V's and W's

The media and politicians are currently doing a lot of speculating about when the recession is going to end in the UK. The government are forecasting that the 2nd half of 2009 will feature growth followed by strong (above trend) growth next year and beyond.

This is known as a V-shaped recession. Short and sharp followed by a quick recovery. In this instance, it is also accompanied by a group of flying pigs and songs from Elvis on the moon...

There are various other recession patterns, a popular one being a W-shape. This has the initial fall followed by a false recovery and then a 2nd dip as the economy actually heals itself. The early 80's is a good example of a W (or double dip) recession. The 2nd dip is where the pain is really felt - higher unemployment, major cutbacks, etc. Oh, and minor things like rioting and crime rising!

I might be overly pessimistic, but I think a W-shaped recession is a nailed on certainty despite what most of the media say! The Sunday Telegraph's Liam Halligan honorably excepted. The UK has a bit of a conundrum to solve, namely:

1. Borrowing this year: approx £200bn (artificial stimulation of economy)
2. GDP: approx £1400bn
3. Increasing total debt (increased interest payments)
4. Need to cut spending in future years
5. 3 & 4 shrinks economy = recession

Note that the bank bailouts that everyone gets hot and bothered about are excluded from these numbers. That's even more borrowing to cripple our economy!

Looking at (1.), borrowed govt money now forms 10-15% of the total economy. The UK government takes in approximately £500bn in tax revenue, but is spending close to £700bn. As a guide, you would have to raise the basic rate of tax to 70p (from the current 22p) to balance this budget. What a balls-up! If you're not angry about this, then you should be...

The added problem is that the £200bn of extra stimulus does actually stimulate the 'real' (private sector) economy. So more than £200bn of the £1400bn GDP is linked to government debt. Let's say £300bn as an example. To balance the economy by cutting spending, GDP would have to drop 20% - which would be a horrendous depression.

We are stuck between a rock and a hard place. Raising taxes is not an attractive option - it becomes self-defeating after a while, failing to increase govt income. But at the same time, drastic cuts is not attractive as it would devastate the economy. There are no easy options...

What should we do? My simple answer is that we should not have come here in the first place. Dodging the question I know, but it is the fundamental point.

The UK/US dropped rates drastically in 2001 in the 'recession that never was'. We stimulated our way out of it by borrowing (and dropping rates drastically). But then we did not put the brakes on the boom that followed. We had chances to knock the boom on the head in 2003 and 2005 but chose not to do so. In doing this we just made the problem bigger. Now it is so big that we don't have a viable solution.

2005 made me angry at the time as it was such a missed opportunity. The UK dropped rates when we should have risen them (BoE Governor Mervyn King voted against the cut) - while the economy was doing a controlled slowdown. This made the boom worse and distorted the economy more. Consumer borrowing was £1100bn then - it is now £1470bn and will cause a lot more human misery. The public sector has had 2-3 more years of unnecessary growth. Unwinding that is going to be much messier in 2011 and beyond than it would have been if we had applied sensible thinking in 2006.

But we couldn't have predicted this all, I hear you say. Rubbish! It was painfully obvious that we were heading for the buffers from 2003 onwards. We just chose to look the other way because the value of our houses were going up and we were all getting rich quick...

We've had a major failing in leadership, particularly since 2001. Gordon Brown maintaining that public sector spending increases are the right thing in future just shows he does not get it at all. Maybe we should give him a 'V' of disapproval...