The world is obsessed with politics as I write but I have a very strong suspicion that economics will, at the end of the day, still dictate the terms of what happens next. That is because I have little doubt at all that the UK is now heading for recession, and that it could be prolonged and deep. To explain why requires a little bit of economic theory.
What a recession means is that there is a sustained downturn in national income, which is also called GDP, which stands for gross domestic product.
GDP is made up of four parts. The first, and biggest component, is household consumption. This covers most domestic spending, except on new housing.
The second element is investment which represents expenditure on new equipment by business and household spending on new housing. I stress, this is not a financial activity: investment in this context means spending on real things and not putting money aside in savings accounts like pension funds or buying shares.
The next component is net exports i.e. the difference between exports and imports. If exports exceeded imports then they contribute to national income, and vice versa, if imports exceed exports that reduces national income. Once more, finance is not the issue here: trade in real goods and services is.
Last, there is government spending. Once more there is a caveat: this does not include what it described as transfers, which include pensions and social security expenditure because these turn up again in consumption and the formula must not double count. So, what counts as government spending is, in effect, the discretionary element of its spend that, in particular, is either investment or does not turn up in consumption e.g. some defence spending.
There are, of course, lots of nuances to all of these items which are sufficient to let an economics professor spend their whole life discussing the finer detail of these issues but in reality the above is sufficient information to explain why a recession is likely now that the UK has voted Leave.
There are two pretty certain consequences of that Leave vote. The first, and most likely of all trends, is that business will now invest substantially less in the UK. This does not just mean that overseas businesses will invest less here, but UK ones will as well. This is because for the next two or three years it seems very unlikely that the UK's terms of trade with the rest the world will be known with any certainty. As a consequence no business can be sure what the potential return on its investment in this country might be and their rational response will, in many cases, be to simply stop investment spending. This will have an immediate, and downward, impact upon GDP.
Businesses will not be alone, however, in suffering this uncertainty. So will households. One reason for that is that if businesses stop investing there will be less employment in the UK economy, more uncertainty as to future prospects, less chance of wage increases, and a higher probability of people being made unemployed. All of those circumstances create a situation where people are much more inclined to save than to spend, if they have that option (which of course, not everybody does). Whilst accepting that some people spend absolutely everything they earn every month, whatever happens, there are sufficient who exercise discretion to ensure that it is very likely that people will be saving more over the next two or three years than they do now. This will, then, reduce consumption expenditure. And for those who cannot save, there is the risk that their earnings will fall because of a reduced demand for people to work because investment will suffer a downturn. This, also, is likely to reduce consumption expenditure.
I think these two trends are extremely likely to happen. What is less certain is what the impact of the Leave vote will be on net exports (or rather, as we have in the case of the UK, net imports). Some argue that the devaluation of the pound that we have already suffered is advantageous to exporters and, therefore, our international position should improve. Unfortunately, this assumes that whilst the rest of the world will buy more of what we have to offer because it will now be cheaper we will at the same time be in a position to substitute a UK made product for what we have previously imported, which will now be more expensive. If we cannot do that because there is no UK alternative then the benefit resulting from increased exports is completely wiped out by the increase in the price of imports, and even exaggerated because we have, for some time, imported more than we export. Given that the unfortunate fact is that there is little evidence that we are able to produce alternative domestic goods and services to those we import, partly because of the very nature of globalisation and also because we simply do not have the manufacturing base that we once enjoyed, I am not at all confident that we will actually benefit from a fall in the value of the pound, and might actually suffer from it. At best it would seem wise to presume that there is no net overall effect for the time being.
This then means that with falling consumption, falling investment and at best a neutral position on net imports/exports whether or not we have a recession depends entirely upon the reaction of whatever government we might have to the situation in which we find ourselves. There are, very broadly speaking, two possible responses although I would entirely accept that there would be plenty of ground for nuance between them.
The first response would be that which we would expect from a Johnson government. If this is composed of those around the Leave campaign, made up of those that many would think from the hard right of UK politics, with a significant representation for organisations like the Taxpayers' Alliance that has persistently demanded large-scale cuts in government spending and a balanced budget coupled with significant tax rises for the well-off, then it is very likely that there will be significant cuts in government spending as a result of the UK voting Leave. If that were to happen then all the other trends noted above would be significantly exacerbated and the UK could suffer a substantial fall in GDP, with government debt rising significantly at the same time because the collapse in government income.
Alternatively, if there were to be a left of centre government that believed that, in Keynesian style, it had to spend counter-cyclically to compensate for the uncertainties in the marketplace and so increased government spending at this point in time then the impact of falling consumption and investment would at least be partly addressed. Whether any government would be brave enough to entirely reverse that trend, and spends sufficiently to promote growth is a good question and the answer is as yet unknown, and so whether recession could be avoided at all is again, also unknown. What is beyond doubt is that it is within the power of government to ameliorate any such downturn, and that there is a real political choice to be made on this.
Until such a choice is, however, made, the economic trend will be substantial, and significant, and I think indisputable: all the economic indicators suggest that we are heading for a recession. And, unless, against all recent political trends, we get a government that is willing to counter that trend by incurring significant new expenditure, so severe are the potential reductions in consumption and investment that the recession could be deep, long-lasting, and profoundly difficult.
Voting Leave has established the economic environment for the UK for the next decade. The political choices that are made will determine how bad things turn out to be.
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What about (at least as initial process) much more radical than Keynesian style – firstly can we apply it now and would it stop the rot or even build a strong fort out of the mud? Does Leave check hopes for significant Courage just because (truly) progressive politicians couldn’t bring themselves to jump a higher hurdle or because of compromise by a new reality?
Predicting another recession? You’ll get it right one day.
I always have
Would you see this as a prime time for Green quantitative easing?
Yes
Good, that helps my above pondering.
I’m hoping the latest Blairite madness forces a new way forward without them of a united left that persues such things.
The entire West is heading towards social, economic and political collapse. If you cannot see that you have not been paying attention or, more likely, you simply refuse to read the writing on the wall. I can understand the latter sentiment, few men have the stomach for this.
You will, however, live to see all this Mr Murphy. History did not end in 1946 and nor did it end in 1989.
What are you talking about?
There is no simple answer to your question.
Oddly enough, I was just reading one of Albert Edwards (SocGen), commentaries which, economically, roughly explains where the West is headed:
“But Edwards concludes by setting the scene for what is to come…
Let me tell you how all this ends.
It ends with investors accepting that they can pretend no longer and profits are sliding into recession.
It ends as the equity market spirals into a deep bear market as company management reach the end of the road in the face of the recessionary conditions and ‘kitchen sink’ years of EPS manipulation.
It ends as corporate bond spreads explode as years of excess debt accumulation lead to widespread corporate bankruptcies, making the recession much deeper.
It ends with social unrest and double digit budget deficits (again).
It ends with investors losing faith with the Fed as the resumption of QE proves ineffective in reviving the economy.
It ends in deeply negative interest rates, currency and trade wars, helicopter money and ultimately inflation.
In a nutshell, it ends badly.”
http://www.zerohedge.com/news/2016-05-08/albert-edwards-let-me-tell-you-how-all-ends
For me personally, it is what comes *after* the inflation generated by helicopter money that is most interesting. Historically, helicopter money always fails so I see no reason why it will not again and it is the last “role of the dice” so to speak of the current regime. When helicopter money fails it will be followed by Western systemic financial collapse, the death of the FIRE economy, the $USD as the world’s reserve currency and the end of the US as the world’s global superpower. That is when Western social, economic and political collapse will occur.
Timing is difficult but, as of now, I would say less than 10 years and definitely no more than 15.
Article 50 must be invoked without further delay. You had your ballot, the results are in, get on with it. Faffing about will only do harm to the very fragile state of the UK economy, and you currently present an unacceptable and irresponsible risk of contagion in Europe. If you care even just a little bit about what happens to us EU citizens you will get your affairs in order and leave quietly. The door’s over there. Thank you.
I have no idea who you are
But you have no right to say that
Working on the basis that mr Schnau is Austrian or German his point of view could be (as a German/Austrian) that the UK needs to decide asap what it wants to do. The referendum was advisory to the Uk parliament. Over to parliament asap – all this talk by Cameron of passing it to his successor shows cowardice – he wanted the ref’ he needs to handle the result.
The French go to the polls next year – I guess the Germans/Austrians have an eye on this & want a Brexit trajectory in place (if indeed it comes to this) well before then. The UK has voted to exit a club – one of the club members says – well don’t muck around – either stay – definitively – or get on with it. To me that is fair comment.
Do you think there will be any impact on university funding?
I’m about to start a Research Council UK funded position, with a contract for four years. As I understand, this is in effect paid for directly from the Treasury (the money passes through RCUK as an intermediary).
What I’m worried about is that, in the event of a Sterling crisis, payments from the Treasury might be garnished or halted. It is, of course, possible for the Treasury to pay for anything by printing. It would also be silly for them to stop payments to RCUK, since the money is guaranteed to remain in the UK. Nevertheless, a severe drop in Sterling might make payments difficult.
I cannot say for sure
I suspect it will work OK
I also think those with already agreed EU funding are OK
Longer terms? That does not look so good
If your funding is from one of the UK Research Councils (RCUK) you will be safe, don’t worry. Speak to your supervisor/colleagues to settle any nerves. University funding may, into long term, change but if you have a contract you will be fine. Enjoy your future work.
Your Research Council funding is as safe as any other government-funded activity in Britain today.
It is certain that their budget will be reduced; less likely that existing funding commitments will be reduced; certain that most new applications will be rejected; and unlikely that any existing grant will be cut completely.
Unlikely, but not impossible.
It is certain that your department will lose EU funding for research: anything between 20 and 60 percent of the department – or the entire institution’s – budget will go, and some researchers are receiving notification, already, that their funding for the coming year been withdrawn.
If that’s your supervisor – or the bulk of the funding for the research group you’re joining – you’re unlikely to complete the contract, or even publish anything useful to your career.
There is a significant risk that your department will close: this is one of the scenarios in which you can lose an existing Research Council grant.
You’ll know within a year, so you can at least get your foot in the door.
If you do not use the time you have to build a network of contacts in overseas research groups then you will have no long-term academic career; and I would encourage you, in the strongest possible terms, to investigate your eligibility for an Irish (or Polish, or any other) EU passport.
So no change then? We are in a permanent recession, Richard which has been ‘covered’ by statistical juggling, much of it involving cruelty to certain sectors of the population. There cannot and will not be any recovery under the present circumstances.
“The amount the average British household can save each year has dived 10 per cent since 2010 to just £3,781, reducing their ability to save to below that of counterparts in struggling EU economies such as Spain and Italy.” (This is Money 2014-it will be lower now)
House prices ensure that people cannot save and our average savings figure is even lower than Spain.
The situation was always heading this way. I think you yourself, Richard,posted a blog that said that 36% of higher paid professionals would not be able to cope with a sudden bill of £500 without recourse to borrowing.
The particular configuration of housing and private debt for consumption is a singular feature of the UK.
Brexit might speed up a process that was inevitable anyway.
The chance now of Green QE with the illiterate and predictable squabble in the Labour Party is <0.
The 'dialectical' working out has begun which is what I thought would happen with a Leave vote.
Yes, one of the illiterates was Yvette with her very aggressive public attack on Corbyn when she told him that PQE would be inflationary. Does she not know that this is wrong, that all government spending creates savings for households, or is she a monetarist?
Either way, there is little hope of PQE with Corbyn gone. Let them eat credit.
Excellent article. I think the rest of the UK will suffer and London will continue to be in it’s own bubble. Politicians need to make reasoned decisions backed with proper analysis as ultimately this decision has and will affect the younger generations in the long term.
I read this today and found it interesting.
http://www.filmsforaction.org/articles/the-left-should-celebrate-brexit-the-uk-just-kicked-neoliberalism-in-the-nuts/
Brexit has shook Europe and there will be no status quo from here. This could well be the beginning of the end of the failed neoliberal experiment which brought us into the EU in the first place. And in fact over in the US too where Texas is talking about Texit.
I am hoping that the new ‘something’ that will replace it arrives soon.
Can I also say as a gentle rebuke that people do have the right to say things, they just don’t have a right to be listened to.
I agree with your sentiment about the EU being an experiment. It was an attempt to apply socio-political dogma, in many ways it is/was similar to Marxism [one of Germany’s less successful exports!]. However, I personally think that the EU’s semi-socialist/semi-command economy model was at the Communism/Capitalism intersection [a bit like East meets West in Turkey] and as such was a compromise that the USA and USSR could both live with following WW2. You will recall that the Soviet and USA empires benefitted the most from WW2 and the Third Reich and British Empire paid the highest price.
I disagree with your comment that the EU is a ‘failed neoliberal experiment’. Although, ultimately, all systems fail, the EU has not yet failed. In the same way that the USA and Texas [to quote your example] has not ‘failed’, EU growth may slow or stop but that doesn’t necessitate stagnation. The EU establishment may well wake up to the fact that change is essential. One of the biggest issues is corruption but that is so institutionalised that an empty trough may be the only solution.
A recession predicated on a reduction in investment is easily averted by dropping taxation on investment to the correct level.
And what might that rate be Geoff?
And what evidence do you have to support the claim?
I’m a politician , not a database of economic papers. All you want to know about optimal taxation theory is out there, you just need to ask your staff nicely.
Geoff
If you think that fundamental uncertainty can be compensated for by a tweak in a tax rate they you are living in cloud cuckoo land
But then, of course, you are: in the massively state subsidised empire that is Jersey Finance
Richard
I should have added liberalisation of planning is another excellent way to kick start investment ( Sissons and Brown, 2011 – I remember that one as my background was in planning so keep an eye on the literature ). Specific to the UK is the option to relax height restrictions in inner urban areas and to relax restrictions on use of farm land with no special status or leisure benefits.
Geoff
Keep digging
If you really think supply side reform on housing overcomes fndamental economic uncertainty I have to say I can really see why Jersey is in the deep mess that it is suffering
Try using your skills at home I suggest
Richard
Not at all. You made a good argument that if investment reduces then recession will follow, and described the consequences. I’m stating that there are tools available to stop that investment reduction occurring.
We’re keeping an eye on that minimum 3% tax on private sector investment in affordable rental housing that the UK introduced from 1st April this year, and expect that investment will reduce as a result. I’d like to be wrong as we don’t want the UK to make bad policy any more than you do. I won’t bet on your frankly rather dismissive view though that taxing investment has no effect on investment levels.
Of course there is a link
But market fundamentals are vastly more important than tax and your glib comments to the contrary reveal a remarkable lack of understanding of the real world
And in which direction does that link operate? It must hurt to admit that lower taxes and lower barriers to investment actually do increase investment.
I have a late meeting with a gentleman from the farmers’ union excited that his members will be able to sell you more food when tariffs go up on food between the UK and the EU. His ideas of investing for a return when the UK exits are good and for that reason I like him. We have a good investment climate here. The basis of the idea that tariffs will actually go up is insane though.
I said there must be a link – at some point
But as everyone I know agrees – including every Big 4 partner I have ever spoken to – it’s variable five at the highest in a list of no more than seven
Your belief that it solves all is just absurdly wrong
And as for your farmer – poor deluded sole: there’s no evidence we’ll leave as yet. As Johnson said ‘there is no hurry’.
Richard,
The investment climate IS a market fundamental ( among others ) and the deteriorating state of it in the UK was pivotal to your joyless argument predicting recession.
Until you show some consistency in your arguments, you will not be engaging with me again.
Geoff
Geoff
I am rather glad we will not be engaging
a) You meet the criteria for a troll on this site
b) You clearly have not the faintest idea what you are talking about
c) You promote the undermining of democracy and free markets in your role for Jersey and I have little liking for people who do either
Enjoy your state subsidies Geoff – bizarrely you could not survive without them
Richard
Good Evening!
I voted Remain because I felt that the EU and its former incarnations had not only reduced the risk of catastrophic war in Europe since 1945 but it had also prevented mass migration when it adopted the former Soviet satellite states post-USSR disintegration. Not one politician made that point during the debate but I guess the significance would have been lost on many UK citizens. The UK’s contributions to the EU funded the ‘stay at home’ strategy in the form of numerous regional development plans throughout the New Member States [NMS] and by doing so prevented ‘failed states’ in the east of Europe. Someone at the Foreign & Commonwealth Office could probably justify my thoughts more eloquently because, in many ways, EU subsidies are very similar to the overseas aid the UK has been giving to Third World countries for decades. The difference is that in the NMS there is a tangible difference to, say, Afghanistan or the Democratic Republic of Congo where ‘aid’ is often ‘invested’ in places far removed from the recipient country.
To me, the Referendum’s message from UK citizens was ‘we have had enough of supporting countries that were economically broken by the USSR’. I reluctantly agree with that sentiment because most countries should be able to sort themselves out within one generation. I personally believe that the EU subsidies to former Eastern Bloc states are just a continuation of the cost of destroying the Axis of Evil that emerged after World War Two. This is, of course, different to the most recent Axis of Evil defined by George Bush and Tony Blair.
Put that to one side for now because seventeen million UK citizens have decided that the UK will leave the EU [seventeen million out of sixty five million ain’t bad!]. Many of the people I have spoken with believe that EU bureaucracy is the big issue in the EU and that leaving will solve the problem. It would be nice if the alleged £350,000,000 a week that has been ‘squandered’ on economic development and preventing civil unrest [amongst other things] in Poland, Hungary, Bulgaria, Czech and Slovak Republics, Romania, Latvia, Lithuania and Estonia, did find its way into the NHS, as suggested by the Remain group, but the realists amongst us suspect that within five years that money will be in the coffers of multi-national non-UK tax-paying corporations that pick up the lucrative bits of the NHS as its body parts are gradually donated to the private sector – by OUR ‘elected’ representatives [Labour and Tory].
It’s one thing to say that ‘the People have spoken’, but for the Establishment to actually listen and understand what UK citizens had to say is something about which I am sceptical.
Well the gloves are coming off and the post-Second World War “phoney peace” between Malignant Capitalism and the Working Class coming to an end. Eventually it will end in a Benign Capitalism not State Capitalism (been there done that) but the odds against getting there quickly are long.
Richard, just like to take issue with you that a right wing govt will seek to implement more austerity and a balanced budget.
Personally I think it is more likely that they will have a relatively loose fiscal policy. This is because they will be keen to provide the economy with as much stimulus as possible, because they will be seeking to do everything possible to show that Brexit isn’t detrimental to the economy – however irresponsible their fiscal stimulus might be in the long term. Eg. it is certainly likely they would cut corporation tax and also probably income tax.
So that’s just my thoughts: a Boris govt would play fast and loose with govt finances because they will seek to be as populist as they possibly could be in the hope that people wouldn’t realise they have wrecked the economy.
Certainly Regan and Bush spring to mind as two examples of high spending right wing govts.
Adam C
Fair argument politically, but…
1) It depends on the Govt being able to borrow. Pre-exit we could’ve sold all the bonds we wanted into the market but now? Might be more tricky..
2) Regardless of what expansionary policy the Govt might want, if the £ falls down like a one-legged man doing the hokey-cokey the BoE will have no choice but to jack up interest rates to prevent hyper-inflation. The BoE will have put a brake on the Govt.
QE
QE into the economy itself, not into the banking sector, you mean?
Yes
Richard we were always heading to a recession the biggest problem with this is it will allow Brexit, rather than neo liberalism, to take the blame. I fall firmly in the camp of private debt levels being the great problem.
The positive I take is that defeating neo liberalism is an easier task on a national rather than EU level. Yes I know the arguments for the Tories being worse but they also have a track record of catastrophic failure leading to un-electability.
Richard, you explain how we derive our GDP figures, which is helpful for someone like me who is still struggling with economics fundamentals. However, I assumed that our economy was largely growing because of the housing and stock market bubbles created by the last round of QE. I don’t see shares reflected in your description of GDP, so am I wrong? If so, what is it that has kept our economy growing thus far? Arms sales maybe??
House sales fuel consumption spending
Stock market rises make people feel they do not need to save as much. That also fuels consumtpion
Surely the biggest fuel for consumption has been the ‘renting’ of money by banks (aka credit) that has ‘compensated for stagnant wages. Non of this so-called growth would have been possible without that. That’s the music that has to keep playing..it stopped once and there weren’t enough chairs but the musics on again.
Is there a typo here? “significant tax rises for the well-off” should be “cuts” shouldn’t it?
Yes