Monday, July 21, 2008

What of the UK?

I have had another comment from Dan, who has posted the following questions:

'To get back to my original point, what does the author see Britain being like in one year from now? Would we recognise it as the country we know today? Or will it be a very different place, where many of the rights and absolutes we take for granted no longer exist? Are we heading for the 2nd, or even 3rd world? I feel that the author still is shying away from telling us how this is all going to end. I can understand any reluctance to do this, because it really is going to be that bad. Social disorder on an unimaginable scale.'
The first point is that this blog's purpose is to try to examine economics, rather than social consequences (though they are interlinked to some degree). As such, I will not deal with these aspects of Dan's comment.

If I answer the 'years time' question there are several certainties - but also uncertainties. The reason why it was possible to predict the current crisis was that there was a stability in the policy and economic activity that was clearly leading to the current crisis. It was very clear that no one would change direction, or that anything would/could occur to deflect the inevitable crisis.
I have already written here that there will likely be some bank failures as the second credit crisis bites. This second crisis will lag the rise in unemployment and company bankruptcies. I have also suggested that there will be a major crisis in government funding as government revenue plunges, and expenditure climbs. What we then have is a series of crises, and the trouble is that, in a crisis, it is not always obvious how individuals will react. Will individuals accept the real reason for the crisis, or will they continue on the same assumptions that created the problems in the first place?

There are already voices suggesting that the solution to the problems lies in more state spending. For example, Will Hutton suggests in the Guardian a Keynesian economic boost to the economy - using borrowing and spend as a way out of the crisis. However, even assuming that is the solution adopted by the government, it is very unlikely that the government would gain funding for such a 'boost'.

For the moment it is worth considering this idea, as it will certainly gain support in the coming months. I am personally of the view that this kind of Keynesian (neo-Keynesian) policy would be absolutely wrong under nearly all circumstances. However, for the moment we will pretend that we agree in principle. Even if we do this we face some serious problems, as one of the foundations of the idea is that we pay off debt in the 'good times' and spend in the 'bad times'. If we look at the last ten years, we see that national indebtedness has increased in every part of the economy, including the government. As such, this kind of policy just becomes a fig leaf for just running up more debt. There would be no real justification for it. Picking a Keynesian solution at this stage in the cycle, having already increased borrowing, is just being dishonest - you can not just jump into this solution at your convenience. Either you follow it 100%, or you do not follow it.

(as a note, you may want to see here for the 2007 levels of debt in the UK and here for a discussion of the debt from another blogger)

The point in bringing this up is that it is quite probable that this will be one of the proposed solutions to the coming crisis. It is just another economic dead end and, if the government goes down this route, then the crisis can only be magnified. As I have said, how individuals react to the crisis will be what determines the future, and there are many options open to the government. Some options will accelerate the crisis, others will ameliorate it.

If we add to this the rather odd idea of 'sentiment', then life gets even more complicated. I have predicted a loss of confidence in the UK economy, and that this will likely lead to the government going to the IMF for a bail-out. This is just one element of sentiment. What individuals in government do will, for better or worse, effect sentiment inside and outside the UK. If individuals lose confidence in the government's solution to the crisis, then sentiment will be negative, and the spiral down will accelerate.

These are the unknowns in the current situation, which will determine how bad things will become. There are still some certainties that mean, whatever course of action is followed, the situation is going to get much worse before it gets better. These circumstances I have detailed elsewhere.

One certainty is that, in a years time, the UK banking system will still be in crisis, as will be government finance. Unemployment will still be climbing, consumer confidence will be rock bottom, and house prices still falling. Businesses will be closing down in large numbers. All of these events were put in place over the last few years, and can not be reversed. The real question is whether the changes will be put in place for recovery, and whether the government will take the tough decisions necessary to create a future stabilisation. The big question that this raises is how might this be done?

One element of change is already taking place - the fall in the £GB is one of the solutions, but the fall in the pound comes at the cost of the country becoming poorer (as I have detailed elsewhere). At some point, the UK needs to take positive steps to improve the economy. These are the long term and tough solutions.

I have already addressed one of the fundamental issues, which the UK government can not handle alone. That is the question of how to deal with the rise of China, such that it starts to trade fairly. The second question is how the UK can adapt to a world in which we now have to face the competitive threat that China presents, and how we can win against such a threat. This is a question that I hope to deal with in the coming weeks.

It will mean that the UK will have to make some major changes in the way that the economy is structured. Part of that will be for the role of the state in the economy to shrink, and part of it will be wholesale reform of many institutions, such that the UK can become prepared for a tougher world. None of these are quick fixes. The economy has to sink back a long way before it can even start to stabilise, and that process will continue for at least two years, but maybe much longer, in particular if the government ignores the fundamental problems, and continues down the path that led the UK into this mess. Of note is that there is no avoiding the debt hangover, and this will be an ongoing drag on the economy for many years to come. Can reform be made to ameliorate the effects of the debt hangover - 'yes' - but many of the problems are structural and will take many years to resolve.

As soon as I have time, I will start with my solution to just one of the keys to economic success - an effective education system. It is the kind of reform that will only start to bear fruit in 5-10 years time, but needs to be started immediately. Education lays the foundations of future success, but the education must be of a high standard, and must see the major investment required produce real quality, not the ersatz quality that has become the norm.

To return to Dan's question, will we recognise the UK one year from now? The answer is that, whatever happens, the UK will look to be a much poorer place, though it will be too soon for this to deeply effect the institutional structures of the UK. In some respects the UK will look much as it does now, just a poorer and very depressed version. The real question mark will be whether there will be the preparations for a real long term recovery, or a continuation towards decline and eventual stagnation and irrelevance. Will the reform of institutions and structures of the UK be starting, or will there just be inertia such that the institutions simply wither, along with the UK and UK economy? As I have said, the answers to these questions lie in the hands of individuals, and the decisions they take.

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