It’s crunch time. The world stands on the brink of another recession, rather as it did in the early 1970s, 80s and 90s. Global trading flows actually fell during the last quarter. The German economy is slowing down dramatically.
US GDP growth is down to 0.7% in the last quarter and falling. Japan has been struggling for the past 10 years and it’s getting worse. The oil price has trebled, and the world stock market bubble is unwinding, leaving a trail of bust dotcoms and over-extended telecom companies in its wake. The respected National Institute of Economic and Social Research has likened some aspects of the current global picture to that of 1929.
The UK is not immune. GDP growth fell to 0.3% in the second three months of the year compared to the first. The Ernst and Young Item Club, a group of City economists, have spelled out the dangers. Manufacturing is now in recession and has been crippled for the past nine months by the slowdown in the global export market and the high pound; one in five jobs is directly involved in manufacturing – and another one in five jobs indirectly.
The service sector will be able to maintain buoyancy this time around. If the whole economy is to avoid being dragged down, Titanic-like, by the hole in the forward bulkheads that are the manufacturing sector, then the pound needs to fall urgently. And the government needs to ensure at the very least that the increased spending it has earmarked actually gets spent, unlike the last two years.
The Bank of England has heard the message: its decision to cut interest rates to 5% was a welcome recognition of how serious the situation is becoming.
Confidence is needed, and all eyes are turned to the beleaguered US. Treasury Secretary Paul O’Neill is one man, for certain, who believes the US will be able to ride to the rescue. He believes that the US economy will grow at around 3% next year as a result of productivity improvements and, critically, consumer-led spending, as the first of President Bush’s tax cuts is delivered to US homes this month.
O’Neill is obliged to strike that happy note – but his optimism is overdone. First, irrational exuberance in the stock markets driven by US consumer spending helped to fuel the dotcom bubble and so helped lead to the current global downturn. But the tax cuts are illusory – they only kick in next year. Consumers are just as likely to pay off existing debts and save.
Second there is no reliable evidence that the US economy has realised genuine productivity growth. As Professor Robert Gordon of Northwestern University in the US has argued, strip out investment by firms in upgrading computer based capital and the natural fluctuations of the business cycle, and there’s precious little evidence of sustained productivity growth. Include the recent downward revisions to productivity announced this month, and it is clear that the upturn in US productivity is only modest. So what can the UK do?
First we shouldn’t look to the US to provide all the immediate answers. Short term, the Monetary Policy Committee of the Bank of England needs to continue to cut interest rates. This will provide a boost to both the manufacturing and service sector.
The government’s existing public spending plans need to be revised. Gordon Brown has built up a war chest over the past four years. He needs to announce both that he will ensure that his spending targets will be met, and that he is preparing contingency plans to ensure that what was not spent in the last two years is spent in the next two. We need the strength in public spending to underwrite the economy.
But what of the final conundrum: how to reduce the level of the pound which alongside the downturn in global trade has placed manufacturing in such a vice? The government signals it will be holding a referendum on the UK’s membership of the euro sooner rather than later, and that it believes the current level of sterling is seriously overvalued. That should help skim some of the froth off sterling’s valuation, give exporters and the eurozone generally a much-needed boost and allow the debate on the UK’s long-term economic future to begin in earnest.
The risks today are all on the downside. We need the government to become much more proactive if its promise to eliminate the boom-bust economy is genuinely to be met.