Philip Hammond could be putting the UK on course for another recession

On the historical average, Philip Hammond should be worried. Recessions have tended to occur once in every decade since the 1970s, and we’re now almost 10 years from the start of the last one.

But while Brexit might be the obvious catalyst – for which the chancellor earmarked £3bn in emergency funding at the budget – two lost decades of earnings growth and more austerity to come should be just as troubling. In this regard, Hammond may be putting us all on course for another crash.

Faced with the longest period of falling real incomes since records began more than 60 years ago, households are given two choices: accept the fall in living standards, or borrow to make up the difference.

There is already evidence of the latter taking root. Personal debt on credit cards, loans and car finance is growing at five times the rate of earnings to levels unseen since the financial crisis. Meanwhile, the dismantling of the welfare state stands only to exacerbate the problem by pushing more people into debt, while also whipping the safety net from under our feet.

The Office for Budget Responsibility, the government’s independent economic forecaster, gives an evens chance of a recession in any five year period – but didn’t factor one in to its expectations for the current parliament. Meanwhile, it predicts slow wage growth and rising prices, as well as a slowing in economic growth. Brexit is another wild card that it hasn’t been able to quantify.

But with Britons needing to borrow more than they already do to buy a house or keep on shopping, we could be witnessing the construction of a house of cards primed for a fall.

The watchdog gives some indications of this. Finding that household debt has been rising as a share of disposable income since the end of 2016, the OBR said there will be a continuation of this trend. The overall personal debt pile of mortgages and unsecured credit of £1.9tn this year is now forecast to rise to almost £2.3tn in 2021.

A sustained period of falling pay when accounting for inflation could reduce real economic activity – resulting in recession, according to Carl Packman, a researcher at the poverty charity Toynbee Hall.

“Personal financial crises happen daily for people, but this will become noticeable on a macroeconomic scale when the difference between pay and the cost of living has a widespread material effect on real economic activity,” he said.

Should another crash come, the persistence of high levels of government debt mean there are significant risks. To mangle a favourite phrase of George Osborne’s: the roof wasn’t fixed while the sun was shining. That’s if the sun was shining at all for large numbers of people in the past seven years.

In the dying days of the last Labour government, David Cameron launched an election poster with a simple message: “We can’t go on like this.”

But despite £46bn of spending cuts since the pledge to “cut the deficit, not the NHS” was set in bold, blue type next to a suspiciously airbrushed-looking photograph, things are much the same as they were. Hammond’s budget last week should not convince you otherwise. If anything, it confirmed seven wasted years.

The deficit stubbornly remains, while according to the Institute for Fiscal Studies, it will be the 2060s by the time national debt falls below its pre-2008 levels should current conditions persist. And that forecast doesn’t allow for a recession to upset the apple cart.

To avert the current trajectory towards unstable levels of personal debt, ballooning to a point that it threatens the wider economy, the government has a few levers to pull.

Making the changes to universal credit announced at the budget is a good start, by helping to prevent people having to dip into debt to keep up with the cost of living when they move on to the new benefit system. But more could be done – with steps at the budget to smooth the transition costing just £300m a year in the context of planned working-age benefit cuts of nearly £12bn over the next five years.

Then there is the minimum wage. The government is increasing its “national living wage” by 4.4% from £7.50 to £7.83 from April 2018. But even with that change, the average wage in Britain will remain below the level it was at before the financial crisis hit, because the rising cost of goods will have eaten away at the real value of those earnings.

The Resolution Foundation estimates it will be 2025 before average earnings are back above their pre-crisis level, suggesting our post-crisis squeeze is on course to extend to an unprecedented 17 years.

Raising public sector pay could be a simple way of boosting pay across the board – as private firms would be forced to increase pay offers to compete with state providers. Hammond hinted he may act here, suggesting at the budget that he may lift nurses’ wages if pay review bodies recommend and increase.

Finally, the most difficult and lasting changes could come by solving the UK’s productivity puzzle – which has baffled economists over the past decade.

Productivity is an economic measure of the efficiency of a workforce. It typically measures the level of output per hour of work, or per worker.

A more productive workforce signals stronger growth and healthier public finances. Productivity gains are vital to economic prosperity because it signals that more is being achieved by workers in less time. Gains are typically achieved through advances in technology and increased skill levels within a workforce.

In the UK, productivity growth has stalled since the financial crisis, putting it behind international rivals. The UK ranks fifth out of G7 leading industrial nations, with Canada and Japan having weaker levels of productivity. Germany is the most productive nation per hour, while the US is top for output per worker.

Weak productivity is problematic because it signals weaker economic growth, therefore eroding the public finances. Without an improvement in productivity, economies miss out on increases in wages and living standards, putting further pressure on the welfare system and depressing tax receipts.

Some industries are more productive than others. In the UK, manufacturing firms are among the most efficient, whereas the services sector operate at below average productivity.

Productivity gains are vital to the prosperity of the economy because they signal more is being achieved by workers in less time – and more productive workers are rewarded by higher pay.

Growth in low-skilled work, self-employment and zero-hours contracts could be to blame for weak levels of productivity in recent years. As could the reluctance of businesses to invest in technology or the skills of their workers. Figures from the European Commission’s statistics body, Eurostat, show that British companies invest half as much per worker in vocational training as the EU average, and that investment in skills has fallen by 9% in real terms over the past decade.

With business confidence taking a knock from Brexit uncertainty, the government has a key role to play. The industrial strategy – due to be unveiled on Monday after 16 months in the making – could be a first step. But will it be enough?

With two lost decades for workers’ pay, rising prices and higher levels of debt, Britain can’t go on like this. The odds of another downturn are on.

Powered by Guardian.co.ukThis article was written by Richard Partington, for theguardian.com on Sunday 26th November 2017 15.58 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010