Why is Britain’s economy shrinking?

The Chancellor was speaking after official figures showed that the economy shrank by 0.2 per cent in the last three months of 2011 – a sign that we may be heading back into recession.

He said the unwelcome news was “not entirely unexpected because of what’s happening in the world and what’s happening in the eurozone crisis”. Mr Osborne added that resolving the country’s debt problems was “made more difficult by the situation in the eurozone.”

His strategy to reduce Britain’s deficit by cutting spending and raising taxes has won the backing of the head of the International Monetary Fund, Christine Lagarde, who told Channel 4 News on Wednesday that it was the only way to solve the country’s financial problems.

Austerity

Asked if the government could ease its austerity programme, Ms Lagarde said: “I am afraid not. Those countries that have fiscal space, and that can slow down their fiscal consolidation efforts, are very few, and I am afraid that Britain is not in that group.”

So is debt in the eurozone responsible for this decline in growth in Britain or are there other factors at play? According to the Office for National Statistics (ONS), which compiled the growth figures, the decline was caused by a fall in production. Manufacturing was responsible for half of the fall, with gas and electricity extraction and supply responsible for the other 50 per cent.

The warm weather in the autumn meant people were less likely to turn on their heating. Their behaviour saved them money on their bills and helped to keep down carbon emissions, but it did not benefit the economy. The irony is that the last time growth declined, in the final quarter of 2010, the freezing weather was blamed for undermining economic activity.

Construction sector output declined by 0.5 per cent in the last three months of 2011. This small drop did not have much of an effect on the overall figures, but the sector is braced for several tough years ahead – with talk of a “lost decade in construction”, exacerbated by big cuts in public spending (more later).

Incomes ‘squeezed’

Vicky Redwood, chief UK economist at Capital Economics, told Channel 4 News the eurozone crisis was not the main reason for the economy shrinking in the fourth quarter of 2011.

“We would say it is a factor, perhaps not the most important one. High inflation and the squeeze on household incomes is a bigger factor,” she said. “The underlying trend in exports has been weak, but the trade deficit improved in Q4. It is not obvious it is trade that has driven this.”

But Ms Redwood said banks were facing higher funding costs as a result of what was happening in the eurozone and there was a general lack of confidence.

Weak demand

The Engineering Employers’ Federation (EEF), which represents manufacturers, is convinced weaker demand in Europe is affecting British companies.

EEF chief economist Lee Hopley said: “Clearly the turbulence in manufacturers’ major markets in Europe has gone past depressing only sentiment and is now holding back production.”

But Ms Hopley said a survey of top manufacturing executives had shown that they were positive about 2012 and were hoping to take advantage of opportunities outside Europe.

Declining orders

A survey by the employers’ organisation, the Confederation of British Industry (CBI), is less bullish. It found that domestic and export orders fell in January for the first time in two years, with production weakening sharply over the past three months.

CBI chief economic adviser Ian McCafferty said: “While the acute fears seen at the end of last year over global demand may be subsiding, 2012 will prove to be a difficult year for UK manufacturing, as the crisis in the eurozone, our biggest export market, has yet to reach any definitive resolution.”

House building

The Home Builders’ Federation, whose members construct 80 per cent of private homes in England and Wales every year, argues that building is not keeping up with demand because would-be housebuyers are still struggling to obtain loans.

But the organisation’s spokesman told Channel 4 News that the sector had already taken a hit and was not faring as badly as other parts of the construction industry. “Private house building is one of the areas that has not dropped because it did its dropping a couple of years ago,” he said.

But the commercial property sector is more of a concern. A spokesman for the British Property Federation (BPF), which represents developers, told Channel 4 News: “Development finance has dried up quite radically, even on schemes that have tenants in place.”

The BPF says the debt crisis in the EU is also having an effect, while work on London’s Pinnacle office block, mooted as the capital’s tallest skyscraper, has stopped at the seventh floor because of a lack of tenants.

Infrastructure

The construction industry as a whole, including companies involved in infrastructure such as roads and schools, is worried. A five-year forecast from the Construction Industry Training Board-ConstructionSkills, predicts that output will fall by 3 per cent in 2012, with 45,000 skilled workers and tradesmen losing their jobs.

It says that while activity is likely to rise in 2013, it will fall again in 2014-16, meaning that in four years’ time the industry will not have returned to its 2007-08 peak.

Deputy chairman Judy Lowe said: “The sluggish return to growth means that we could be talking about a lost decade in construction and a loss of key trade skills. But the real shock is the impact that cuts to public sector spending has had.”

While George Osborne has a point about events in the eurozone damaging the British economy, Ms Lowe is not the first person to question the effect his austerity programme could be having on UK PLC.