Monday 19 October 2020
Alistair Darling and Mervyn King, who were both at the centre of the 2008 crisis, talk to James Harding about what’s coming next
This episode of the Slow Newscast is part of Tortoise’s File on Recession 2021. To see the rest of the File’s contents, please tap here.
James Harding: Hello, and welcome to the Slow Newscast. In 2020, you can’t help feeling that we’ve found it hard to see beyond the end of the week. Impossible, it seems, to see even a few weeks ahead. So many of us have been susceptible to optimism bias, prone to hope for the best. And yet those who are in the know, those who can see what’s coming, well, they generally don’t say – they don’t want to be blamed for talking things down.
But there’s not much good in pretending it away. All the signs are, it’s coming: a recession. Different, perhaps, to the ones we’ve seen before, but a recession no doubt. Mass unemployment. Business closures. Debt defaults. Recession 2021.
Basia Cummings is off this week, so you’ve got me, I’m afraid. I’m James Harding. And if this week’s Slow Newscast is a little less chatty, short on wit and warmth, not an amazing story, I hope you won’t hold me entirely responsible – because we’re talking about what’s to come. If 2020 was defined by health crisis, 2021 is shaping up to be an economic onslaught.
I’m joined by the two people who were in charge of the British economy when the last recession struck, when the global financial crisis hit 12 years ago. Alistair Darling was the chancellor of the Exchequer. Mervyn King was the governor of the Bank of England.
Firstly, Alistair, hello.
Alistair Darling: How are you, James?
JH: I’m well. How are you?
AD: Alright, you know, we can’t complain. We’ve got a nice house and a garden.
It’s depressing because this is going to go well into next year. I always thought it would go into next year, but the question I have on my mind is: what happens at the end of it?
Mervyn King: In the discussions about what’s happening in the economy, I think people have rather lost their way. They’re talking about recession. Now this is not a conventional economic recession.
AD: The economic effects, this will be with us for some considerable time – well into the decade.
MK: And I think that what we’re going to see in the next three years, around the world, is a wave of defaults, of businesses and, in many cases, governments, where there will need to be a process of significant debt restructuring in order to allow some businesses to continue; others will fail.
AD: I am very clear that if you do what was practised in the 1930s, actually, when you had a massive recession which became a depression, and you think that the best thing to do is not to incur any more expenditure, in crude terms, the cost will be massive. It won’t just be economic, but it will be social, and it will be with us for generations – and I mean generations – to come.
MK: I think the risk is that businesses will start to fail and close their doors. And yet, 18 months, two years, three years from now, we will regret that those businesses disappeared – and it will be too late to bring them back again.
AD: It’s a bit like a war. You can’t say halfway through it, well, I’m sorry, we can’t afford another battleship or any more tanks. You’re in this and you’ve got to see it through.
JH: Let’s start with the numbers. They’re almost impossible to wrap your head around, but they point, I’m afraid, all in a similar direction.
Nearly 700,000 people have lost their jobs since March. One in three people aged between 18 and 24 have been laid off or furloughed; that’s double the rate of older adults. The unemployment rate has nudged up to 4.5 per cent already, but there were more than six million people who were still furloughed at the end of the summer – and that scheme comes to an end next week. A much less generous one is going to take its place.
Companies have started laying off more and more people. And there are fears of growing unemployment; unemployment rising above two million, above three million, up to levels that have not been seen for 30 years or more.
The UK economy is forecast by the OECD to contract by more than 10 per cent this year. That’s the worst performance of any economy in Europe, other than Spain.
And when the year began, the government was expecting to borrow about £55 billion in 2020. Now it looks set to be seven times that sum, more like £350 billion – and even that may not be enough to support businesses and sustain jobs.
In this week’s Slow Newscast, we’re looking ahead at Recession 2021 – and we’re going to try and understand what’s coming and what needs to be done.
Alistair, what’s to come?
AD: Well, you haven’t seen the full effects of this yet. You’re just beginning to see it.
As of mid-October, the last unemployment figures started to show the inevitable and worrying trend, especially amongst younger people, starting to lose their jobs. And my guess is that’s from the hospitality and associated industries, which employ an awful lot of young people.
But I think you’ll begin to see what is going to happen when the furlough scheme runs out at the end of October, because then firms are going to have to take a decision as to whether or not they keep people on.
And, of course, beyond that, there will be other consequences. Some of them are foreseeable.
Again, it’s difficult to be certain, but I think we should prepare; if we don’t do anything, you could be looking at the 1980s and maybe three million people.
Now, that needn’t happen. I would argue very strongly that what needs to happen is that you need to give the regions, particularly in England, give them budgets because they’re much better at knowing what they can get going fairly quickly, whether it’s housing, infrastructure projects, and so on.
If you do all these things, then you’ve got some chance of keeping those unemployment totals down.
What I would say about the 1980s – and unfortunately, by definition, there’s fewer people around who remember that than were around at the time – if you get mass unemployment, it isn’t just the economic consequences, which are huge, it’s the social consequences.
When you start children growing up in a household where nobody works – and, of course, by the 1980s and 90s, sometimes there was a third generation where nobody had worked – we must do well to remember all that when people talk about cost. Unemployment comes at a very high cost.
JH: And, Alistair, is it possible that it’s already too late to prevent that three-million-plus unemployment level?
If you just look at the numbers that we’ve seen – one third of people who are 18 to 24 having lost their jobs or been furloughed; big increases in the numbers of people losing their jobs, leaving the labour market; particularly a decline in the number of men who are self-employed – how worried are you that, actually, the nature of economics is that things lag, and that by the time we get to the end of the year and into the first quarter of next year, you’re going to see those redundancies mount and we are inevitably set for mass unemployment?
AD: Well, I think you can say it’s never too late. But what you can definitely say is that every day you don’t do something, your risk increases.
On average, if people lose their job and come off the furlough scheme and go on to Universal Credit, on average their income will drop by half. Now, if you’ve got nothing or very little put by, because you couldn’t, then immediately you are in a major, major problem. We’ve got enough people relying on food banks as it is.
As I say, nothing is inevitable. But I’m worried, unless an awful lot is going on behind the scenes in secret – if only it was – I think we are going to be in for a very difficult winter.
JH: You said that you saw the economic consequences of this running well into the decade. What do you mean by that?
AD: Well, what I mean is that, if you go into a recession or anything like that, it takes a long time.
Let me give you an example. I distinctly remember being told in the summer of 2008 – that’s before the big banking crisis – and one of my Treasury officials told me, the going rate for a recovery after a recession caused by a financial disruption is seven years. And everybody around the table said, oh, come on, surely not, we’ve had ten years of growth and all that.
When actually – and, of course, there were other things that came after we left, austerity and so on – but our economy was barely growing when we went into this. The problem you’ve got now is, if businesses have to close, they don’t just get up and get going, because people will be nervous about it
This isn’t just a UK problem, it’s all over the world, frankly, you’ve got these problems. And so, you get… some industries will be affected and will recover sooner than, you know, five years. But some of them will still be feeling this effect in years to come.
And, of course, you can’t be sure that the economy is going to return to where it was, say, 12 months ago. Things will change.
JH: And what’s the role of the Treasury in this? How much should the government borrow and spend now?
AD: Well, clearly the role of the Treasury is crucial all the time, actually, but particularly at a time like this.
Having spent some years in the Treasury, I am well aware of the need that, at some point, you’ve got to get the money back in. That will happen.
However, I’m also aware of the fact that if you don’t spend money – especially at a time like this – the costs in the longer run could be far greater than they would otherwise be.
So I would urge the present Chancellor to err on the side of doing more to support the economy than he might naturally be inclined to do, because I think the cost of him not doing so… he’ll be forced into spending money because politics… if you’ve got three million people out of work, say, for example, in the middle of next year, the Chancellor is not going to be able to say, well, I’m sorry, we can’t afford it.
You know, it’s a bit like a war. You can’t say halfway through it, well, I’m sorry, we can’t afford another battleship or any more tanks. You’re in this and you’ve got to see it through.
JH: How much is there a mindset problem, Alistair, in that the current generation of politicians was scarred and obviously educated by the experience of the global financial crisis, so there’s such a focus on debt that they might well be frightened of it, whereas actually it might be the case that this is the moment to embrace borrowing in order to get the economy through this.
How much do you think that we’re in danger of fighting the last war, economically speaking?
AD: So the mindset has got to be, you are in entirely different, uncharted waters at the moment. Not for a hundred years have we had a pandemic – and, of course, the economic situation a hundred years ago was rather different.
This needs action not just here, but one of the things we had ten years ago, you will recall, is the international cooperation, from America, China, Japan, Europe, the Middle East, everybody was doing the same thing.
We’ve got to get out of this mindset that says if you don’t spend money, it will all be alright. A simple example, the great economist John Maynard Keynes made the point, it’s better to employ a man to dig a hole in the road and then fill it up in the afternoon, because he earns money and he goes and spends it in the shops, and the shops get income, and the shops get suppliers, and so on.
None of that’s gone away, actually.
JH: And that is the choice, though, isn’t it? Isn’t the choice really that we face now…. and the reason I pressed this point is I’m struck by the fact that chancellor, Rishi Sunak, is still talking about the “sacred duty” to balance the books.
The real choice now is saying, okay, borrow now with the risks of tax rises of debt defaults five years from now, or don’t borrow and have a massive unemployment problem that causes even greater problems down the line.
Isn’t that the choice that the Chancellor faces today?
AD: Yes, it is.
Certainly, the sacred duty is a sacred duty to the Tory party conference rather than the world at large.
I am very clear that if you do what was practised in the 1930s, actually, when you had a massive recession which became a depression, and you think that the best thing to do is not to incur any more expenditure, in crude terms, the cost will be massive. It won’t just be economic, but it will be social, and it will be with us for generations – and I mean generations – to come.
The UK has never defaulted on its debt in modern times, so I think the mindset in No.11 or the Treasury has got to be different. We have got to do whatever it takes to support our economy, otherwise you are going to be in for a very, very, very difficult time economically, never mind the social consequences that will come on the back of that.
JH: Alistair, what is – one final question – the lesson that we should learn from the management of the financial crisis? And what are the lessons that we shouldn’t take too closely to heart?
AD: Well, I think the key lesson is that you’ve got to do more than people expect and you need to do it more quickly than people expect. That, in itself, instils confidence.
One of the problems today, with the talk about lockdown and where next and how much, is that people are rapidly losing confidence that the government has got any control over this. And losing confidence is one of the most damaging things that can happen in a country and to a government.
So, the government has to – if I were telling them what to do – be confident, be prepared, and start getting on with it now.
At a time like this, this is precisely what governments are for. Just as they are there to defend our country in the event of a military attack; in the event of an economic attack they are there to take action, because, frankly, nobody else can do it, nobody else is big enough to do it. That’s one lesson that I learnt ten years ago. If it really comes to it, and things are really bad, only the government is big enough to deal with it.
This is a crisis, and it is up the current generation of politicians to rise to it – and, without being indelicate about it, I think they’ve got a job of work to do.
JH: Alistair, thank you very much indeed.
That was Alistair Darling, but, of course, we wouldn’t be doing our job properly if we didn’t get a second opinion on this economic patient.
Sir Mervyn King, we hear about redundancies, bankruptcies, recession. What should we expect in the next 12 months?
MK: I fear exactly as you described it: bankruptcies, a continuation of what some people call a recession. And I think that the most serious thing is that, in the discussions about what’s happening in the economy, I think people have rather lost their way. They’re talking about recession.
Now this is not a conventional economic recession. This is a sudden contraction of the economy, created by the government intervening to say you can’t go to work, you can’t go and spend money in certain ways. So we’ve seen household savings go up; we’ve seen businesses and governments having to borrow even greater levels than before merely to stay afloat.
And I think that what we’re going to see in the next three years, around the world, is a wave of defaults, of businesses and, in many cases, governments, where there will need to be a process of significant debt restructuring in order to allow some businesses to continue; others will fail. And, certainly at the level of many governments in the world, debts will need to be restructured.
Now, we’re used to the idea of one government or company getting into trouble, but not so many at the same time.
JH: The issue it seems to me, though, is that, depending on your age, you’ve grown up and lived through certain recessions and, as you say, this one promises to be very different in its impact.
One thing that does seem clear is that it is going to have a different order of magnitude impact on employment and jobs because so many businesses are closed.
And so, for many people who lived through the recession after the global financial crisis, that had an impact on incomes and living standards that is different to this one. This one seems to have an unemployment package attached to it.
And I just wondered how you think about preparing for that. And if you think that’s the right analysis; if you think that the real problem is going to be one of mass unemployment.
MK: Well, everything will hinge on the measures which government takes to support businesses.
Businesses are failing today, not because they’re in unviable sectors, which is what we saw in the 70s and 80s and, to some extent, in the 90s as well, when old industries were collapsing and it was inevitable that we were going to see a need to shift people from one sector of the economy to another.
This is not true today. Many of the people suffering may well have perfectly viable businesses in the long-run. We won’t know for some considerable time. And the argument for government support to keep these businesses going is precisely to avoid a significant rise in unemployment which doesn’t correspond to any long-run shortage of demand for their services.
This is government spending that is not wasted. This is a transfer from taxpayers in general to businesses, to enable them to maintain employment.
Let me give you one simple example: if you look at theatres and orchestras and concert halls, no one has suggested that, five years from now, or three years from now, when we come completely out of all this, that people won’t want to go to theatres or concert halls. But if we allow all these enterprises to fail, it’s going to be much more difficult to reconstruct them in future. There’s a real cost to allowing these businesses to fail.
And in the short run, if the government imposes restrictions of the kind we’re currently going through, they will fail, because without support from government to get them through this, then they will have no choice but to close their doors.
Now the government is trying to do something. Whether it’s enough remains to be seen. But the more stringent the restrictions, the more generous the support needs to be.
And I think the risk is that businesses will start to fail and close their doors. And yet, 18 months, two years, three years from now, we will regret that those businesses disappeared – and it will be too late to bring them back again.
JH: So what is the… any normal person is completely baffled by the numbers when it comes to debt. How much government can step in. How much it can continue to keep supporting people who are furloughed or threatened with redundancy. What’s the sensible calculation for what the government can afford to borrow to get through this?
MK: I don’t think there’s any immediate constraint. We’re still at levels of the ratio of government debt to our GDP or national income which are higher than we’ve seen for some while, but they’re still well below the levels that we had in the immediate post-war period.
And the most important thing is that, today, unlike previous episodes, the government can borrow at extraordinarily low interest rates.
And the government will be wise to lock in as much debt as possible to very long-term borrowing at extremely low interest rates. If it does that, then, actually, I don’t think it matters so much in the next three, six, even 12 months how much the government has to spend on supporting businesses – because it’s not wasted resources, it’s a means of trying to keep people employed.
JH: This feels like a fundamental choice, or something that needs to be baked into political thinking, and I’m not sure it is.
You heard Rishi Sunak, the chancellor, at Conservative party conference, talk about the “sacred duty” of balancing the books. Is that not premature, even the wrong economic calculation? Isn’t the primary responsibility now thinking about employment and a return to growth?
And there is availability of debt, and there is therefore an availability of government finance to step in and help businesses and help people by supporting their employment.
MK: Absolutely. And, of course, Rishi Sunak is not trying to balance the books this year or next year. There will be a very large deficit.
I think what he must be worried about, and anyone in his position would be worried about, is whether financial markets start to lose confidence and whether the UK, in the long run, is capable of ensuring that the ratio of debt to GDP does come back down.
But I think we’re in very different circumstances than we were certainly in 2010. The situation is totally different. It’s not the wasteful spending of British governments that has brought on the virus. The virus has come from outside, we have to deal with it.
And, actually, maintaining the structure of our business sector until such point as it’s then possible to allow the market economy to decide which businesses are going to thrive in the future and which are not… that’s the moment when you can withdraw support and let the market decide who will prosper and who will fail. But we’re nowhere near that position yet.
And it’s certainly striking that there are other countries in Europe who have been willing to extend their furlough-type schemes right through next year. I think that we are going to end up doing something very similar.
JH: Mervyn, can I just take you back to what you said about a wave of defaults? So, can you spell out what a wave of government defaults, and business, might look like? And what can be done to tackle it when it comes?
MK: I think it will start to show up in businesses saying, we can’t really repay the principal of our debt, we can service the debt in terms of interest payments, but we can’t repay the original loan.
And then you’ll see that financial intermediaries – people like banks and others – will say, hmm, we’re not going to get repaid, so we’re not worth as much as market investors previously thought.
So people get nervous then about the viability of banks. Not the big banks in either the UK or the United States, because they have been very careful in building up their reserves, they provisioned for a sharp increase in bad loans.
But, undoubtedly, there will be a significant jump in bad loan provisions; many businesses won’t be able to meet their commitments; we will see a rise in people taking advantage of procedures to restructure debt; insolvencies, bankruptcies.
And at the level of governments around the world, it’s already there. We already see that there are about 70 or 80 countries in the world that the IMF has identified as being in need of extra support to avoid defaulting on their debt. There’s bound to be significant debt relief given to those countries. This is a very large number of countries.
We’re seeing with some of the large emerging market countries… we’re seeing, recently, Argentina having to restructure its debt.
This is going to continue, I think, and what we’re not used to doing is having to cope with these problems when so many businesses and governments at the same time want debt relief and debt restructuring.
JH: So do you think, in 2021, you will see multiple Argentinas?
MK: Each country is its own case. I think what we will see is two things. A lot of small and low-income countries desperately calling for more debt relief. And the other thing I think you will see is… when we thought about debt relief to low-income countries in the past, we thought of this as something which was primarily governments in the West lending to poor countries who could then not repay.
What we now find is that countries have borrowed from three distinct groups: countries like the G7 countries in the West; financial organisations like hedge funds and others that have been willing to invest; and China. China has been a very big lender to this part of the world.
So you’ve got to get coordination between the private sector, governments in the West, and China. That’s going to be extraordinarily difficult, I think.
JH: And what’s the role of central banks in this? And, particularly, in the UK context, what’s the option of negative interest rates? How would they work?
MK: That’s, of course, what the Bank of England is trying to work out now.
I wouldn’t put too much weight on that being likely to happen. I don’t believe that will have a significant impact and I don’t believe that it’s relevant to the current circumstances.
If people are not spending money on travel or entertainment or hospitality or various other things because of the lockdown and the restrictions, the idea that people are going to say to themselves, “Darling, let’s go out for a wonderful holiday or a meal tomorrow because interest rates are just 50 basis points lower than they were last week…”
People are worried about the health implications of going outside. So I don’t think interest rates are at all relevant to today’s situation.
JH: Just to be clear, when a central bank – when the Bank of England – asks banks to consider the implications of negative interest rates, to someone like me that reads like they’re socialising a policy that they’re planning on bringing in.
Why would they air that if you think they’re not actually going to bring it in?
MK: It’s being discussed in public for two reasons. One is that a number of academic economists find lower interest rates, or negative interest rates, attractive. I think this is a misleading viewpoint because it may be true in a certain, rather narrow model of the economy, which they like to work with, but it’s not a description of the real world.
The other is because significant parts of the world, particularly Japan and now the monetary union in Europe, have actually instituted negative interest rates.
Now, in most cases, they haven’t gone as far as lowering them enough that ordinary depositors receive negative interest rates, which would then pay you to go to the bank, take your money out and put it under the bed, rather than see your money whittled away at the edges each week, each month. And people don’t want to go that far, which puts a limit on how far you can cut interest rates into negative territory.
Basically, in Europe, the European central bank is subsidising the banking system. The banking system is in deep, deep trouble in Europe, and as a result they’re being subsidised. We don’t want to get into that position.
JH: What are the lessons that we should learn from the global financial crisis? And, as importantly, what are the ones that we should not take to heart?
MK: The main lesson we should learn is that we allowed the banking system to get into a position where it had no resilience at all. Everyone was focussed before the financial crisis on how profitable it was. We allowed them to get away with borrowing so much themselves that they didn’t have enough equity capital at stake in the business to absorb losses when something bad happened.
So the big lesson from the financial crisis is that profitability is not everything. Resilience matters, particularly in parts of the economy that are really important, like the financial sector and the banking sector.
So, fast-forward to today, the big lesson is: make sure that key parts of the economy – whether it be banking, whether it be the electricity supply, whether it be the health service – are resilient and can cope with unexpected events that come along.
And, clearly, we weren’t able to cope with an unexpected virus when it came along.
JH: Mervyn King, thank you.
There’s a question of resilience for all of us in the years to come. Thank you for listening.