UK recession Will the economy recover soon?

7 July 2009

Disclaimer: I am no economist, and I have absolutely no idea about economics, so whatever I write is probably all wrong.

Recently, there have been encouraging news about the shape of the economy, and the worst is over, or so it is according to some. As a pessimist, I find such optimism unwarranted, if not delusional and dangerous. The economy will not recover for a while, not in a way people feel or understand. As unemployment and job insecurity increase, and number of work hours decreases, those little and not-so-little luxuries that make us feel better, richer and happier will be harder to afford.

Public finances are in a dire state, and the state cannot go on stimulating the economy indefinitely, unless it wants to go bankrupt or inflate its debt away by printing money. Bankruptcy and hyper-inflation do not count as sound policy proposals. As the economy stagnates and tax revenue falls, the demands on the public purse (social security) increase. Higher taxes would only futher depress the economy (though tax rises are inevitable once there’s a sound recovery), and borrowing is likely to be more expensive, as Britain’s credibility will be questioned.

Banks and bankers, rather like drug addicts who have been put into a rehab programme thanks to the tax-payers, will soon relapse into their ways. Bonuses are not the problem, irritating and infuriating as they may be, but their unwillingness to lend and ease the credit crunch is the real problem. With the economic situation so volatile, more and more loans (banks’ assets) will become toxic. Hitherto ‘prime’ loans will become less than ‘sub-prime’. It’s a vicious cycle: banks and bankers become more and more hesitant to lend money because it’s risky to do so, then more companies and people will have cash flow problems and go bankrupt, therefore more loans become toxic.

Stimuli are needed, but the room for manoeuvre is getting smaller all the time because there is less money to throw about, and perhaps the state ought to play a more direct role in easing the credit crunch, using the nationalized banks as instruments. In the short term, the state needs to borrow money, and that means the government has to come up with credible policies that would reassure the purchasers of the bonds. Mr Brown’s government seems to be trading on the future Tory government’s credibility, as pointed out in In 2009 as in 1931, debts must be repaid. Drastic public spending cuts and higher taxes must be accepted as the price for the profligacy of the past decade or so: it’s our generation’s mess, it’s our duty to clean it up for the future generations.

The road to recovery will be bumpy, and there will be false hopes on the way. Politicians must be candid with the electorate. Britain needs such honesty, desperately.