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A brief history of... recession

Updated Thursday, 8th October 2009

What constitutes a recession? To find out, Ione Mako talks to Malcolm Prowle, visiting professor at Centre for Financial Management of the Open University Business School and Professor of Business Performance at Nottingham Business School.

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Ione Mako: You’re listening to the Open Finance series on Lessons From History from The Open University Business School. My name’s Ione Mako, and today we’re discussing economic recession with Malcolm Prowle, who is Professor of Business Performance at the Nottingham Business School and Visiting Professor to the Centre for Financial Management at the Open University Business School. Hello, Malcolm.

Malcolm Prowle: Hello Ione.

Ione Mako: Economic recession, depression, credit crunch; we hear these terms a lot, so can you tell me what is a recession, is it different from depression or credit crunch?

Malcolm Prowle: Well yes, it is different. I think the start point we have to talk about is, we hear a lot in the media about how our economy is growing each year, and obviously the faster the economy grows the better off we all are. A recession is the opposite; it’s where the economy declines in size as measured to things like gross domestic output. Now it’s a bit more precise than that; there is a technical definition of a recession which is where the economy of a country contracts for two successive quarters in the year. So, although in Britain we’ve talked about recession for well over a year now, we’ve only technically been in recession for the last two quarters.

Now a depression is basically something much worse than the recession and much more long lasting, a much larger contraction in the size of the economy lasting for a much longer period of time – we always think about the Great Depression in the 1920s. Now we’re not at a depression yet and possibly we won’t get there, but it does remain to be seen how long the current recession lasts and how deep and how serious it actually it ends up being at the end of the day. The Government, of course, has an election to fight; they will talk up the recovery of the economy but at the moment we don’t know.

But credit crunch is different. The credit crunch arose because of problems in the banking sector with banks making large losses on what was referred to as the sub-prime mortgage market in the United States, which meant the banks incurred very large financial losses. Consequently they became very frightened, very much risk-averse, and in many ways stopped lending to the commercial sector. Now the implications of that is that businesses now find it very difficult to obtain loan finance to meet normal working capital requirements or to finance future investments. So they are different but they are linked together.

Ione Mako: Yes and, in a sense, the credit crunch with the housing situation led to the recession.

Malcolm Prowle: Yes, in many ways. Overpriced housing assets was one factor in it, yes.

Ione Mako: It feels like this economic recession is different from previous ones, why is that?

Malcolm Prowle: Well, I think there’s a number of factors we have to say there. Firstly, as I mentioned, a recession is a decline in the economy’s size for two quarters. This one could become much more serious, it could move into a depression but possibly not. But the other two factors I think are, of course, firstly the credit crunch.

There are many companies at the moment who - if it was what I might call a normal recession, might survive because they would be able to tide themselves over by obtaining finance from the banks - are now finding they can’t obtain that finance, so that means that they could run into liquidity problems and not be able to borrow from the bank to finance that liquidity problem. Or they may have contracts for large amounts of work but they are unable to get the finance to buy the new capital equipment to make that product. So either way they are in trouble.

So the credit crunch adds a dimension. The other one, of course, is the globalisation of the economy. I’m old enough to remember the last three recessions and, of course, although the economies of countries are interlinked, those recessions we did think very much about the British economy, we didn’t think too much about overseas. Today, of course, the economies are interlinked and what happens in one economy impacts in another country and another country and so on. If you think about it, how often do we see China mentioned in the context of the UK recession? Well that’s because so many British countries are involved in exporting to China and we receive many goods from China. So two main things are the credit crunch and the globalisation economy, which makes this recession very different from previous ones in history.

Ione Mako: And businesses themselves, we’ve got far more multinationals now.

Malcolm Prowle: Oh, absolutely. That’s one aspect of what I mean by globalisation. We have global companies, we also have free movement of capital across international boundaries, we have free movement of labour, all of these things now make the whole world economy much more multinational.

Ione Mako: And what might be the implications for all of this now then? Let’s look at public services first.

Malcolm Prowle: Right, well, public services, I mean, it’s well known from the media now - I think everybody knows this - that our government has run up a huge amount of debt through financing its public expenditure programmes. We’re having to borrow record amounts of money this year and next and, of course, that can’t go on. Now, that is not entirely caused by the recession, I think it has to be said that it is largely caused by mismanagement of our public finances.

Ione Mako: And surely also by shoring up the banks recently?

Malcolm Prowle: And by shoring up the banks, undoubtedly, yes. But what we do know from history is that, in a recession, what happens is that the tax revenues to the Government decline and the demands for public services go up because of things like unemployment benefits. So a recession is likely to make our public finances worse. Now in the past when there has been a recession governments have tried to counteract that by investing in things like public works, new roads, new schools, new hospitals, but the problem is now because of the state of our public finances and the debt we don’t really have scope to do that.

So public finances, there’s two aspects to it really. The state of the public finances means it’s almost certain we’re going have to suffer real-term cuts in public spending in years to come, but also the Government can’t take this sort of action that’s been done in the past to try to counteract the recession by large scale public investment.

Ione Mako: And we’ve touched on the implications for businesses in the sense that a lot of them are going to go to the wall if they can’t borrow now or meet their commitments, but what might the other implications be for business?

Malcolm Prowle: Well, I think there’s a bit of a problem here because we have this huge degree of uncertainty about how this recession is going to pan out. You know, some people talk about recovery later this year or next year, other people will say it could last five years, you know, things like this have happened in Japan in the past. I mean in those circumstances, if it was a short term recession, many businesses might do things like managing their cash, looking after their customers, to try and ride it out.

However, if they think the recession is going to last a lot longer that’s probably not sufficient and many businesses may need to think about things like collaboration with other organisations. We’ve seen something in the media about the BBC possibly collaborating with independent television to share broadcasting facilities, for example, if that reduces the overall costs.

So many businesses might have found this anathema in the past, the idea of sharing or collaborating with a competitor, but it could be that that is something they have to think about. Equally, it’s possible that a business may have to radically rethink the whole structure and operation of its business; should it carry on manufacturing goods and services in the United Kingdom or should it think about transporting that to another country where labour costs are cheaper? It might need to think about its markets, should it be putting a greater focus on export markets rather than domestic markets? A lot of questions, serious questions, businesses have to face if this turns out to be a much longer recession than we’re sometimes led to believe.

Ione Mako: You mentioned about sharing resources there, in that case with broadcast rivals, and those sound like very sensible initiatives, they could save costs, but what does it do for the economics and society as a whole? If they’re going to save costs in that way and share resources then doesn’t that inevitably lead to more lost jobs? How do you balance out increased survivability or profitability with an economy that benefits all?

Malcolm Prowle: Well you’re absolutely right because this idea of collaborating, of companies collaborating together, is one aspect of it. There’s also very strong emphasis on public service organisations collaborating together again.

Now a classic example of that might be that a public service organisation doesn’t have its own IT department, it shares that service with another local authority or health trust or whatever it happens to be. Now the problem there, of course, is you end up with one IT department instead of two and somewhere in some part of the country that IT department is going to have to close and there will be undoubtedly job losses in that local area. So you’ve picked on a very important issue there.

I think what I would have to say is, it’s difficult enough for the organisation, whether it’s a commercial firm or a public sector firm, to manage the recession as it stands without having to worry about larger scale social implications. So I think a company or local authority would really have to think about this collaboration in shared services from the point of view of their organisation. Issues about larger scale social implications are really, I think, a role for central government.

Ione Mako: And what can they do? If we’ve got lots of companies restructuring and there are going to be job losses there - we’ve seen with the banks there are already job losses - and if people are sharing resources and that’s going to lead to some departments closing, and if they’re not the ones going to look at the societal implications, what can government actually do?

Malcolm Prowle: Well there are various well trod methods here, you know, we’ve had examples in the past of where industries have disappeared for technological reasons or they’ve gone out of fashion. The mining industry is a classic example. The usual tools of our government are to try and compensate with economic investment in particular areas; improved training, improved job-finding facilities, those sorts of things.

Ione Mako: But they’re all going to cost the government money and they haven’t got it.

Malcolm Prowle: They’re all going to cost the government money, yes, exactly. It’s a balancing act, the use of public expenditure, how you use it is always a balancing act and you have to decide priorities and allocate accordingly.

Ione Mako: It sounds like we’re on a real, viscious downward spiral though because there are so many things needing money, and less money and people living longer, and the government even trying to make us live longer with all their health initiatives.

Malcolm Prowle: Yes. That’s undoubtedly the case. I mean a good example I think is, there was a report from the Institute for Fiscal Studies a few months ago which talked about at the very least two parliaments of pain. Two parliaments is ten years, you know, we can expect at least ten years of pain. Whether it goes beyond that, that’s a long way ahead but we certainly shouldn’t expect any short term solutions and a return to normality very quickly.

Ione Mako: And that actually seems to be a theme that’s coming out a lot that some of these problems have been brought about by very short-term thinking and we’re now going to be suffering long-term pain because of it. And maybe one of the lessons is that we need to step back and take a long-term view of this. Do you want to comment on that at all?

Malcolm Prowle: Well yes, I think this is starting to get to a personal view really but, yes. I mean, of course, the problem we have is that governments have to face the electorate every five years so that’s their sort of horizon; can we get re-elected? The other thing we all know about MPs’ expenses, and a comment that’s often made, of course, is that our House of Commons is now populated largely by people who are professional politicians. They’re not people who’ve come from another career into politics for a period of time, they are professional politicians. They don’t want to lose their jobs so, not surprisingly, they will take actions which have short term impacts which will help them get re-elected when the general election comes. And we’ve talked about potentially the next election there could be 300 MPs out of work, that’s the situation we’re in at the moment. So very difficult to know what to do.

Ione Mako: That’ll be an interesting time, they might actually think of having a longer term view then.

Malcolm Prowle: Hmm.

Ione Mako: So, in a nutshell, okay, maybe we need a bit more long term thinking but what are the lessons do you think we could learn from this recession that might be different from the lessons of the past that we’ve either learned or failed to learn?

Malcolm Prowle: I’m not sure we should be so confident at the moment of knowing what the lessons are because, as I’ve suggested, I think this recession has got some time to run yet. We shouldn’t be making judgements now about the longer term impacts of that. I think what we might think on is whether - we often think about recessions as having impacts on business and economies and what have you; it could be that this recession, if it becomes really serious, has a major impact on our society and could lead to such things as people being much more risk adverse, people being much more conservative about spending, wanting to save more. Not surprisingly if people have large scale debts and they’re unemployed, they’re more likely to want to save. Being less bullish about investing large sums of money in housing, these sorts of things.

These could be long term impacts on society, but we don’t know yet. It’s got some years to run yet, and I think if you asked me this in three years’ time, "What were the lessons of this recession?" I think I might be in a much better position to answer that question then.

Ione Mako: That sounds like individuals may think about, in a sense, living a simpler life which also ties in with the whole sort of green movement that’s happening...

Malcolm Prowle: It may well do. It may well do. You’re absolutely right, yes.

Ione Mako: Well we’ll see, and maybe we’ll talk again in three years’ time, that would be lovely. For now, thank you very much Malcolm.

Malcolm Prowle: Okay, thank you.

Ione Mako: You’ve been listening to Open Finance on Lessons From History from the Open University’s Business School.

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