the bulls are right to point out that there are forces that will support growth this year. One is that monetary policy remains expansionary, with bank rate now approaching the two-year anniversary of its drop to 0.5%. While it is true that lenders have failed to pass on the full benefit of lower borrowing costs to their customers, millions of homeowners have seen their monthly home loan payments plummet and this has enabled them either to spend a bit more or to reduce their personal debts.
The second piece of good news is that the rest of the world economy is looking healthier. In the first half of 2010, the story was that the big emerging economies – India, China and Brazil – were acting as the locomotive for global growth. But during the second half of 2010, there were signs of the United States and Germany joining the party. Most of the economic data in the final quarter of 2001 surprised on the upside.
That brings us on to the third reason to be modestly cheerful: the strong performance of UK manufacturing. For most of the past 15 years, industry has languished while the service sector has boomed, but in recent months the strength of global demand coupled with a competitive exchange rate has turned the tables. Last week's purchasing managers' indices showed the strongest performance by manufacturing in close to two decades at the same time as the service sector flirted with recession.
Manufacturing only accounts for about one eighth of the economy, but there are tentative signs that a rebalancing of the economy is underway. This will take time and it will not be pleasant, but it is inevitable if we want to wean the country off its dependence on property speculation and excessive debt.
Some of you, I'm sure, are thinking that all this sounds a bit too good to be true, and a degree of scepticism is warranted in the light of the host of dangers lurking out there. Inflation could prove stronger than policymakers expect, prompting an increase in interest rates or a sell-off in bond markets. High unemployment and a weak housing market could cause a relapse in the United States. China could overheat or the eurozone implode. Financial markets believe that inflation will be tamed, interest rates will stay low, the US will continue its recovery, China will go from strength to strength and the single currency will survive intact. Yet were interest rates to rise or the prospects for exports be impaired by a slowdown in global growth, it would clearly have an impact on Britain's growth prospects.
That is especially true given the lack of an obvious get-out-of-jail-free card for policymakers. In the 1980s, Margaret Thatcher had the bonus of colossal North Sea oil revenues; in the 1990s John Major reaped a growth dividend from the end of the Cold War and the dawn of the digital age; in the 2000s, Alan Greenspan's relaxed approach to asset bubbles flooded the global economy with cheap money.
Now, there may be a quick fix for the economy out there that nobody has yet detected, but it is not obvious. The North Sea oil money has been spent, Europe is in big trouble and only 7% of UK exports go to China, India and Brazil combined. The economy may well avoid recession in 2011, but if we imagine that the next few years are going to be anything other than a hard slog, we are deluding ourselves.
