Bill Robinson: After the bad and the ugly, the good

There are many reasons why the UK should be in recession. Last year's dot-com bust devastated the technology, media and telecoms sectors – and the stock market.

There are many reasons why the UK should be in recession. Last year's dot-com bust devastated the technology, media and telecoms sectors – and the stock market. The ripple effects have continued all this year. Merchant bankers, accountants and lawyers face a sharp drop in revenues after the abrupt end of the mergers and acquisitions boom. And because dot-com start-ups burnt huge sums of money promoting their launches, there has been a dramatic fall in advertising spending, affecting both the industry and the TV companies which depend on ad revenues.

Independently of the dotcom collapse, manufacturing industry continues to struggle with a very strong pound. Farming has been devastated by foot and mouth. And tourism, badly hit by that disease earlier this year, was dealt another huge blow by the terrorist attacks on 11 September. The resulting drop in demand has hit not just airlines and hotels but also associated trades such as taxis and restaurants.

So must the UK inevitably follow the US into recession? The OECD has revised its GDP growth forecast for 2001 down from 2.5 to 1.9 per cent, followed by 1.6 per cent in 2002. But this is still a long way short of the output declines seen in 1980 and 1990. The downgrading reflects the view that recessions are caused by lack of confidence, and the war has badly damaged confidence. But there is an alternative view that recessions are caused by a lack of demand; since wars always boost demand, recession should now be less likely. Both views are true. Confidence will matter most in the short run, and demand in the longer run.

The key short-term issue is what consumers will do with the pounds and dollars they are not spending on travel. Will they save the money, or spend it on something else? Data published since 11 September has shown that UK consumers are still fairly confident about their own finances, and September retail sales were 0.2 per cent higher than in August – in contrast to the 2.5 per cent fall in US sales over the same period.

The reason for the resili-ence of spending may be that unemployment, as measured by the benefit-claimant statistics, is still falling. Downturns in demand become recessions when consumers observe job losses, worry about their own jobs, and save for that rainy day. The fall in spending translates into another round of redundancies, sparking another rise in saving.

In the 1990s recession, the cycle of misery was compoun- ded by the failure of some of the jobless to keep up their mortgage payments. The resulting downturn in house prices, as they were forced to sell their homes, had a devas-tating impact on confidence. The UK consumer is much more sensitive to the housing market than to the stock market. When house prices fall, the high street suffers.

And herein lies the clue to the UK consumer's remarkable insouciance. House prices are high but the burden of interest payments is much lower than in the early 1990s. Moreover, interest rates have been falling and are expected to fall further. Policymakers worldwide are committed to sustaining demand, and the Bank of England has joined in because inflation is on target. In this way, adverse short-term effects on confidence after the events of 11 September have been staved off.

Further down the line we can look forward to a big boost to demand from the resource implications of the war on terrorism. Wars are bad for some sectors (tourism) and good for others (security and defence). So far we have seen and felt the bad effects. The good are still to come.