Facing up to the crisis

12 November 2009

Yesterday saw a dire warning from ratings agency Fitch that the UK is, of all major economies, most at rist of losing its top-tier AAA credit rating.  Also in the news in the past week has been the pumping of an extra £25 billon into the economy through the programme of quantitative easing, making a total of £200 billion of phantom money spent by the Bank of England this year.

The two stories are related.  The government's measures to help the economy through the recession are being exhausted.  No one believes that the Bank of England can continue the quantitative easing programme further without a massive loss of economic credibility.  The options are rapidly closing down for this Labour government.

Although there are more optimistic signs in terms of house prices and industrial output, it is quite likely that we will see at least a 'double dip' recession.  Optimists who expect us to emerge strongly out of this recession should be prepared to see their hopes dashed in 2010.  Our economic troubles will be playing out for a while yet.

In short, we are in a crisis that requires bold moves and tough action.

Can we learn anything from history though?

Much of the 1970s was a period of 'stagflation', a combination of high inflation and economic stagnation.  Unemployment remained persistently high and the economy seemed to lurch from one crisis to the next.  Just as it seemed some order was being restored to the public finances, the trade unions took on the government in the so-called 'Winter of Discontent' in 1978-9.  It was a bleak winter.

What is extraordinary is what came next.  Margaret Thatcher's incoming government in 1979 promised tough spending controls and tax cuts, but it is perhaps a little noticed change that had one of the most lasting effects.  The new government abolished exchange controls, a mechanism that limited the amount of currency that could be taken out of the UK.  Almost immediately there was a huge outflow of capital as investors scrambled to take advantage of the new regime.  The capital flight was dramatic: UK privately owned assets increased from £6,300 million in 1979 to £24,300 million in 1981 as investors pulled out of British industry.

If the position had remained the same, the new government's decision would have been seen as a huge mistake.  In the end, however, the abolition of exchange controls was one important step along the road of securing investor confidence.  From now on investors would put their money in the UK by choice and not be compelled by bureaucratic penalties.  In fact, in the years ahead the UK had significant inward investment, trailed most famously by the decision of Nissan to locate production in the UK in 1986.

Sometimes tough decisions, though they attract a lot of flak and even ridicule, pay off in the end.  We need to be taking tough decisions now.

Yesterday the European Commission announced new deadlines for thirteen countries to get their public spending deficits back into line with the EU's 3% limit.  The UK was one of four countries (the others being France, Spain and the Irish Republic) to have their deadline extended as the situation has worsoned since previous deadlines were announced in April.  The 3% limit now seems a distant memory with public borrowing now at around 13% of GDP and rapidly spiralling out of control.

And so it is that we need a government that is prepared to act decisively to bring spending under control and give potential investors confidence in the long term economic health of the UK.  While we await the next general election any hopes for positive action may seem remote.  Paradoxically, this is just the time when a bold move - with the element of surprise - may actually provide the signal that major investors need to tell them that the UK is a worthwhile proposition.

Your move, Mr Brown.