So we will continue to work hard to steer the economy through difficult times. I think the experience I have built up over 11 years enables me to do the right things by the British economy. We will not hesitate to take whatever action is necessary to bring the British economy through these difficult times. But I think that people should remember that though unemployment is rising in America at a very fast rate and while we have very high unemployment in France and Germany, although we had a small rise in the unemployment figures yesterday, we have seen half a million more people into jobs over the last year, and British employment is still at record levels and never been higher in the history of our country. So we have many advantages: low debt, having kept inflation lower by public-sector pay deals over 3 years, and of course the action that we have already taken, we have many advantages as we face what is a difficult world situation.
Prime Minister, Gordon Brown
Source: 16 May Prime Minister’s Press Conference, 16 May, 2008.
But we know we face additional challenges too: at the same time as stagnation spreads from the west, inflationary pressures are spreading from the east, not least from the race for commodities --- with oil, coal and gas prices up 60 per cent, world food prices up 45 per cent, and global food reserves at their lowest level in 30 years.
Prime Minister, Gordon Brown
Source: Speech to the Institute of Directors, 30 April 2008.
Gordon Brown’s statements to the media in April and May 2008 present a picture of a UK economy experiencing difficult times primarily as a result of external or, as economists would say, exogenous factors. In his speech to the Institute of Directors, the Prime Minister attributes the difficulties to recessionary pressures arising from the USA, the source of the ‘credit crunch’ in the West, and inflationary pressures from the East, spurred by economic growth in China and India that is forcing up commodity prices and thereby worldwide inflationary tendencies. The UK economy, sound in its essentials according to Mr Brown, is caught in the crosscurrent of these international trends.
This paper takes issue with the Prime Minister’s view: rather, the UK economy is slothful rather than sound and too reliant on too few ‘essentials’; the credit crisis is symptomatic of deeper, structural problems facing the UK and Western economies; and these underlying problems are unlikely to be addressed in Britain by current government priorities such as expansion of training programmes, improved regulation of the financial system and financial services enterprises, and containing public sector spending. In the final section, the paper examines the consequences of the credit crisis for London’s economy, suggesting that the city is highly susceptible to the negative effects of the recent downturn in the UK’s economic fortunes.
Credit crises are not unusual events. The expansion of credit in the 1970s and early 1980s in Western economies such as the US and UK, helped stave off recessionary trends arising from the weak performance of the production sector; but eventually led to debt-inflation that was addressed by governments in the mid-1980s by curbing public spending and tightening credit controls (Brenner 2006: 159). The current credit crisis is generating calls for similar solutions but has different origins in the service sector, arising from a credit squeeze in the US housing market.
Andrew Palmer, explaining in The Economist how ‘Paradise’ was ‘Lost’, notes that bankers and finance houses forgot the maxim ‘know your customer’. They lent to people who did not have publicly available credit histories and were, therefore, categorised as being in the sub- prime, as opposed to prime, market (Palmer 2008: 7). Exposure to the high risk sub-prime market may have caused relatively few financial institutions to suffer, when in the summer of 2007 the US housing market first dipped and started to prompt subprime borrowers to default on loans. However, painful effects soon spread throughout the financial world because the institutions that originally sold sub-prime mortgages had re-packaged the debts and sold them on to other institutions in the sector. What was designed to make the system more resilient by spreading risk became instead the source of contagion: ‘the risks flowed back to the banks as toxic assets.’ (Palmer 2008:6)
This process, called securitisation, originated in the 1980s and was designed to enable banks to share risk with other investors by passing on loans as if they were assets. The original credit note arising, or derived, from the transaction with the customer, is sold on in the form of bonds or securities (hence the description ‘derivatives’). In turn, these asset-backed securities were invested in by others such as hedge funds - privately owned investment companies that engage in complex investment portfolios designed to secure high returns for wealthy individuals and institutional investors like pension funds and insurance companies.
The consequences of this merry-go-round, whereby an original value is resold many times over, was that banks and other financial institutions were unable initially to identify the extent of their exposure to the credit crisis that commenced in the US housing sector. Meanwhile the international character of these institutions ensured a rapid spread of the contagion. Banks and other institutions stopped lending to each other: the wholesale money markets in the USA and UK effectively closed down causing the US Federal Reserve and, subsequently, the Bank of England to step in to inject liquidity.
In the UK, Northern Rock had to be saved by Bank of England and government intervention, while many other prestigious institutions were forced to undertake write-downs in their values, to the tune of around $200 billion in the US alone. An estimate produced by the US Monetary Forum in February 2008 suggested that a write-down of $200 billion would mean that the credit made available by US financial institutions to US households and companies would contract by $910 billion by the end of 2008 (US Monetary Policy Forum, 2008). The consequence of the credit crunch has, therefore, some distance to run, but the erstwhile availability of ‘easy’ money and the resulting credit crisis cannot be blamed on the banks and financial institutions alone. Instead the source of the problems lies in more fundamental issues facing Western economies.
In the period since the early 1970s Western economies have experienced a long downturn, from which there have been only brief periods of respite as, for example, with the superficial ‘New Economy’ boom of the late 1990s. The main characteristic of the downturn has been the loss of the dynamic pattern of economic growth experienced in the post-war years. GDP growth, since the late 1970s, has risen at a rate that is half that achieved in the 1950s and 1960s in most developed industrial nations (See Table 1). Over the last two decades, the economies of the USA and UK have remained relatively stable without undertaking significant investment in production industries, excepting some parts of the IT sector. In short, production industries have tended to engage in a constant process of rationalisation but in the absence of any significant destruction of ‘old’ capital and its replacement by ‘new’, with only brief exceptions to this trend occurring, for example, in the US manufacturing sector in the mid-1990s (Brenner 2006, 297). The consequence of this unspectacular but stable growth, and the underlying lack of investment in productive capacity, has been a rise in the amount of liquidity available to circulate in financial markets (Mullan 2008: 3). Accompanying the loss of dynamism in Western economies, has been the parallel process of dynamic expansion within developing economies, particularly China.
| 1960-69 | 1969-79 | 1979-90 | 1990-95 | 1995-2000 | 1990-2000 | |
|---|---|---|---|---|---|---|
| US | 4.6 | 3.3 | 2.9 | 2.4 | 4.1 | 3.2 |
| Japan | 10.2 | 5.2 | 4.6 | 2.0 | 1.7 | 1.9 |
| Germany | 4.4 | 3.6 | 2.15 | 2.0 | 1.7 | 1.9 |
| Euro 12 | 5.3 | 3.7 | 2.4 | 1.6 | 2.5 | 2.0 |
| G-7 | 5.1 | 3.6 | 3.0 | 2.5 | 1.9 | 3.1 |
| UK | 3.8 | 3.5 | 2.5 | 1.5 | 2.7 | 2.5 |
China’s spectacular rate of economic development has enabled it to become a manufacturing workshop to the world, especially the US economy to which it has exported increasing volumes of manufactured goods. For example, between 2003 and 2004 alone, China’s exports to the USA expanded by some 57 percent (worth around $70 billion). At the same time, China sustained high foreign exchange reserves, significant proportions of which were used to purchase US securities and especially treasury bonds which helped suppress long term inflationary trends1. By September 2007, it is estimated that China’s holding of US securities had reached $1 trillion (see Table 2 and CRS 2008:5).
| Total | Long Term (LT) Treasury | LT Government Agency | LT Corporate | Equity | Short term | |
|---|---|---|---|---|---|---|
| Japan | 1,106 | 535 | 184 | 108 | 195 | 85 |
| China | 699 | 364 | 255 | 59 | 4 | 17 |
| UK | 640 | 47 | 28 | 249 | 300 | 16 |
| Luxemburg | 549 | 52 | 38 | 233 | 193 | 32 |
| Cayman Islands | 485 | 19 | 50 | 111 | 178 | 31 |
| World Total | 7,778 | 1,727 | 473 | 2,021 | 2,430 | 615 |
| China’s Holding as a % of World Total | 9% | 21.1% | 53.9% | 2.9% | 0.2% | 2.8% |
The ‘special relationship’ between China and the US in economic terms enabled the latter’s economy to act as a vast market for the consumption of manufactured goods, which helped to stave off international recessionary trends in the early years of the new century, and assisted the US in reaching new heights of consumption, fuelled by easily available credit to private consumers. This US consumption-led boom, in practice, an example of a society living beyond its means, has only recently burst as a result of the housing crisis and consequent credit crunch.
Unlike earlier credit crises, the current crisis started in financial services and is set to spread to other parts of the economy via, for example, the curbing of private consumption. A broadly similar process is unfolding in Britain as in the USA, a process that has led one leading commentator to suggest that: ‘what is happening in credit markets today is a huge blow to the credibility of the Anglo-Saxon model of transactions-oriented financial capitalism’. (Wolf 2007:1)
The capacities of the US and UK economies to deal with the resultant recessionary trends may vary, but perhaps the key point is that not all commentators would agree with Gordon Brown that the ‘Anglo-Saxon’ model is all right in its fundamentals. Indeed, its ‘fundamentals’ illustrate a major relative decline in dynamism, a growing dependence on financialisation or ‘thin air’; and, perhaps most instructively, an underlying and long term shift in global economic leadership away from the West and towards the East. The current credit crisis is not a defining moment but it is illustrative of this underlying trend in global economic affairs – much of which is beyind the scope of this paper. Its remaining focus on the immediate impact and consequences of the credit crunch is limited to a brief analysis of the UK and, in particular, the London economy.
The London economy has out-performed other UK regions over recent years. Its Gross Value Added per person is significantly higher than other UK regions (Table 3) and forecasts in May 2008 suggest that employment and output will continue to grow despite the drawn-out impact of the credit crunch during 2008 and 2009 (GLA 2008: 1-6). However, London’s economy is reliant upon precisely those activities that are most likely to experience the direct consequences of the credit squeeze – finance and business services, and retail, leisure and other sectors that rely upon buoyant, credit- driven consumer demand. The city’s economy is, therefore, highly vulnerable to the adverse economic and social consequences of the credit crunch. Here, this vulnerability is outlined through a brief examination of the finance, business and related sectors, the housing, construction and ‘regeneration’ industries, and public services.
Table 3: Gross Value Added Per Head of Population
Source: UK Government, Office of National Statistics 2006
London’s economy is largely structured by its relationship to the finance and business services sectors and in particular, international financial services (Table 4). Of approximately one million financial service-related jobs in London, it is estimated that over 700,000 of these rely upon London’s role in international markets rather than the domestic economy (Corporation of London 2005).
| Industry Group | % Share of GVA (2006) |
|---|---|
| Business & Financial Services | 40 |
| Leisure | 16.6 |
| Health and Social Work | 8 |
| Utilities & Manufacturing | 17 |
The likely impact of the credit crisis on these jobs is difficult to evaluate with any precision, but estimates to date suggest that between twenty and forty thousand jobs may disappear between mid-2008 and the end of 2009. Major companies have already shed jobs, including UBS (900 in London) and Citigroup (2000, divided between London and New York), with many of these in areas such as derivatives, corporate finance and investment banking (Edgington, 2008). The rate of job loss is likely to exceed that suffered in the fall-out from the dot.com bubble bursting between 2001 and 2002, though there is an anticipated net growth in employment projected for the sector over the period 2008-10 (from 1.2% growth in 2008 rising to 2.6% annual employment growth in 2010) (GLA Economics 2008: 30).
Such projected employment growth may be optimistic, however, and an important consideration is what might be called the secondary impact of job losses in other sectors linked to finance and business services. A report undertaken by GLA Economics (GLA Economics 2007) revealed that 53 per cent of the demand for creative industry outputs within the UK, such as advertising, architecture and software, arise from the business and finance sectors. Thus a downturn in the financial and business services sector has a direct impact upon the creative and cultural industries. The dip in fortunes of the business and financial services sector after the 2000-2 dot.com crash led to a drop in employment in the creative industries in London in the period 2001-2004. This amounted to a fall of almost 10 per cent, or approximately 50,000 jobs in the creative sector:
‘The strong economic link between London’s creative industries and London’s finance and business sector services is evidenced by input-output tables produced by the Office of National Statistics (ONS). These tables confirm that business services are a major purchaser of creative industry outputs..The balance of evidence is therefore that the decline in London’s creative industries is a direct result of the slowdown seen in London’s private sector, especially finance and business services…’
(GLA Economics 2007:7)
The inter-connection of the creative economy with financial and business services suggests that the credit crunch will have a marked impact on employment in other sectors including the cultural and creative industries in London between 2008 and 2010.
Evidence of the impact of the credit crunch on the property market is based upon data drawn from the last quarter of 2007 and first of 2008. A report published by the GLA suggests that prices have fallen and ‘significant falls in transaction levels have occurred in office, residential and retail markets’ (CB Richard Ellis 2008:1). The property market has, unsurprisingly, witnessed some of the major initial impacts of the credit crunch with estimates of rents and capital values projected as falling. Rent values are estimated to decline, assuming a modest slowdown in the economy, by nearly 14 per cent in 2009 whilst capital values are projected to decline by 11 per cent in 2008 and over 21 per cent in 2009 (CB Richard Ellis 2008: 4).
As banks have tightened their lending criteria, a weakening of demand has had an impact upon the residential housing market in the wake of the credit crunch. This problem of translating need into market demand is likely to be exacerbated over the coming period. The historical imbalance between demand for housing and its supply has been the main feature of the residential property market for over 20 years, and an important cause of the rise in house prices. Housing completions in the UK of about 150,000 per annum have not kept up with population growth, and local authority contribution to new social housing development ‘has virtually ceased since the early 1990s compared with its 40 percent share of new housing during the 1960s and 1970s.’ (CB Richard Ellis 2008, 46) With the credit crunch diminishing access to mortgage finance for customers, house prices are set to continue falling (with some disparities across different areas of London), while housing need continues to expand. As finance institutions restrict lending, mortgage finance for customers declines, and finance available to developers also falls. The consequence for new development and regeneration projects is likely to be severe.
Speculative development-starts in the City of London were cut by 50 per cent between November 2007 and the end of April 2008 (Drivers Jonas 2008: 4); and prime rents in the City fell over the same period (CB Richard Ellis 2008: 61). Available office space has also expanded in many of London’s central locations. The central London property market has already experienced the impact of the credit crunch, though observers suggest that the impact may be relatively short-lived. It is likely that the main impact will be upon the more speculative or marginal brownfield developments proposed on sites where there are high remediation costs. Many of these proposed developments in East London and the Thames Gateway are likely to come under pressure, some being significantly delayed or scrapped.
In the wider context, the Government target to achieve the construction of three million new homes by 2020 was about 30,000 units per annum above construction rates prior to the credit crunch. This ambitious target looks unachievable in the wake of the economic downturn, partly because developers will not wish to be ‘burdened’ by Section 106 agreements and affordable housing provisions at a time when building costs are rising, profit margins squeezed and financial institutions are unwilling to release funds for speculative development. The total volume of affordable housing being built is likely to fall dramatically, though in the remaining developments which do move forward the proportion of this type of housing available compared to private homes may temporarily rise, simply because the market demand for private housing will fall as mortgage availability is severely curtailed. Overall housing need will not fall; but more of it will tend to remain unmet.
In summary, the credit crunch is likely to impact on development in the following ways. First, development projects associated with regeneration areas located outside central London are likely to be significantly delayed, re-scaled or not take place at all. Second, there will be a marked slowdown in the construction of affordable housing units. Third, new developments in the office, retail and commercial markets will continue to contract in number, with construction schedules delayed. Fourth, the development sites most likely to achieve completion and retain their value are those close to existing or new transport hubs such as Kings Cross, and those taking place around the London 2012 Olympics. Finally, the government’s target for the construction of new housing is in severe jeopardy (CB Richard Ellis 2008, 71; Drivers Jonas 2008, 4-6).
The public services have been the most important driver of employment growth in the UK since 2000. In London, public services employment has been less significant compared to business services as the source of job growth, though this pattern varies from borough to borough. For example, in Newham, East London, according to figures for 2006, of those employed 34 per cent work in public services compared to 23 per cent for London and 27 per cent for the UK as a whole (ONS/NOMIS 2006).
The recent downturn in the UK economy, catalysed by the credit crunch, will ensure that the contribution of public spending to the UK economy will decline over at least the next two years (Mullan 2008:5). This will affect the London economy in a variety of ways. First, employment growth in public services will be curbed, with the least well-off boroughs being the ones most affected. Second, employment in those private and third sector enterprises and agencies that depend upon public funding will be placed under considerable pressure, with job growth declining (Poynter 2007); and, perhaps most importantly, public spending as a ‘Keynesian’ instrument for off-setting recessionary trends will be severely limited since the government is already at the margins of its own self-determined public spending limits.
A brief examination of some of the underlying causes of the credit crisis reveals that the UK economy is increasingly reliant upon a form of financial capitalism from which it can neither escape nor control, despite the ever-increasing efforts of the state to intervene and regulate (Wolf 2008: 2). In servicing the global circuits of financial capital, the UK economy is highly susceptible to external events but its susceptibility arises from a loss of domestic dynamism that is becoming increasingly evident as the focus of global economic development begins its long shift from West to East.
The ‘sound’ fundamentals of the UK economy to which the Prime Minister refers – continued employment and GDP growth – are already under significant pressure in the short period since the emergence of the credit crisis. The crisis is not comparable in many of its essentials to those that arose in the late 1980s and early 1990s. Its origins in the financial world and its effects on property markets and consumer behaviour will take some time to unfold across the UK economy. Ironically, those least likely to have been considered credit worthy in the past, are most likely to suffer from the credit crunch and commodity price hikes as affordable housing development stalls, wage increases are curbed, and public sector spending is curtailed.
The London economy is particularly susceptible to the fall-out from the credit crunch. The City’s banks and finance houses are already cutting jobs and curtailing recruitment, and some of the famed city bonuses will not be paid later this year. Most significantly, regeneration projects and speculative developments in East London and the Thames Gateway will be stalled and many scaled down, with the result that the housing problem will persist in heightened form. Whilst the real promise of future economic success lies far to the east of East London, the city’s economy will, no doubt, revive – particularly if it hitches a ride on to those markets that were once ‘emerging’ and which have now emerged.
Professor Gavin Poynter is chair of the London East Research Institute
© 2009
So much of the infrastructure delivery in the Thames Gateway is dependent on funding via the Section 106 mechanism that the impact of the credit crunch could very well throw infrastructure plans for the Gateway into disarray.
James Stevens
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