Monday, February 2, 2009

Why is Recession Hitting UK hardest?

The IMF recently stated that the UK economy would shrink 2.8 per cent this year. (UK to face Recession at FT) They also added that the global economy would shrink for the first time since the Second World War. We face a truly global slowdown, but, why is the UK experiencing the worst recession?

Financial Services

This recession is affecting all sectors from the car industry to retail, but, the finance sector is one of the hardest hit. The finance sector is one of Britain's most important sectors in terms of foreign currency earnings and national output. (The sector also makes a significant contribution to income tax and corporation revenues). With hedge funds and interbank lending both declining the Finances sector is in deep recession and rising unemployment.

Housing Market

The UK is not the only country to have a boom and bust in house prices, but, in the UK, the rise in prices was one of the largest. The fall in UK house prices has been one of the sharpest. Also, the UK has one of the highest rates of homeownership in the world. When house prices fall, it has an almost paralysing effect on the economy. The decline in wealth and confidence is a powerful negative impact on consumer spending, once a mainstay of the UK economy.

Low Savings Rate.

The strong period of economic growth in 2000-2007 was driven by consumer spending. The UK saw a rise in personal borrowing and a dramatic drop in the savings rate. In August, 2008, the savings rates was less than 1% - an historical low; compare this to a savings rate of 10%+ in 1994. People are highly indebted and the recession has been a stark reminder of this. I feel we have gone from an attitude of carefree spending to a new attitude of frugality as we try to improve our savings ratio. There is a sharp demand for higher savings.

Reasons that didn't cause a recession to be hardest in UK

Government borrowing. In 2007, government borrowing was 37% of GDP. This really should have been lower given the long period of economic expansion. But, it was not reckless and not a cause of recession.

Why are Government Policies Not Working?

Many Factors have made the recession very severe. The policies of lower interest rates and fiscal expansion may be limiting the depth of the recession. But, they take time to have an effect. But, the main thing is they are being outweighed by other factors.

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