HM Treasury Spending Review and The Recession

It is just under a month now until the HM Treasury 2010 Spending Review.

The Spending Review is a Treasury-led process to allocate resources across all government departments, according to the Government's priorities. Spending Reviews set firm and fixed spending budgets over several years for each department. It is then up to departments to decide how best to manage and distribute this spending within their areas of responsibility.

In addition to setting departmental budgets, the 2010 Spending Review will also examine non-departmental spending that cannot be firmly fixed over a period of several years, including social security, tax credits, some elements of local authority spending and spending financed from the proceeds of the National Lottery.

Spending Reviews have been an important part of governmental planning since the late 1990s. Prior to their introduction, departmental budgets were set on a year-by-year basis which made multi-year planning more difficult. The 2010 Spending Review will cover the four years from 2011/12 to 2014/15

This year it was made more interesting as the Government launched the Spending Challenge website to give us – The Great British Public - the opportunity to shape the way government works and to help get more for less as they attempt to tackle the GIANT deficit.
The response was quite big: over 100,000 suggestions, including more than 44,000 ideas from the public.
The Spending Challenge website is now closed and the theory is that the powers that be can investigate the ideas in further detail to see which can be taken forward in time for the Spending Review on 20 October.

At the same time we have the political ‘conference season’ kicking off.

So in advance of this I thought I’d summarise a few of the key themes, comments and ideas I have heard relating to the spending review, the recession and the economy in general in recent weeks at financial conferences I have attended.

We are all aware by now that we have been in an economic recession in recent times, ever since the credit crunch.
It has been said the technical definition of a recession is typically defined as a decline in GDP for two or more consecutive quarters.
I prefer to say a recession is when even those who had no intention of buying stop paying!

The average recession in the UK (as measured above) has been 5-7 quarters. Currently we are in qtr 6 of this one.
At the moment it is popular to discuss whether we will be having a plain old ‘U’ shaped recession or the worse ‘W’ shaped double dip recession.
I met an economist so pessimistic he was predicting an ‘L’ shape!

But on a more serious note, it is always instructive to remember that someone’s expenditure is someone else’s income.
And the Government are still spending (although how much that will reduce by we will see clearly on 20 October)
The previous Government (and this is fact, not political comment) spent 155 billion (that’s a thousand million) MORE than they collected in tax in one fiscal year.

Our current Net Debt (as a % of GDP) was forecast at 75% for 2013 by Chancellor Darling in his last days. 40% is what is reckoned is a sustainable level. Anything over 40% and basically the next generation has to bail us out.
So nationally (as we are all aware) we are in trouble.

Interest rates are currently 0.5%. They hit this low in April 2009. It is the lowest in over 300 years, since records began. And we have become accustomed to it. But how soon we forget. It was actually only March 2008 when interest rates were at 5%
The Bank of England Monetary Policy Committee meet each month to set the rate. They haven’t done anything since April 09 and I don’t see them doing anything soon (what a great job, they must just spend the 2 days drinking tea and eating biscuits!)

Someone with a national average mortgage of £150,000 owing, is £4,000 a year better off now than 2.5 years ago.

So will we lift out of recession or is it, like low interest rates, here to stay?
Well, there are some positive indicators. Generally, in surveys, confidence is up across manufacturing, services and construction.
House prices and mortgage approvals are VERY slowly increasing. It is a slow improvement but it appears to be off the floor where it has been slumped in recent times.
Retailers that have spent the last year running down stock are now starting to spend to restock (remember that earlier line, someone’s expenditure is someone else’s income)
Export growth is starting.
So this points to a slow recovery – at a modest rate – which is good as we should try to avoid a bounce, or a boom.

The economy, as a whole, dropped in size by 5% in 2009. This year 1.2% growth is forecast so again, not brilliant, but better than it was. Remember we ideally need a growth rate of 2.5% for ‘business as normal’ with a generally healthy growing economy.

So far , so good. But let’s remember back to BEFORE the credit crunch and recession. Back to the days when you couldn’t open your front door when you returned home due to the giant pile of offers from loan companies and credit card companies pushing cheap credit.

This is where I think we still have pain to come. At the time it was popular in the financial press to talk of the Personal Debt issue in Britain. The consumer debt total was reckoned to be £1.5 TRILLION.
To put this in perspective the total UK economy is only £1.4 trillion.

So we have a vast ‘debt overhang’ to deal with as a nation. Why mention this in a piece about Govt spending? Because whilst the focus is on Govt spending (or what they won’t be spending) to get the economy going, it is worth remembering that in 9 out of the 11 years before the recession 2/3 of all spending was consumers. This is equivalent to 2% of the 2.5% growth we saw as a nation in those years.
The AVERAGE debt in the country represents 19 months pay.
The AVERAGE is 160% debt to earnings ratio.
(that said, do remember average is meaningless in this context. You could argue someone with their head in an oven and their feet in a freezer is, on AVERAGE, comfortable!)

Consider this – if you are one of the people with no debt, or at least less debt than equates to 19 months pay, what of those with above average debt?. There are some big personal debt problems stored up out there and when the cheap credit ends (ie loan deals or credit cards taken out in 2007) there will be issues.

What will these people do? Currently consumers are not borrowing - and/or banks aren’t lending – depending on your viewpoint.
The cost of food, energy and utilities is on the up.
And the debt overhang, for many people, is still there in the background.
So discretionary expenditure, the nice things in life, will be under pressure.
There are short term sticking plasters around (“buy a big new flat screen TV now before VAT increases”) but these are just sticking plasters, not cures.
Remembering back to the election, and again thinking of the upcoming spending review, a big issue has been public sector spending.

But some people (probably conveniently in the case of politicians!) forget that the issue is not really how much debt you have, more, what does it cost.
As a consumer, it could actually be worse to have a small mortgage when interest rates are high (remember 15%+ in the 90’s) than a big mortgage when rates are low.
This principle applies to Governments too. The John Major Govt had higher interest rates than now with lower public spending but actually the overall cost as a % of the GDP was higher.
We had ‘QE’ (or printing money) to the tune of £200 billion but we are still debating whether companies and individuals are not borrowing or if it is the banks not lending.

So we really need to hear what is announced in October to see what will really happen. However, even if the Govt hit all their targets when we get to 2015 there will still be a VERY big debt.

Of course some cynics say that if they make it sound worse than it is now, they can take the credit when it gets better sooner!

Interest rates look like they will stay low for a time yet, perhaps edging up (or is it doubling!) to 1% early next year and maybe getting to 2% by late 2011.
But as interest rates are still less than inflation it remains a stimulus to activity rather than saving.
As before, not great, but better than a year ago.

So when do I think the recession will end, whatever happens in the spending review?
I say with absolute conviction…around half past ten.