Managing recession

The horrors of 11th September that shocked the world now seem likely to trigger a recession. What should be done?

Firstly, recognise the severity of the situation. In past decades, recessions have been prompted by external shocks that had unpredictable consequences to which economic decision takers over-reacted. Government and businesses have learned how to avoid repeating mistakes. In the last ten years the world economy has absorbed hikes in oil prices and crises in Russia, Latin America and much of the Far East. Until September 11th, the collapse in IT investment, the slowdown in America, combined with a languishing Far East economy, all seemed manageable.

But the current situation is unique and, because it has hit the confidence of producers and consumers alike, its effects could be very profound. The US Federal Reserve has cut interest rates for the ninth time in as many months and the key federal funds rate is just 2˝%, its lowest level in 40 years Much of Europe seems certain to follow the US lead.

These drastic cuts are correct responses to a huge body of evidence that the US economy is now in serious trouble. The US economy managed to expand by barely 0.3% in April-June, after growing 1.3% in the first 3 months of the year. Whilst the country has weathered a recession in manufacturing, the sector has contracted for 14th consecutive months, retail spending has kept the economy moving.

But surveys of consumer confidence in the second half of September have shown sentiment slumping to the lowest level in a decade. Unemployment has hit a four-year high of 4.9% with layoffs in aviation, technology and other sectors certain to badly affect consumer spending.

The US problem is worsened by slowdown in Europe and Far East. Over the last year, in Japan, industrial production has fallen almost 12% and unemployment has reached 5%. Growth rates across six of the main Eurozone countries are likely to drop to about 1˝%. In the UK, the latest predictions show the economy slowing from a growth rate of 2% this year to just 1.3% in 2002. Yet these forecasts do not yet factor-in the impact of falling confidence. A Mori poll published at the end of September showed confidence in the outlook for the British economy slumped to its lowest levels since 1980.

Whilst unemployment remains low - and has continued to fall - it will certainly start to rise before the end of the year. Throughout the last six months, the job loss announcements have kept rolling in. Most are in manufacturing - ranging from Xerox cutting 1,350 in Gloucestershire to 400 making pizzas in Bedford. It takes some months before these lay-off decisions translate into higher numbers of people claiming benefits. But a further raft of lay-offs have started - in the airlines and holiday industry, in retail and services. Many of these will work their way through to the unemployment numbers more rapidly.

So what kind of recession is Britain facing? Until September we took the view that a recession (technically defined as two successive quarters in which the economic growth turns negative) was unlikely. We predicted a period of very low growth in which unemployment was likely to rise - but not dramatically. Instead we must now conclude that Britain faces a period, probably a short blip, in which the economy shrinks and unemployment rises followed by a reasonably sustained recovery as confidence returns. In these circumstances, there is a severe danger that mass layoffs could throw many people permanently out of the workforce and, in the medium term, cause costly shortages of skilled labour.

What should Government do? At the very least, it should not panic.

Firstly, it needs to safeguard jobs by reducing the costs of doing business and by incentives to boost output. Already some business leaders are calling for a cut in the minimum wage - but this would just dump the burden of poorly managed companies onto low paid workers. Instead, the Government needs to create tax incentives for growth, boost the efforts of its Regional Development Agencies and crank up its use of selective regional assistance - directing investment funds mainly to firms in manufacturing. And for companies that are intrinsically robust yet face acute immediate problems, why not zero-rate National Insurance payments on those employees that might otherwise be placed on short time working or be laid off?

Secondly, newly unemployed people need to be helped immediately they lose their jobs. The most critical group of workers are those with high levels of skills - particularly in industries like telecommunications and aerospace. The Government needs to act so that these skills are not lost. They should expand the Job Transition Service and make these services available, from the first day a statutory redundancy notice is served.

The objective should be to maintain and improve skills during a lay-off period and this is where a more flexible type of funding - Personal Job Accounts - should be should be introduced to help individuals to help themselves. Additionally the Learning and Skills Council should earmark more of its funds to help its 47 local bodies develop re-training and re-settlement packages for victims of closures and significant lay-offs. In next month’s pre-Budget report, Chancellor Gordon Brown has promised to ‘expand the New Deal again (and) invest more in skills retraining’. So, the Government commitment is there.