Some pundits are predicting that the worst of this recession will be over pretty quickly. I wouldn’t be so confident, says Tim Bennett.
How bad was the 1990s recession?
Economists don’t put it in the same league as the Great Depression of the 1930s or the 1973-1975 recession that spawned the ‘winter of discontent’. But it was still painful. The economy began shrinking in the third quarter of 1990 and continued for five quarters in a row. At the start of the downturn, inflation measured by the retail price index was heading above 9.5% and the base interest rate was already 15%. In the depths of the downturn, unemployment peaked at around three million, a rate of just above 10%. House prices saw a peak-to-trough fall of 13%, tipping many homeowners into negative equity.
What caused that bust?
The precise trigger is still debated – the sharp rise in rates that took the base rate to 15% in 1989 is a prime suspect. But as with all busts, the real culprit was the boom that preceded it. In the 1980s, as in the past decade, cheap mortgages and low interest rates resulted in a booming housing market. House prices rose to a then-record four times average income. Tory government policies added fuel to the fire with a tax break (MIRAS), which allowed mortgage interest to be offset against income. Meanwhile, Britain was grabbing its share of a global financial-services boom, epitomised by the development of Canary Wharf. Thanks to the ‘Big Bang’ deregulation of 1986, building societies rapidly grew lending, while the scrapping of many trading restrictions saw a rush of US and European banks into the City. So jobs, in the south-east particularly, were plentiful and debt was cheap. The mood was captured by the title of comedian Harry Enfield’s 1988 record, Loadsamoney (Doin’ Up The House). When interest rates jumped at the end of the decade, the bubble was popped, businesses shrunk or went bust and jobless homeowners were left with unaffordable debts.
Will it be better or worse this time?
Monetary Policy Committee member David Blanchflower reckons we can avoid a “deep recession” and is confident that “in the medium term our economy will recover and prosperity return”, says David Smith in The Times. The Bank of England will slash rates to stimulate demand, something Chancellor Norman Lamont avoided in the early 1990s for fear of sterling being thrown out of the European Exchange Rate Mechanism. Other central banks will do the same. Combine low rates with huge injections of liquidity into the financial system and “US consumers will recover their nerve next year”, says Hamish McRae in The Independent. Where America leads, other economies should follow. Meanwhile, the falling pound – last week it hit a five-year low against the US dollar – should boost our exporters, and Chancellor Alistair Darling has also promised that the government will “spend its way out of recession”.
But will this be enough?
Unlikely. A low base rate won’t instantly reduce household borrowing costs. That’s because our mortgage, loan and credit-card rates are set by commercial banks. The rate at which they lend to each other – known as Libor – is still what Motley Fool’s Neil Hume calls “exceptionally high”, at more than 1% above base rate. HSBC’s David Hodgkinson has confirmed already this week that “home loan rates are unlikely to fall in the short term” as banks shy away from writing mortgages. As for Darling’s vague pledges on public spending, these are likely to make an already bad public borrowing position even worse (see below). Lastly, a falling pound may make exports cheaper, but that’s no good if no one is buying them – as Capital Economics’ Jonathan Loynes points out, export volumes are still falling “very sharply”. This would be bad enough were we heading for the “shallow” recession predicted by McRae and others. The trouble is, this one shows every sign of being far worse.
Why’s that?
The property bubble was even bigger this time round. House prices are already down 14.6% in the past year, says Nationwide, the fastest rate since 1952, let alone 1990, and repossessions are climbing rapidly. That has had dire consequences for both consumer confidence – also at its lowest level since 1974, says Gfk NOP – and retail spending, which hit a two-and-a-half-year low in September. Even at this early stage, firms have issued more profit warnings than at any time since 2001, says the Ernst and Young ITEM Club. The European Commission expects the UK to be the worst-performing major EU economy next year, shrinking by 1% and entering a “deep recession”. Capital Economics believes the recession will last a full two years, rather than five quarters, with output falling by 3%, “higher than the 2.5% fall seen in the early 1990s”. Unemployment would then spike well beyond its previous three million peak.
Public finances are in a big mess too
The Government is entering recession with a considerably higher level of public sector net debt than at the start of the last downturn, says the Institute for Fiscal Studies. And the structural deficit (public sector borrowing as a proportion of national income) is deteriorating more rapidly – it’s already 40% above its level in 1990. We already have the second-highest structural deficit of any G7 country bar America (from being sixth in 1990). The FT’s Chris Giles notes that if our deficit hits the EU Commission’s forecast of 5.4% of national income by 2010, it will take a £36bn tax hike, or the equivalent in spending cuts, to bring it down to the EU’s target of 3%. So regardless of Darling’s claims, there is little room to borrow and spend more.