IntroductionThe crisis period of austerity and its effects
Posted On June 4, 2019
IntroductionThe global financial crisis has been recorded as one of the most controversial economic disasters to have affected the UK economy in recent years. The crisis has shaped the current commercial business sector after causing a collapse in international and in some cases instigating trends of negative economic growth. There are many debates to where the crisis originated, however the most appraised argument contends that the roots of the crisis can be traced back to the deregulation of the financial markets within the United States and the collapse of the ‘Lehman Brothers bank.’ Howard, D. (2014) The impact of the crisis was felt throughout the global economy, including the UK with virtually everyone being affected in some way. This paper will evaluate the impacts of the crisis on the UK and on the UK labour market in particular, including the post crisis period of austerity and its effects on the economy. This project will analyse both the material and ideational effects on the UK domestic economy while referring to long `standing traditional International Relations theory of idealism and materialism using the following research aims:To evaluate the impact of the financial crisis on the UK finance sector.To assess the impact of the financial crisis on the housing market within the UK.To examine the case for Austerity within the UK following the crisis.This project will investigate the above research aims guided by analysis of relevant sources from economists and other academic articles. The term ‘ideas’ can be defined as “…subjective claims about descriptions of the world” (Parsons, C. 2002). Within this example, it is important to understand that ideas can effect change in international relations through their ability to empower people through discourse. In terms of materialism, material forces can be defined as factors which exist independently of other factors which within the state system. (Ashley, R. K. 1981). This paper will therefore aim to evaluate the direct effects in terms of materialism and idealism of the financial crisis on the economic system in terms of the financial markets, the housing market and the means for austerity in the post recession period. Outline of the crisisThe global financial crisis between 2007 and 2009 caused excessive credit growth within the global economy. In the UK context, the starting point could be marked by the depositor run on Northern Rock in September 2007, whereby Northern Rock asked the Bank of England for emergency funding. However, other arguments contend that the global financial crisis began in the United States after a deregulation in the financial industry. (Chatterjee, S. Chiu, C-W. Duprey, T & Hoke, S. H. 2017). After a period of positive economic growth and strong business confidence, investment and mortgage lending was on the rise within the US and rest of the world. The rise in GDP and confidence within the economy coincided with the increase in mortgage lending and in particular, this acted in conjunction with a rise in subprime mortgages. The creation of the housing bubble and rapid increase in subprime mortgages followed this period of economic growth. (Helleiner 2011 p, 69). As a result of this, there was an appreciation in the housing market as credit became easily and more readily available. Furthermore In addition to this, it is important to note that within this period of time and as a result of the subprime mortgages there was an “aggressive buildup” of household debt within developed economies which in turn acted as a catalyst for the crisis. (Ciro, T. 2012. P, 32) The effect was to liberalise credit and effectively fuel an outwards expansion of personal and mortgage debt. Additionally, the rise in subprime loans coincided with the rise in Collateralized Debt Organisation (CDO), whereby the CDO became an engine that essentially powered the mortgage supply chain and in addition to this, encouraged the further sale of subprime mortgages and other ‘BBB’ mortgages. (Frank J. Fabozzi, CFA, Laurie S. Goodman 2001). Bank credit within the United States was primarily granted to the middle class, however as confidence within the economy grew and interest rates continued to fall, bank loans were given to high risk low income families and groups of people through subprime mortgages as previously mentioned. However, as a consequence of this, large mortgage lending firms such as ‘Fannie Mae’ and ‘Freddie Mac’ started to report large financial losses and began slowing down their economic output, in doing so, these institutions made severe cutbacks to their workforce. (Peterson, C.L. 2009) The burst of the housing bubble and the collapse of the ‘Lehman Brothers Bank’ was to follow and it sent substantial exogenous shocks world wide, affecting trade and business confidence as a result of the increasingly interconnected global economy. (KPMG 2017) The crisis damaged international institutions, national economies and reduced global trade as both firms and individuals began cutting back on spending which ultimately resulted in a fall in Aggregate Demand and the beginning of an economic recession. Many different economies and businesses were affected in different ways, in particular, this paper will address the implications upon the UK economy and the finance sector which experienced major setbacks in the 2008 crisis resulting in multiple firms filing redundancies and contributing to both the rise in unemployment and the rapid deceleration of economic output.Section one: Impact on the UK finance sectorThe recession of 2008 was the first instance whereby the UK economy had experienced consecutive periods of negative economic growth. (Aldohni, K. A.2016). The initial setback for the UK consisted of an immediate cut back in investments and a steep fall in the availability of credit within the economy. Credit became an important aspect of world economics within the 21st century, within an economy such as the UK the availability of credit allows individuals and businesses to borrow money in order to either make business investments to increase manufacturing capacity for example or in terms of individuals, to buy goods on credit and take out mortgages. Furthermore, the availability of credit within an economy is also important for the government, as often banks lend money to governments in order to fund the building of infrastructure. (Murphy, D 2009). Therefore it is important to understand the growing importance of credit within the 21st century and how an economy which has been starved of credit lacks economic incentive and is likely to experience a recession due to a fall in business confidence. The effects of a decline in investment can be illustrated in the following diagram, labelled: Fig. 1. This diagram illustrates a decline in Aggregate Demand within the economy as illustrated by the move from ‘AD’ to ‘AD2’ and the reduction in Real National Output or Real GDP as illustrated by the shift from ‘Ye’ to ‘Y2’. When an economy experiences a decline in the demand for products it is also likely that there will be a decline in the supply of products, however in order to offset losses made within the economy, firms are likely to reduce the prices of their goods. This is illustrated by the move from ‘Pe’ to ‘P2’. Fig. 1. (Demand shift to the left. PL & Real GDP) Fig. 1. Illustrates a shift in aggregate demand within an economy. Aggregate Demand consists of Consumer expenditure (C ) plus Investment (I) plus Government spending (G) plus (Exports (X) minus Imports (M)). Therefore a fall within any of these components is likely to contribute to a slump within the economic cycle. In terms of the 2008 Financial Crisis, business confidence resulted in a reduction in investment within the UK domestic economy and a fall in the UK’s real GDP, as illustrated on Fig. 1 by a shift from ‘Ye’ to ‘Y2.’ Moreover as firms cut back on investment, this would result in a fall in exports as economic activity slows down, thus consequently it is likely that unemployment would rise as a result of firms laying off workers. This refers to Okun’s law whereby one refers to the link between labour and capital and the theory of the derived demand between, for example, the demand for labour within the economy is derived from the demand for goods and services. (Prachowny, M. F. J. 1993) Furthermore, it is important to understand that the effects of the Financial Crisis developed into a ‘Negative Multiplier Effect’ whereby the initial impact of the crisis had a knock on effect on other sectors and components within the economy. (Allen, R. E. 2016) In terms of material impact within the UK economy, the immediate impression, arguably would be the depreciation of the country’s economic output whereby the UK economy began operating within its production possibility frontier. However in terms of the ideational impact of a recession, the immediate ideational impacts arguably refer to the large spikes in unemployment within the UK economy in 2008. (Allen, R. E. 2016) Large cutbacks within the financial sector consequently led to numerous workers being made unemployed as firms slowed down their output. (Allen, R. E. 2016) In addition to this, other sectors were dramatically affected by unemployment, for example as consumers cut back on spending the retail sector was significantly affected by the recession. A prime example of this is the retail store, ‘Woolworths’ which closed down as a result of “rising rents and a recession induced cash crisis” (Pearson, S. 2009). Therefore, one could classify the ideational effect of the crisis as the potential impact in the available income of people in some cases can cause a fall in the standard of living. Section two: Impact on the housing market.The housing market within the United Kingdom was also affected by the Global Financial Crisis in 2008. The crisis made getting on the property ladder very difficult for first time buyers and consequently increased demands on the private sector. (Savills 2017) The short term effects of the financial crisis were dramatic, whereby the average house prices within the UK “fell by 20% in 16 months.” (Savills 2017) this can be identified as the trough of the UK housing market according to Nationwide’s Monthly Indices which illustrates the Average House Pricing in the UK from November 2007 to 2009. Within this period it is most noticeable that there is a steady decline in the average prices of housing within the UK up until March 2009, where the average price begins to rise. Fig. 2. Illustrates the fluctuations within the UK housing market from October 2007 to October 2009, Source: (Nationwide 2017) Fig. 2. (UK House Prices 2007-09. Data Retrieved from: Nationwide)The continuing pressures on the UK economy had a direct effect on the business confidence and the value of the housing market and in conjunction contributed to the depreciation of the property market. The level of the availability of credit in the final quarter of 2007 prevented many first time buyers from being able to take out mortgages, thus further contributing to what has been identified as the “dramatic slump” in spending and transactions on new homes. (Savills 2017) Consequently, many individuals relied heavily on the “bank of mum and dad,” due to the fact that the slump in house prices and reduction in the availability of credit confined many individuals to renting property. (Savills 2017) The level of economic confidence within the UK during the recession further contributed to the demise of the property market. Reductions in both Consumer expenditure and investment acted in conjunction with significant rises in interest rates resulting in individuals and firms withholding their money and reducing their spending. This section has assessed the material implications of the financial markets on the property market within the UK. In terms of the ideational implications of the UK housing market, effects majorly derived from the economic downturn and availability of credit within the economy. Many individuals were unable to apply for mortgages as banks were simply not giving out loans, consequently resulting in a fall in demand for houses and a fall in the average pricing of houses within the UK.Section three: The Case for AusterityFirstly, Austerity refers to an economy undergoing a period of voluntary deflation in which the economy adjusts through the reduction of wages, prices and public spending in order to restore economic competitiveness. This refers to a government cutting the state’s budget, in order to cut national debt and national deficits. (Blyth, M 2013) In terms of the material implications upon the deregulation of a state, austerity measures have the potential to pose great threats and develop further issues for an economy following a period of economic recession. As mentioned above, Austerity measures aim to reduce government deficits through the administration of cutbacks on government spending and increases in tax within the chosen state. (Callan, T, Leventi, H, Levy, H, Mastaganis, M, Paulus, A, Sutherland, H. 2011) However, following a recession the most common outcome for the majority of the population would likely culminate in groups of people cutting back on spending also. Initially, the observable material impacts could involve a period of stagnation within the economy affecting economic output and therefore potentially resulting in a progressed period of unemployment within the economy. (Sen, A. 2015) Furthermore, the ideational implications entangled with Austerity measures are likely to be revolved around increased unemployment and groups of people affected by income poverty. (Callan, T. et. al. 2011). WIthin the period of austerity within the UK, the government had cut nearly “£75.2 billion from its social spending” (O’Hara, M. 2015) In addition to this, it is important to note the ideational effects of such reductions in social spending. For example, according to (O’Hara, M. 2015) half of the cuts were targeted towards reductions in cash benefits and local government employment. Moreover, Austerity measures have been responsible for cuts made to the benefits available to disabled people and health care. This has made for many of the ideational effects associated with Austerity in the post financial crisis period. (Clark, D. 2016) Moreover, it should be noted that the measures introduced within the UK austerity are likely to have contributed to the level of income inequality within the UK economy. (Callan, T. et. al. 2011) It is likely that further ideational effects would derive from the length of time at which one is in a state of recession, thus affecting the level of inequality within the economy as in terms of economic policies to orchestrate an economic recovery, Austerity tends to be one with long term results. (BBC 2010) This can also be illustrated on a diagram, see fig. 3. The diagram illustrates an increase in Aggregate Demand from ‘AD1’ to ‘AD2’ over a Long Run Average Supply curve, this applies to Austerity within a state as it is a concept, as previously mentioned, with long run effects. LRAS Fig. 3. ConclusionTo conclude, this paper has illustrated both the material and the ideational effects associated with the Global Financial Crisis of 2008. As a result of the poor banking decisions made across developed economies and the confidence in “free money” such as loans and mortgages economies suffered in what has been identified as “an almost perfect storm” (Ciro, T 2012, p, 32) Following the research aims, one could say that the global financial crisis had drastic implications upon the financial market and the unemployment rate within the economy. As illustrated within section one of this paper, it is possible to suggest that the most significant effect forced upon the economy derived from the collapse in economic confidence and the level of economic output at which the UK was operating at. Moreover, when the dust settled from the Global Financial Crisis millions of people were made unemployed and homeless worldwide, it is important to note that the one of the primary ideational impacts to have occured is the fact that people worldwide were forced from their homes and left without jobs. Furthermore, this paper has further illustrated the case for Austerity within the UK as a means to stimulate an economic recovery. However, as illustrated in section three of this paper one could suggest that the measures presented by Austerity not only worsened the state of recession but also elongated the period to economic recovery. For example, the deregulation of markets and the cutbacks made on groups of people classified as being in a state of income poverty had significant effects on income inequalities and therefore furthering the ideational effects of the crisis. (Welch, L. 2012). Moreover, one could further present the argument that the ideational effects of the Global Financial Crisis were far greater than those classified as material, based on the notion that the recession affected different groups of people from different ends of the wage spectrum in different ways, groups of people on a considerable lower income are likely to have lost their homes and their jobs.