The chancellor enshrined austerity to keep financial markets on side but now even they are getting jittery – the UK economy is a disaster area
Is this the real life? Is this just fantasy? You had to go back to the year 1975, when Bohemian Rhapsody topped the charts, to find the last time Britain was in a double-dip recession – and Freddie Mercury's lyrics seemed particularly apposite for the many City analysts left with egg on their face by the dire performance of the economy in the first three months of 2012.
This was not real, they claimed. It was just fantasy, they suggested, that the hard data showing a second successive quarter of negative growth should fly in the face of the upbeat picture of business surveys. Give it a few months, they said, and fresh information would show a second recession in three years was a figment of the imagination.
Even if this occurred – and there is no guarantee it will – it will come as cold comfort to George Osborne because the damage has been done. For him the next two lines of Bohemian Rhapsody – "caught in a landslide, no escape from reality" – were the ones that sprang to mind following the baleful news from the Office for National Statistics.
Here's the position. When the government took office in May 2010, the economy was in the middle of a relatively vigorous recovery from the slump of 2008-09, the deepest in Britain's postwar history. Helped by cheap money, a falling pound, temporary tax cuts, the bringing forward of infrastructure projects and a pick-up in global demand, the economy grew by 1.1% in the second quarter of 2010.
Now look at what has happened since then. The economy grew by 0.7% in the third quarter of 2010 – another respectable performance – but then contracted in four of the next six quarters. Britain has clambered only half way out of the deep trough into which it fell in after the collapse of Lehman Brothers in September 2008, making recovery even slower than in the 1930s.
To be fair to the chancellor, he is not solely to blame. He inherited a deeply dysfunctional economy in which the taxes generated by financial and property speculation in the south paid for higher public spending in the north. It was an economy in which the City had been poorly policed and in which growth was too dependent on debt.
Osborne, though, has made matters much worse. He shredded consumer and business confidence by his repeated warnings that without austerity Britain would be like Greece. Raising VAT pushed up the inflation rate at a time when real incomes were already being squeezed by low wage settlements and rising commodity prices. And he overestimated the ability of the economy to cope with spending cuts. The Treasury has stopped trying to blame the eurozone for the state of the economy, which is just as well since that was tosh. Exports have actually been supporting growth over the past 18 months: the problem has been the domestic side of the economy.
Osborne is in a dreadful place. As a keen student of history, he knows that the precedent for a Tory U-turn – the volte face by Ted Heath in the early 1970s – is not an encouraging one. The boom set off by the then chancellor Tony Barber, when he liberalised banking, relaxed exchange controls and cut taxes, led to an even bigger bust.
The coalition's fear is that the government would be punished by the markets if it went soft on austerity – and there is no obvious magic bullet for Osborne to fire. Since the recession began, the Treasury has borrowed £500bn, the pound has depreciated by 20%, interest rates have been pegged at 0.5% for more than three years, and the Bank of England has plonked £325bn of newly created money into the banking system. The result has been the weakest recovery of the past 100 years.
There are ideas knocking about. The left-of-centre thinktank, Compass, suggested another round of QE to fund a big home insulation programme. The free-market Institute for Economic Affairs proposed cutting red tape, debt and taxes. Between the two, the Social Market Foundation proposed a funded stimulus in which temporary tax increases and cuts in spending that generate little growth would fund a big expansion of capital investment.
Osborne has no Plan B and shows no sign of wanting one. He has made reduction of the budget deficit the judge and jury of Britain's performance, talking tough in the hope that the financial markets will spare Britain the harsh treatment they have meted out to the weaker members of the euro. Until now they have, but slow growth has meant progress in getting the deficit down has been much slower than the chancellor planned, and the credit rating agencies are getting jittery. Two of them have put the UK's prized AAA rating on negative watch.
A second recession hard on the heels of the first gives the (accurate) impression that the economy is a disaster area and makes a downgrade more likely.
It is not uncommon for economies to suffer a brief relapse when they are coming out of recession. But the last time it happened to Britain, the annual inflation rate was above 25%, Margaret Thatcher was elected leader of the Conservatives and the country was about to be introduced to Basil Fawlty, a man who had as much success running a hotel as Osborne has had running the economy.