The UK is back in recession with GDP contracting 0.2% in the first three months (Q1) of 2012 after contracting 0.3% in the last three months of 2011. Given that even before today we knew that the economy had contracted in three of the previous five quarters, it was fairly arbitrary to claim we weren't already in recession.
Why? Well, in an accounting sense the economy was dragged down by a rapid contraction in construction during 2012 Q1. But that's accounting, rather than an economic explanation. It is true that in the past couple of years in quarters when construction grew rapidly the economy grew, and in quarters when construction fell GDP fell. It is also true that construction is sensitive to government investment plans (spending on new roads, hospitals, etc.) – and government investment was scheduled by Labour to contract very vigorously. As it happens, the Coalition has added very little to Labour's planned cuts in government investment.
The Coalition's plans almost all relate to cuts in consumption spending (salaries, jobs, etc.), and virtually none of those have occurred yet. Most of the Coalition's deficit reduction programme so far, inasmuch as it added to Labour's plans, has been additional tax rises. There is a rather odd argument that goes roughly: "We said that cutting spending would cause the economy to contract – see, this proves you were wrong to say that cutting spending would allow the economy to grow faster! – Err, but spending hasn't been cut yet. – Ah, but if the economy contracts even before the spending cuts start, that just proves that when they do start the economy will do even worse." (!)
I continue to believe that there is every reason to hope that once spending cuts actually get going the economy will gradually start to improve. I attribute the difficulties so far to five factors:
a) The underlying capacity for the economy to grow is much lower than most people comprehend. With public spending pushing half of GDP, heavily over-indebted households and largely unaddressed demographic issues of increased longevity, it should have been no surprise that official estimates of the growth rate in potential output are now around 1%. That means that 2011 was a year in which the economy grew broadly in line with its potential growth rate. There might be a little bit of scope for catch-up of output lost during the recession, but fundamentally, growth isn't that much slower than it could be, given the supply-side structure of the economy.
b) The banks were bailed out rather than going bust (by which I mean having debt-equity swaps imposed on them so they fell into the hands of their creditors). If the banks had gone bust they would have been restructured and those that survived would be healthy, and new banks would have entered. New banks and surviving banks would have looked to expand their balance sheets rapidly by doing lots of new lending. This would have provided a solid flow of credit in the economy. Instead, we maintained bust banks in place and insisted that they shrink their balance sheets gradually. The consequence is that whereas if the banks had gone bust then by now credit would have been expanding again, as it is credit growth is still stagnant.
c) Our trading partners in the Eurozone are having terrible problems associated with the euro and their own domestic challenges. That impedes our export growth somewhat – but in fact export growth in the UK hasn't been too bad. So though there is an issue here, it's not an overwhelming issue. The other thing that Eurozone problems do is to undermine confidence, for a disorderly collapse of the Eurozone could trigger the collapse of much of the banking sectors of the developed world and impose as much to twice as much recession upon the UK as we had in 2008/9. This confidence factor is much more important.
d) The government chose to front-load the tax rises and rear-load the spending cuts in its deficit reduction programme. Tax rises tend to damage medium-term growth; spending cuts to promote it. The risk is that the early tax rises come, then the spending cuts never really happen and instead there are more tax rises – a disastrous possibility. So the higher the proportion of tax rises there are early on, the greater the risk of damaging growth. I don't believe this is an especially important factor – I know of no evidence of any past occasion in which an economy running a 10% of GGP deficit would have been better to run a 12% deficit rather than an 8% one, nor any theory supporting this proposition. But I share the instinct of other economists that early large tax rises in an already-fragile economy are probably likely to have some at-least-modest short-term impact on growth.
e) I always – always – urged that the deficit reduction programme should immediately, and from the off in 2010, be accompanied by additional quantitative easing (money printing). Around half the time deficit reduction programmes promote short-term growth they do so without the need for additional monetary loosening, but the other half of the time it's the monetary loosening they allow that is key. I had no interest in finding out to which category our programme belonged. We should have done more QE from mid-2010. Given that the economy is now smaller than it was in mid-2010, I feel more than vindicated in this view.
Overall, coming on top of political difficulties over the back-track on the EU Treaty "veto" (that wasn't), donor dinners, the Budget, and now the latest twist in BSkyB-Hunt-Cable affair, and with Conservative opinion polls ratings reverting to their 1993-2005 flatline norm of 32%, official statistics saying the economy is in recession are politically toxic. Cameron was in terrible trouble already. Now the journalists are in search of a superlative beyond "omnishambles".