David Smith recommends a middle course between hope and the encircling gloom.
The shape of the 1990-91 recession, always assuming, of course, that it will not turn into the 1990-22 recession, has now become fairly clear.
It began with a bump, just over a year ago. Everyone in business must remember that, having gone on holiday believing that nothing more than the normal summer lull in activity was underway, they returned to find that the economy had died on its feet.
Some sectors, plainly, had seen it coming long before the summer of 1990. The peak in, for example, housebuilding roughly coincided with the official peak in the economic cycle, way back in 1988. For the builders there was no gentle easing back from the boom years but a rapid transformation from feast to famine.
This was not, however, the general picture. Indeed, in the early months of last year the remarkable development was the economy's resilience, and in particular the strength of consumer spending, in the face of 15% base rates. Luckily it did not last, or else 15% might not have represented the base rate peak and the recession could have been even more severe.
Why did the economy "fall off a cliff" in the summer of 1990? The explanation is twofold. Firstly, until then high interest rates were partly offset by a weak exchange rate. When this was no longer the case - and remember too that interest rates operate on the economy with a lag - monetary policy suddenly began to exert powerful downward pressure on the economy. Add, in the second part of the explanation, the effect on business confidence of Iraq's invasion of Kuwait, and the recession became an inevitability.
The result was that gross domestic product, on the output measure, having grown by 0.3% in the second quarter of 1990, fell by 1.4% in the third. And, while the Government was slow to see the recession, and even slower to admit to it, the question last autumn was not whether the economy was in recession but how deep and long it would last.
Shortly after the start of the fourth quarter of last year, on October 8 to be precise, the significant event of Britain's accession to the European exchange rate mechanism (ERM), accompanied by a cut in base rates from 15% to 14% (insisted on, as we now know, by Margaret Thatcher), took place. Here, a curious switch occurred in official thinking. Having emphasised the long lags between monetary policy actions and effects when interest rates were being raised, the Treasury appears to have taken the view that the impact of relaxing policy would be far speedier.
This, and an over-emphasis on the temporary effects of a Gulf-induced loss of economic confidence, offers the only explanation of why the Treasury, at first under John Major and then Norman Lamont, was not in a hurry to cut interest rates further. Nor was it particularly concerned about the length and depth of the recession, which it saw as largely blowing itself out in the second half of last year.
John Major, in one of his last acts as Chancellor, delivered an autumn statement which had, as its centrepiece, the prediction that the downturn in the economy was coming to an end, and that recovery would begin early in 1991. Norman Lamont, on succeeding him, concurred, and last December was talking of a short-lived and shallow recession. Thus, even as the economy was falling deeper into the mire, the Treasury remained confident of an early recovery, and the next base rate cuts did not come until February.
For the Government, one source of comfort has been that, following the economy's sharp contraction in the third quarter of last year, subsequent quarterly falls have been smaller. Thus GDP fell by 0.9% in the fourth quarter of last year, and by 0.6% in the first quarter of 1991. At this rate, it was argued, the economy was due to hit bottom in the second or third quarters of this year, paving the way for a subsequent bounce in activity.
There is a danger, however, in reading too much into the pattern of quarterly changes. Indeed, the sharpness of the fall in the third quarter of 1990 owed much to a big drop in North Sea oil output. For non-oil GDP, the picture of a recession gradually lessening in intensity was far less clear. As well as this, special factors can provide for temporary growth in one quarter, which is then cancelled out in the following period. A case in point would be the temporary blip in consumer spending which followed the Budget announcement of an increase in value added tax from 15% to 17.5%. Shoppers were given three weeks to spend at the lower VAT rate, which came into force on April 1.
The fact is that recessions leave long and bitter memories. Consider the latest forecast from the Paris-based Organisation for Economic Co-operation and Development. This suggests that Britain will grow at an annualised rate of just 0.3% in the second half of 1991. Leaving aside the possible difficulty that the recovery in business and consumer confidence that the OECD sees as necessary even to generate this modest upturn may not occur, it is clear that the economy is seen as doing little better than bumping along the bottom.
The official hope is that this small "uptick" in economic activity will give way to stronger growth next year and that, gradually, the economy will return to something like its long-term sustainable rate of expansion of 2.5 to 3% a year. And the basis for this will be the interest rate cuts that have come through, at times painfully slowly, since October 1990, together with the historically correct observation that recessions do not last for ever. Sooner or later, driven by a rebuilding of stocks and an improvement in confidence, things pick up.
What are the risks? The first is that, as with Iraq's invasion of Kuwait, some external shock will come along and knock back confidence. The second is that a shock will be imposed by the Government, perhaps because, perish the thought, it is forced to raise interest rates in response to sterling weakness in the ERM. Either event could come at a time when confidence is too weak to withstand it.
The other danger is that the economy has taken much more of a battering than the forecasters are prepared to admit. Consumers and companies are still heavily borrowed and, even in a period of falling interest rates, their first instinct has been to reduce their debt. When the gloomiest forecasters see unemployment rising to three million next year, with little let-up in its climb, it is small wonder that personal spending has been hemmed back. The growth of self-employment and the small business sector, which provided the spur for the economy, and the impetus for jobs growth in the 1980s, is unlikely to return quickly after the bruising experience of high interest rates and the recession.
Record business failures may simply be the counterpart of the boom in new business formation of the Thatcher years. But each one includes a human tragedy, and many will have snuffed out the entrepreneurial flame for ever.
It is easy to fall into the trap of being too gloomy when the recession is biting hardest. But the Government, understandably perhaps, has fallen too easily for the temptation of always looking on the bright side, when it has not been justified. The best hope, and it is no more than that, is that the truth lies somewhere in between.