After the party, the hangover looms: London’s golden Olympics may soon be a distant memory as Britain returns to the reality of its economic mess and years of more belt tightening.The 2012 Games have lifted the nation’s spirits, but the government has few alternatives to an austerity drive that may last for the rest of this decade—although some academics and economists believe yet more radical policies may be needed.
“Quite frankly the Olympics is helping to paper over the fact that we are on the verge of a depression,” said Simon Lee, senior politics lecturer at the University of Hull. “If the economy goes into freefall, then politicians desperate to get re-elected will discover that they can do much more radical things in the national interest.”
Few economists share Lee’s belief that Britain will suffer a 1930s-style depression. Nevertheless, it will take years to heal the economy’s scars from the global financial crisis, the euro zone’s turmoil and the drive to slash a huge budget deficit.
“Unlike the Olympians who have thrilled us over the past fortnight, our economy has not yet reached full fitness,” Bank of England Governor Mervyn King said last week.
“The recovery and rebalancing of our economy will be a long, slow process,” he said, warning that Britain may take at least two more years to return just to the levels of output it already achieved before the financial crisis struck four years ago.
Britain’s last great economic mess, the inflation- and strike-ridden 1970s, propelled Margaret Thatcher to power and led to a decade of painful change.
Now radical ideas, albeit some very different from the Thatcher reforms, are being floated again to haul Britain back up. Many people believe that some taboos will have to be broken to fix Britain’s problems.
For the Bank of England – which has already pumped huge sums into the financial system by buying government bonds from commercial banks – this might mean purchasing loans and mortgages with newly-created money from lenders.
For the government, it might mean turning Thatcher’s free market ideology on its head with measures such as fully nationalizing the Royal Bank of Scotland.
The Bank of England is now factoring in that the crisis has destroyed some of the economy’s ability to grow without stoking inflation.
If this is correct, the message is dire: there may be less room for the central bank to pump easy money into the economy in the future. Likewise, more of the hole in public finances could be structural, needing a permanent fix, rather than a temporary problem that will disappear when growth returns.
This would allow for even less government spending. Prime Minister David Cameron has already warned that austerity, initially planned to take five years, could last until 2020.
Finance minister George Osborne has launched a flurry of measures to get credit flowing and boost infrastructure investment without directly spending taxpayers’ money. But the public increasingly doubts the coalition of Conservatives and Liberal Democrats can get the country moving.
Notwithstanding the Olympic boost, the economic mood among the 62 million people in Britain has been rock-bottom for most of the past four years. Finding an economic fix remains Britons’ top priority, said Gideon Skinner from polling firm Ipsos MORI.
The economy has shrunk for the last nine months and now produces 4.5 per cent less than before the crisis. Government debt is well above 1 trillion pounds and is predicted to rise above 90 per cent of GDP even with the austerity policies.
Many Britons have experienced the worst squeeze in their living standards since the dark 1970s.
“Everything’s a struggle. The mortgage is extortionate, electricity bills are hitting the roof and it’s generally not great,” says Francesca Woolloff, a 25-year-old accounts assistant in insurance, taking a smoking break outside her office in London’s City financial district.
A 20 per cent drop in the pound’s value since 2007, an increase in sales tax and climbing costs of raw materials and oil have driven up consumer prices, eating into meager wage rises and hurting the poorest most.
Even middle-income earners will have seen 7 per cent of their spending power wiped out by the end of this year compared with pre-crisis levels, the Institute for Fiscal Studies estimated.
The crisis has hit young people the hardest and youth unemployment has soared above 20 per cent. Young families are also scaling back spending to meet banks’ demands for higher deposits when they take out a mortgage loan to buy a home, an aspiration ingrained in the national psyche.
Britons must also save more for their retirement as pension schemes suffer the effects of record-low interest rates.
All this makes a return to the pre-crisis consumerism funded by the credit card unlikely. Total household debt is still 1.5 trillion pounds, equal to total annual gross domestic product.
Ditching austerity is unlikely, as repairing public finances is the glue that holds the coalition together and Osborne has staked his reputation on defending Britain’s top credit rating.
Much discussions now revolves around what economists at think tank NIESR called a dysfunctional banking system.
British bankers have aroused public anger since taxpayers had to bail-out several large lenders. A string of scandals and multi-million pound bonus payments have only made things worse.
As the banks try to clean up their balance sheets, they have become much more restrictive than before the crisis. The lack of lending may have already hurt the country’s growth potential, the central bank warned last week.
Together with the government, the central bank launched an 80 billion pound scheme to lower banks’ funding costs if they keep up lending, but more radical solutions are gaining ground.
Business Secretary Vince Cable, a Liberal Democrat cabinet member, seems sympathetic to fully nationalizing RBS—which is already over 80 per cent state-owned – to create a business bank and lend more to small firms suffering in the recession. However, Osborne’s long-standing goal remains to sell the bank back into private ownership.
“Nationalization does not come without its costs or risks – but it might prove the only way to get lending flowing again if all other attempts fail,” said Vicky Redwood from Capital Economics.
Adam Posen, a departing external member of the central bank’s Monetary Policy Committee, has called on Governor King to drop his opposition to buying assets such as loans and mortgages with newly-created money from the banks directly to unblock lending.
“I personally view the teeth-gnashing and garment-rending about what’s fiscal and monetary as too much drama for too little content,” Posen told the Financial Times.
A political battle is raging over who is to blame for the mess. The Labour opposition has gained public support by saying the government’s plan to cut one of the largest budget deficits in the world within five years has strangled the recovery.
Osborne has pointed to the euro zone debt crisis and blames the legacy of the previous Labour government’s lavish spending, plus reckless lending by the country’s oversized banks.
The NIESR think tank has been calling for a relaxation of the austerity drive. It calculates that launching the budget cuts in 2010 will cost 239 billion pounds in lost output over 10 years compared with if the austerity had begun in 2014.
Britain is acutely susceptible to the euro zone crisis. “Half of what the UK exports goes to the euro zone, UK banking exposure is massive; if the euro zone goes belly up UK banks are in big trouble,” said ING economist James Knightley.
“That’s why UK companies, which sit on massive amounts of cash, are not going to invest when confidence is so low and the risks from the euro zone so large,” he said.
NOT ALL GLOOM
Britain has seen only limited protests compared with Greece and Spain, at the centre of the euro zone crisis. However, some observers saw riots in London last year, when thousands of mainly young people looted shops, as a writing on the wall.
But in one of the richest countries in the world, many people still enjoy a good life: Department store John Lewis, which offers all the brands for a middle-class life in style, has recorded double-digit growth rates throughout this year.
The government’s push to rebalance the economy away from consumer spending to export-led growth is showing some success. Inflation is also falling, easing the squeeze on incomes.
The Bank of England’s policy of keeping rates at the record-low of 0.5 per cent and pumping 375 billion pounds of newly created money into the economy has helped to ease the crisis.
Unemployment has even started to fall and at 8.1 per cent is now lower than in the faster growing United States. But how the economy created 180,000 new jobs over the three months to May remains just a mystery.
Many economists and business lobbies simply don’t believe the size of the officially-reported drop in output in the second quarter. A near 10 per cent decline in construction output over the first half of 2012 has been met with particular disbelief.
Outside London and the wealthy southeast England, life remains uncertain. “It is still fairly tough whichever sector you are in,” said Graham Morgan from the South Wales Chambers of Commerce. “The average business is very worried what the next 6-12 months will look like.”
Wales has been particularly dependent on public spending, suffering now from cuts in infrastructure spending as well as a lack of homebuilding.
Mark Davies, Managing Director of LBS Builders Merchants, said customers from the construction industry face severe strains as more firms bid for the few contracts up for grabs.
Family-owned LBS which employs over 200 staff, has actually added branches as the big national builders’ merchants reduce their presence in Wales, Davies said.
For the Welsh business community, the main obstacle is a lack of finance. “The general feeling from businesses is that banks are taking a very, very tough line,” said Morgan from the chamber of commerce. “Those with reasonably good ideas that are untested are just not getting the businesses off the ground.”
Davies agreed: “Smaller contractors and developers are completely frozen out of the market.”
(Additional reporting by Sophie Kirby; editing by David Stamp)
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