Insights from Henley Business School
The Recession – Is there a Way Out?
The government wishes us to believe that we can 'spend our way out of recession' and return quickly to the 'good times' that have characterised twenty-first-century New Labour Britain. The current recession, it claims, is due to the failure of international capital markets. Apparently, traders have not been pricing risk correctly, and this has caused the markets to seize up. They need to be lubricated with some cash in order to increase liquidity, and then lending will start to flow again and the good times will return.
Common sense suggests, however, that increased consumer spending may not be a good thing. Didn't excessive consumer spending create the problem in the first place? Wasn't it the risk that consumers could not repay their mortgages or credit card bills that was under-priced? Common sense is almost certainly right. It is not a quality that is readily found amongst government policy-makers these days, however.
Changes in regulation
Did you realise that for the past few years there has been no effective regulation of high-street banks and building societies? If you had £100 to deposit, and the Nationwide offered you 5 per cent and the Northern Rock 6 per cent, you probably thought that it was right to take the 6 per cent from the Northern Rock – that's how competitive markets are supposed to work, isn't it? That was the line initially taken by the regulators – the Bank of England and the Financial Services Authority. They believed that the interest rates were directly comparable because both investments were perfectly safe. Unfortunately, however, the regulators didn't know much more about the financial health of the two institutions than you did. So when rumours began to spread about Northern Rock, the regulators changed their tone. If depositors were stupid enough to put their money into a bank with a weak balance sheet, they said, they should be punished – that was how competitive markets work. Apparently personal investors were supposed to do 'due diligence' on every financial institution that they put a penny in. Until ten years ago, by contrast, financial regulation was based on common sense; the regulators checked up regularly on whether individual banks had enough liquidity, and were able to assure depositors that their money was safe. But not any more. Once common sense departed, and free market ideology took hold, the regulators gave up traditional regulation and left the job to you and me instead. It is no surprise that a crisis of confidence developed when the public realised that the regulators they trusted had not been doing their job.
Time for common sense
Now the recession is biting, there are growing numbers of boarded-up shops and half-finished building sites. The government says that if we only spend more these assets can be rescued and revitalised. But common sense suggests that many of these assets have no future at all. The personal wealth that fuelled the consumer boom was illusory, based on unsustainable share prices and house prices driven up by cheap credit and under-priced risk. Disillusioned consumers will not continue buying the luxury goods that these assets were designed to deliver. There are just too many shopping malls, leisure parks and high-street boutiques, and some will have to close.
But these valueless assets were financed with fixed interest loans, which their owners cannot now afford to repay. Bad investment decisions lead to bad loans, and bad loans lead to financial instability. Injection of government cash can give investors more time to repay, but bankruptcy is only being postponed. Mistaken decisions over the past ten years have built up a stock of worthless real assets. Unlike financial assets, these assets cannot be easily liquidated; they are fashioned from concrete, steel and glass, and their construction cost is money that is sunk and lost for good.
The future
How can we provide for the future when our stock of real assets is nowhere near as valuable as we thought? How are we going to fund our pensions and pay for our grandchildren's education? Common sense suggests that we have to invest in new and better assets instead. To repay the loans we have taken from other countries, we need to export more; this means consuming less ourselves and selling more to foreigners. We have to find new export-oriented growth sectors to replace our (partially) discredited financial sector. Then we need to invest in the assets needed to make those sectors world class. There is a great opportunity for universities here. Quality education is always in demand, but the kind of education required will change as new sectors emerge, requiring different training for new kinds of job.
This has major implications for human resources. It isn't just the physical capital stock which is all wrong – it is the human capital stock as well. A new world of ascetic consumers will require a different mix of skills – for example, fewer bankers and more teachers, fewer hotel staff and more social workers. Many existing jobs will be destroyed, and nothing will save them – subsidised loans to employers will only delay adjustment and impede recovery, as happened in Japan.
Unfortunately, though, it isn't yet clear where the new jobs are going to come from. We can't be sure exactly what future spending patterns will be like. In the meantime, it makes sense to re-deploy redundant workers to public infrastructure projects which will make our future economy more productive wherever the new jobs turn out to be. Suitable projects include enhancements of public transport and telecommunications, flood defences and heritage conservation. Common sense suggests that bringing forward worthwhile infrastructure projects is a good way of smoothing out the recession. Although the tax burden will increase, much of the tax can be recovered from the earnings of workers who would otherwise be unemployed and claiming benefit.
But while common sense suggests this, it is not clear that the government will do it. Government continues to deny that a structural problem exists. It is relying on consumption to stimulate the economy through a VAT reduction, when it should be promoting exports and public investment instead. Indeed, it is actually cutting public expenditure at a time when it should be increasing it, because it thinks that confidence in sterling could be further undermined. But confidence has already been undermined because the government is so obviously devoid of common sense, and unwilling to recognise the true nature of the problem. Doing something sensible for a change could actually boost confidence, and set us on the road to recovery – long and painful though the road may be.