The Recent Recession in the UK

Background

The business cycle

The business cycle is the regular pattern of rising and falling GDP (output, income and demand) in an economy over time. It includes four phases – a boom, a recession, a slump and a recovery.

Meaning of recession

A recession is a period of falling levels of consumer demand, income, output, profit and business confidence, little investment, spare capacity and rising levels of unemployment.

The official definition of a recession is when there has been a fall in GDP for two consecutive quarters.

(A recession began in the UK in the second quarter of 2008 and continued until the last quarter of 2009).

The effects of recession on businesses

In general

Falling income during a recession means that falling consumer demand is likely and, as a result, businesses will reduce output. This may lead to low profits or even losses being made and workers being laid off. The effect can become multiplied because unemployment means incomes falling further and demand falls by even more. Eventually, businesses may collapse because of falling demand and losses and more workers lose their jobs, incomes fall further and so on.

Numerous businesses have been badly affected by the recent recession. For example, the car and construction industries have been badly hit by falling demand. Other firms that have been laying-off workers include BT, Virgin Media, GlaxoSmithKline, ITV and Vodafone.

Normal versus inferior goods

Generally, during a recession when income is falling, consumer demand will fall for ‘normal goods’. However, some businesses are not negatively affected during a recession. When income falls, demand increases for ‘inferior goods’ because people switch from more expensive products to low-priced substitutes.

E.g.:, sales at discount supermarkets Lidl, Aldi and Iceland have increased considerably while mass market, mid-range and premium rivals such as Tesco, Marks and Spencer and Waitrose have not done so well because consumers are ‘trading-down’ to save money. These discount stores have increased their numbers of middle class shoppers, who normally shop elsewhere. Shoe repairers also do well during a recession, because people think twice about throwing away shoes and instead get them fixed.

Income elastic versus income inelastic goods

Some firms are more vulnerable to recession than others depending on how income elastic demand for their products are. Income elastic products have demand that is very responsive to falling income. For example, house builders are badly affected during a recession because demand for housing is very income elastic. Therefore, during a recession many housing firms go out of business. The same is true for building services such as carpenters, painters and decorators because people put these purchases on hold until they have spare income to pay for it. Demand for household items is closely linked to housing sales too and as housing sales fall, demand for these products also falls. For example, John Lewis’ household goods section has been one of its worse hit departments.

Luxury goods, like foreign holidays, designer goods or gym memberships, have income elastic demand so when income falls during a recession, consumer demand will fall considerably because consumers need to spend their reduced income on necessities. They are known as cyclical products.

Other businesses are affected less because their products have income inelastic demand, which means demand is not very responsive to falling levels of income. For example basic products that are necessities, such as soap and milk are not badly affected. These products are known as non-cyclicals.

Car (automotive) industry / other durables

The UK car industry has been badly affected because cars are luxury durables and as larger purchases consumers delay buying them until they feel more secure about their income. The UK car industry is particularly vulnerable to a recession because it is at a cost disadvantage to global competitors and survival is harder. ‘White goods,’ such as washing machines and ‘brown goods’ such as TVs are also durables with income elastic demand because purchases can be delayed. Strong brands and weak brands

With falling income, consumers have become more price sensitive (demand is more price elastic) and are looking for value for money rather than other factors that add value, such as brand name and quality. They have become less brand loyal and are more likely to buy cheaper ‘own brand’ products. This could benefit smaller businesses with weaker brands. Consumers are also more likely to shop around for

a bargain and are using the internet to do so. This trend includes higher income as well as lower income customers. One major reason why John Lewis’, and Waitrose, which it owns, managed to increase profits recently, despite the recession, was the success of it’s new ‘essential’ range that allowed shoppers to save money.

An important point is illustrated by Dominos pizza’s success in the UK during the recession - customers are more willing to trade-down to buy known brands and quality they trust.

Comfort foods / traditional values

Companies which sell small luxury ‘comfort’ items products have seen sales increase as consumers buy small treats to cheer themselves up in depressed times. Sales of lipstick, chocolate and indulgent desserts have increased and Tescos has seen an increased demand for ‘traditional British fare’ type food such as deep-filled pies and lamb hotpot. Greg’s sold an extra 15 million sausage rolls during 2009 and plans to expand. During a recession consumers buy more ‘traditional’ food that reminds them of childhood’s simpler and happier times.

Firms whose products and services amount to investment spending by other firms

As a result of falling income during the recession, many businesses have cut investment levels (spending by businesses on items such as new machinery or technology and training) and imposed spending freezes on investment projects. These cuts have had substantial knock-on effects on demand in industries, which rely on business investment.  Perhaps the best example is IT, since a large proportion of investment spending is IT-related. An example is falling demand for Fujitsu Services (the UK arm of the Japanese technology company). Fujitsu had to cut about 10 per cent of its workforce and introduced a range of cost-cutting measures.

Firms with a weak financial situation

Firm’s that go into the recession in a weak financial situation will be more vulnerable to a recession.

If a firm has high costs / a high break-even point it will be harder to make a profit, and will have liquidity problems when sales fall. Highly geared firms will have liquidity problems that threaten their survival when income from sales falls.

E.g. BA has high FC compared to low cost rivals, such as Ryan Air, due to relatively high levels of capacity and staff costs. Consequently, in a highly income elastic industry when sales fell, they have made large losses.

E.g. Wolseley plc, a large building and plumbing supplies firm, built up substantial levels of debt before the recession (when banks were more willing to lend and low

interest rates mean that debt is cheap) in order to fund expansion of the firm. High gearing becomes a problem when a fall in sales reduces cash flows and puts pressure on liquidity.

Large firms versus small firms

Large firms will probably be more recession-proof than small firms because they are higher cash reserves (and more assets that can be sold to get cash) when price wars begin.

Small firms are more likely to be short of cash and falling sales will result in liquidity problems threatening the survival of the business.

Bigger firms also find it easier to borrow from banks, have shareholders with deeper pockets and have more bargaining power when asking for discounts from suppliers.A large multinationals will find it relatively easy to get a loan and can put off investment projects to retain cash in order to ease liquidity. A small independent shop has a cash flow position (i.e. less cash in the bank) and needs regular sales to be able to survive.

As a result, the recession is an opportunity for large firms to get market share from small firms. It is also a good opportunity for takeovers because businesses less profitable, share prices are lower and consequently, shareholders want to sell. Larger firms can expand cheaply.

An example is Kraft’s take-over of Cadburys.

Firms that plan for change

If a firm anticipated the recession and has a contingency plan in place this will help them to be quick to respond.

It is preferable for firms to have strategies to deal with a recession in place before it comes along as it is difficult to change things for the better when demand and revenue are falling.

A lesson from the recession was that firms needed to be more ready for greater ups and downs in the economy planning for uncertainty will help.

Contingency planning and risk management would have helped businesses:

- firms would have contingency funs built into their finances, such as bigger overdraft facilities,

- better management of costs to keep costs down

- having higher required rates of return on capital investment

Flexibility in the business model

The flexibility of a firm has a significant influence on its ability to survive and even do well during the recession.

(See later note on ways that a firm can be flexible in long-term strategies in response to the recession)

E.g.: Flexibility - Waitrose's essential range. Usually Waitrose has highly income elastic demand. By quickly introducing their 'essential range' it allowed their customers to trade- down and still shop with them.

Inflexibility will make it harder to survive in the recession. It will make it harder to cut back capacity, reduce costs or provide for customers’ changing needs.

E.g. BA is relatively inflexible compared to rivals such as Ryan Air. BA has more flight slots at the major airports such as Heathrow. Rivals, unlike BA, can reduce capacity easily to cut costs. BA is tied into its flight slots so does not have flexibility to reduce capacity, fixed costs and break-even point.

In addition, BA’s market position was highly differentiated (Porter’s generic matrix). They targeted the high price business sector market. This made it difficult to reposition so customers could trade-down during the recession. They lost sales, while firms such as low cost leader Ryan Air’s sales increased, because firm’s were trading down to economy or low cost flights.

Some firms lack of flexibility due to factors such as stakeholderpower.

E.g.: BA has attempted to introduce cost cutting measures such as redundancies and pay cuts but it’s staff are highly unionised and have taken industrial action that has damaged BA’s image.

E.g. Wolseley has high fixed costs due to high distribution costs and high levels of stock. As a result, the recession tested their flexibility.

Short-term plans a firm may adopt in response to a recession - to help survival (defensive actions)

1. Cut prices / promotions

Discounts or promotions are being used in order to sell excess stock or retain customers. This should improve competitiveness when demand is more price sensitive.

2. Cost minimisation

Many firms have tried to cut costs to maintain net profit margins. Profit margins have fallen due to falling demand but also more competitiveness in the form of price cutting.

Falling demand will also lower the margin of safety between actual output and break-even output. Cost cutting would help by reducing break-even output.

Examples of cost cutting undertaken by firms:

Consolidate suppliers, renegotiate raw material costs or trade-down to cheaper suppliers to push down input costs.

Close or sell off loss-making or low return assets, e.g. poor performing stores

Cut or freeze employee pay (basic and bonuses) Reduce fixed costs Cut back on discretionary spending (non-essential items) to cut

expenses. For example, investment banks are using economy flights and low cost airlines for business travel.

E.g.: % of UK CEOs implemented cost-reduction exercises - 62% of which involved reducing headcount.  Firms have made efforts to increase efficiency.

There are lots of other examples, e.g.: BA, Nissan, etc.

Evaluation

Some firms are less flexible and find it harder to reduce costs, e.g. BA has found it difficult to reduce FC (ref. to earlier notes).

Firms need to stay disciplined on costs, but still may still be worth incurring costs to support innovation,

E.g.: Apple’s innovation during recession or spending to add value to the product.

E.g.: Dominos spending on advertising that persuaded consumers that they were a good substitute for eating out and spending on internet deliveries which increased their speed of deliveries.

3. Cutting marketing spending

4. Cutting research and development spending

5. Reduce investment as part of cost-cutting = cutting capital spending

Business investment fell by around 20% during the recent recession.  That is the worst fall since the late 1960s.  Invesment spending fell most in the manufacturing sector - from the middle of 2008 and the end of 2009, investment spending by the manufacturing sector fell by around 30%.

Cutting back on investment is an effective way of conserving cash, to help liquidity and business survival, in a downturn. For example, postponing or cancelling significant investment projects has an immediate positive effect on cash flow.

The recession means firms expect lower demand, are uncertain about future revenues and, as a result, expect lower returns from investment projects. Investment is perceived to be higher risk during the downturn so businesses have increased their required return from investment (a higher discount rate for NPV calculations). Consequently, investment is less likely.

Examples

Some examples of firms, which cut back their investment:

BT plc aimed to cut capital spending by £100m in 2009, reducing its investment spending to £2.6bn.  However, its capital spending cuts were dwarfed by BT’s objective to cut operating costs by £1bn p.a.

In January 2009, Starbucks announced that it was scaling back its global expansion plans.  It estimated that the decision would cut its capital expenditure for 2009 by around $100m to $600m.

Wolseley, the UK plumbing and building materials group, was another major business, which had to cut capital spending cut costs. Wolseley cut capital expenditure to around £160m for 2009, around half the £317m it spent in 2008.

British Airways was another that cut capital spending in response to the slump in demand and mounting losses. BA cut spending by 20% to £580m in 2008, down from £725m in 2007, and lengthened its schedule of orders for 12 new Airbus A380 aircraft.

Evaluation

Cutting back on investment may affect future productivity, competitiveness and the firm’s ability to take advantage of opportunities during and after the recession.

6. Action to improve cash flow

Reduced revenue and profits have reduced net cash flow. In addition, as a result of the credit crunch, firms have found it harder to borrow. A resulting shortage of cash means they are more likely to have liquidity problems.

Firms have responded by:

Delaying payments to creditors and chase debtors to improve cash flow De-stocking (reducing stock) Significant cuts in business investment, i.e. capital expenditure to

preserve cash Cuts or cancellation of dividends paid to shareholders

E.g. Wolseley plc, a large building and plumbing supplies firm, built up substantial levels of debt before the recession (when banks were more willing to lend and low interest rates mean that debt is cheap) in order to fund expansion of the firm. High gearing becomes a problem when a fall in sales reduces cash flows and puts pressure on liquidity.

7. Cut capacity / redundancies / flexible working

Due to falling demand, it is likely that firms’ capacity utilisation will fall during the recession. Excess capacity increases per unit cost and reduces profitability and cash flow.

Businesses with excess capacity have tried to temporarily or permanently reduce capacity by:

Short-time working or extended un-paid holiday Factory or shift closures Consolidation of production at fewer, larger locations Disposal of non-core operations Cutbacks in previously planned

Examples

JCB has introduced a four-day working week and 50% pay cut.

All the UK major car manufacturers have reduced their production capacity. Firms in the car supplies industry have introduced shorter working weeks, wage freezes, reduced pension contributions and extended shutdowns. Elsewhere, full-timers have been offered part-time work and sabbaticals.

BA has grounded some planes to cut capacity and has asked staff to work part-time, unpaid for a week or take an unpaid holiday.

Evaluation

Longer-term, losing experienced staff could become a problem when demand begins to improve and experienced workers are hard to find.

BA may lose some of its flight slots by grounding flights, which would limit opportunities for future growth.

Some firms, such as Dominos, seeing an opportunity in the recession for accelerating their growth took advantage of cheaper property and fixed assets to actually increase their capacity.

Some firms are less flexible than others so find it hard to reduce staff and capacity, e.g. BA.

Overall evaluation of short-term plans for survival

Short-term defensive actions will potentially damage the ability of a business to exploit short-term and long-term opportunities that arise after the recession.

For example:

Cutting price / sales promotions – risk that customers become used to lower prices and expect high differentiation at low price, which would damange profit margins long-term. In addition, lower prices may undermine the the firm’s highly differentiated market position and firm’s get stuck in the middle (Porter’s Strategic Matrix).

Cutting marketing spending – there is a risk that a business or brand loses customer awareness. It is important for firms to keep a strong brand presence and to communicate with customers.

Cutting investment (capital expenditure) – there is a risk that the business is not able to exploit an upturn in demand when the economy exists recession. Productivity and competitiveness may also fall.

Cutting research and development – there is a risk that a firm’s reputation for innovation is damaged leaving market opportunities for competitors.

Long-term strategies a firm may adopt (offensive strategies)

1. Firms should plan ahead (be strategic) for a recession rather than just reacting to the situation when it arises

It is preferable for firms to have long-term strategies to deal with a recession in place before it comes along as it is difficult to change things for the better when demand and revenue are falling.

A lesson from the recession was that firms needed to be more ready for greater ups and downs in the economy and planning for uncertainty will help.

Contingency planning and risk management would have helped businesses:

firms would have contingency funs built into their finances, such as bigger overdraft facilities,

better management of costs to keep costs down having higher required rates of return on capital investment

2. Increase the flexibility of the business model long-term

The flexibility of a firm has a significant influence on its ability to survive and do well during and after the recession.

Ways that a firm can make itself more flexible:

Capacity can be changed to meet sudden changes in demand, e.g. by suing flexible working, shift patterns and temporary workers.

Operating costs include a high level of variable costs, which fall with demand and hence reduce break-even output, e.g. by making employee wages partly performance-related.

Non-core activities are outsourced to external suppliers who take the risk of falling demand and output

Suppliers are willing to extend credit terms and use JIT systems Be prepared to use sales promotions or change pricing strategies in response

to changing levels of demand Use banks that are willing to extend the firm’s overdraft, or provide loans,

when necessary.

3. Increased innovation A strategy of innovation by investing in research and development will help to create competitive advantage.

E.g.: In an increasingly competitive environment, Nissan-Renault’s CEO aims to

differentiate the firm through innovation by developing an electric car. In addition, by increasing

E.g.: Apple has continued to invest during the recession. It has done this because it’s long-term strategy of maintaining its reputation for developing cutting-edge, innovative products, has been seen to be more important than short-term cost cutting.

The design, development and launch of a new product in Apple’s market sector takes several years so they have had to be committed to long-term investment. This is in contrast to many other firms that have taken a short-term view of investment and have cut back to cut costs.

Apple’s reputation for innovation is a USP that provides competitive advantage. As a result, demand for Apple products are relatively income inelastic and price inelastic.

4. Diversify / search for new markets / segments

One to be better prepared for recession in the future, is to diversify the product range. In this way the business is not too dependent for its profit on cyclical products that have income elastic demand and consequently, sales fall substantially during a recession. Businesses need to include products with income inelastic demand and cheaper, price elastic products in their product portfolio to spread the risk and maintain sales and cash flow during a recession. The earlier example of Waitrose’s own label, ‘essential’ budget range, has helped them to increase their profits.

Another example, is Virgin adding its media service to its airline. The media service, which includes telephone and internet access, is more likely to be recession proof. Selling the existing product in a different way may be an option too. For example selling on the internet rather than having a retail outlet would be a relatively low cost way of expanding that would help liquidity. Many small businesses are also opening at the weekends and trading for longer hours to attract more customers.

E.g. Sony is concerned about the recession and slow future growth rates in the United States, Europe and Japan. It has announced a growth strategy that focuses on emerging markets. Sony’s objective, at the moment, is to increase its annual sales in the BRIC economies (Brazil, Russia, India and China) to 2000 billion yen by 2010. It aims to achieve continued fast growth in these and new emerging markets in the long term.

Evaluation

However, there may be a risk to the brand of diversification such as moving down market. Firms may alienate their existing, loyal customers if they do this. In addition, the cost of diversification should be taken into account, the resources

required, such as manpower, and thorough research is needed to ensure sufficient demand.

5. Long-term efficiency drives

The aim of efficiency drives is to reduce average costs and the firm’s break-even point.

E.g. BA’s plan to merge with Iberia aims to increase efficiency and reduce average costs by achieving economies of scale.

6. Increase investment and training

Firms should improve productivity by improving technology or skills to reduce AC to allow a firm to survive on less income in future.

Firms that continue with expansion plans during the recession can take advantage of short-term opportunities that the recession creates.

E.g.: Dominos benefits from consumers trading down from restaurants and people who have lost their jobs and want to open outlets as a new start in employment.

Evaluation

An offensive strategy means sticking to long-term objectives. There is a danger that management can be reckless and over-optimistic.

7. Stronger branding, improved customer service and quality

Some firms have invested in branding or measures that help maintain high levels of quality and customer service. Creates competitive advantage in this way attracts customers that are looking for ‘quality for money.’

E.g.: Dominos invested in brand promotion (advertising and sponsorship of ‘X Factor’) to persuade consumers that they were a good value substitute for eating out. They also exploited the increased use of online buying by investing in their internet delivery service. Online deliveries increased the speed of deliveries which provided them with competitive advantage.

Evaluation of long-term strategies

An offensive strategy in a recession sees the downturn as an opportunity to build market share when competitors are at their weakest.

Whether an offensive strategy works depends on the nature of the market:

- In a cyclical industry with income elastic demand will fall significantly during a recession (e.g. construction, airlines, house building and premium restaurants). It would be difficult to attack the competition in these markets.

- In a market where demand is relatively stable or rising, an offensive strategy is more likely to work, (e.g. fast food has grown during the recession).

- It would be difficult to use an offensive strategy without some form of differentiation or competitive advantage. If competitive advantage does not exist, then offensive actions may result in higher costs, lower cash and potential business failure.

o E.g. Dominos’ has gained a competitive advantage from consumers trading down from eating out, its effective brand promotion and use of online ordering to increase the speed of deliveries.

Factors influencing the strategies businesses adopt in the recession

1. They type of industry or product – whether it is cyclical or has income elastic demand: In a cyclical industry with income elastic demand will fall significantly during

a recession (e.g. construction, airlines, house building and premium restaurants). It would be difficult to use offensive strategies (attack the competition) in these markets. Short-term survival or cost cutting would be more appropriate.

In a market where demand is relatively stable or rising, an offensive strategy is more likely to work, (e.g. fast food has grown during the recession).

It would be difficult to use an offensive strategy without some form of differentiation or competitive advantage. If competitive advantage does not exist, then offensive actions may result in higher costs, lower cash and potential business failure.o E.g. Dominos’ has gained a competitive advantage from consumers

trading down from eating out, its effective brand promotion and use of online ordering to increase the speed of deliveries.

2. The financial position of the firm when it enters the recession.

If a firm has a weak financial position when it goes into the recession, short-term cost cutting and survival will be important.

Firms with a weak financial position have high costs / a high break-even point high gearing a weak balance sheet ( high debts / few creditors / few assets and cash)

These firms will have liquidity problems that threaten their survival when income from sales falls.

3. Large firms versus small firms

Large firms will probably be more recession-proof than small firms because they are higher cash reserves (and more assets that can be sold to get cash) when price wars begin.

Small firms are more likely to be short of cash and falling sales will result in liquidity problems threatening the survival of the business. Therefore, small firms are more likely to be concerned with survival and use short-term cost cutting strategies.

As a result, the recession is an opportunity for large firms to get market share from small firms. It is also a good opportunity for takeovers because businesses less

profitable, share prices are lower and consequently, shareholders want to sell. Larger firms can expand cheaply.

Therefore, large firms are more likely to use offensive strategies

4. The amount of competition in the market

Strategies businesses could have adopted to prepare for the recession

1. Firms should plan ahead (be strategic) for a recession rather than just reacting to the situation when it arises

It is preferable for firms to have long-term strategies to deal with a recession in place before it comes along as it is difficult to change things for the better when demand and revenue are falling.

A lesson from the recession was that firms needed to be more ready for greater ups and downs in the economy and planning for uncertainty will help.

Contingency planning and risk management would have helped businesses:

firms would have contingency funs built into their finances, such as bigger overdraft facilities,

better management of costs to keep costs down having higher required rates of return on capital investment

2. Increase the flexibility of the business model long-term

The flexibility of a firm has a significant influence on its ability to survive and do well during and after the recession.

Ways that a firm can make itself more flexible:

Capacity can be changed to meet sudden changes in demand, e.g. by suing flexible working, shift patterns and temporary workers.

Operating costs include a high level of variable costs, which fall with demand and hence reduce break-even output, e.g. by making employee wages partly performance-related.

Non-core activities are outsourced to external suppliers who take the risk of falling demand and output

Suppliers are willing to extend credit terms and use JIT systems Be prepared to use sales promotions or change pricing strategies in response

to changing levels of demand Use banks that are willing to extend the firm’s overdraft, or provide loans,

when necessary.

The possible impact of the recession on stakeholders and on relationships between businesses

(Note that BA is an excellent example to use for this issue – use the BA essay answer). Possible conflicts to result from short-term, defensive, cost minimisation: Employee stakeholders

Conflict with employees is likely to result from reduced capacity, job losses, short-time working and pay freezes and cuts.

Job shedding and conflict will reduce employee morale and creates uncertainty and anxiety, which will demotivate staff. As in the case of BA, there may be industrial action. This would have a negative effect on customer service, brand loyalty and the firm’s image.

Evaluation

The size of cost cutting will determine the extent of the conflict with staff.

Customer stakeholders

Cost cutting may reduce the service. Having less staff affects the quality of service and industrial action could inconvenience some customers and result in customer dissatisfaction. This would damage the firm’s image and customer loyalty.

If a firm reduces stock to maximise cash flow, there will be lower stock availability for customers. This could also create customer dissatisfaction.

If the firm’s image is severely damaged, the firm could place itself at a long-term competitive advantage.

Evaluation

The extent that competitiveness is damaged will depend on the competitiveness of the industry and how easy it is to switch to competitors.

E.g.: The airline is highly competitive and it is easy for customers, including business customers, to switch to low cost competitors.

Shareholder stakeholders

If the company is a plc, it is quoted on the stock market and shareholders are key stakeholders. Management is likely to focus on the needs of shareholders and the aim of cost minimisation is to cut losses, which would benefit shareholders.

BA's share price and has fallen significantly during the recession (refer to graph) and the firm made a £401m loss during 2009. Therefore, cost cutting should be in their interest. Conflict between stakeholders

Different stakeholder interests will probably conflict. Shareholders’ interests will be served by cost-cutting but other stakeholders’ interests won’t be. However, the resulting damage to the firm’s image could affect long-term profits and not be in the interests of shareholders.

Evaluation of the extent of the impact of the recession on stakeholders and the relationship between stakeholders.

The extent of the effect on stakeholders and relationships with stakeholders depends on:

- The extent of cost cutting. E.g. BA’s cost-cutting was substantial so the risk of confrontation with stakeholders was significant.

- The business culture and leadership style affects the likelihood of conflict. E.g. BA’s leadership style is confrontational and this increased the chances of conflict.

- The power of different stakeholders. E.g.: BAs staff are highly unionised so conflict was more likely.

- The effectiveness of how the change was managed is an issue. This includes how well the issues and actions are communicated to stakeholders and they are involved in decision-making about changes.

The case for and against different businesses and industries receiving government financial support during a recession

In 2008/9, the government gave 2 types of financial assistance:

1. Specific help to key industries – cars and banking

2. General help – e.g. tax payment schemes, loan guarantee schemes for nearly all firms.

Arguments for government financial support during a recession

1. Subsidies or other support helps to protect employment in strategic industries (industries that are key to the health of the UK economy) and also preserves skills and experience.

Examples of strategic industries are the car industry and banking. The car industry is strategic because of the number of jobs in the industry itself as well as supporting industries, such as steel and other car component manufacturers.

Banking is strategic because collapse of the banks would lead to a melt-down of the whole UK financial system and protecting individual savings.

2. The negative effects of higher unemployment can be prevented by government support schemes. For most businesses the best reason to maintain employment is continued demand for products and services.

The car scrappage scheme was also consistent with a government strategy of supporting the manufacturing sector – which has diminished in importance in recent decades. The credit crunch highlighted the over-reliance of the UK economy on financial services, and many commentators pointed out the need for the UK to balance its economy back towards manufacturing (particularly those industries where the UK could increase exports).

Evaluation

The scale of the downturn in the car industry made some form of intervention inevitable. Also, other European governments moved quicker to support their car manufacturers than the UK.

However, was the government right to only support the car industry and banks?

The steel industry has claimed that the government should have done more to help the industry. For example, in the Netherlands the government provided 70% of workers wages as an alternative to employment. However, the issue for the

government is that steel production is much less important to the UK economy than it was in the past.

Arguments against government financial support during a recession

1. Firms or industries that require support are likely to be either in decline, or unable to operate efficiently on their own.

2. Government support should be focused on encouraging the growth of new firms or emerging industries, rather than propping up the declining or inefficient.

Why should taxpayers bear the cost of subsidising inefficient businesses or industries? In particular, why should the government support industries, such as the car industry, that are largely under foreign ownership?

3. Firms and industries may become reliant on government support, or come to expect further bailouts in future if market conditions deteriorate.

Ev – However, if the government didn’t intervene the effects of the recession would be worse. Unemployment would be higher and there would be a greater fall in demand for other businesses.