28/12/2011 08:01 GMT

2012 Preview: Will The UK Economy Force George Osborne To Think The Unthinkable?

As the year draws to a close, experts are lining up to say there will be another recession in the UK economy next year, and many economists have downgraded their earlier forecasts. The eurozone crisis is far from resolved, the UK’s deficit reduction plan has hit the buffers and unemployment is still rising. Some commentators believe chancellor will have to think the unthinkable in his next budget in March 2012, if he’s to kick-start the economy.

Although there was some Christmas cheer for George Osborne when GDP for the third quarter was revised up to 0.6%, few expect the fourth quarter to be as rosy. Predictions for 2012 have come from the International Monetary Fund (IMF), which cut global growth forecasts next year from 2.3% to 1.6%; the British Chambers of Commerce (BCC) downgraded their forecast to 8% in 2012 (from 2.1%), saying things would improve “gradually”. Standard Chartered recently predicted we would start 2012 in recession.

The former chief economist at the Institute for Public Policy Research, Howard Reed, agrees that the outlook for the coming year is “pretty bad”.

“Goldman Sachs predicted there would be a 40% chance of a eurozone breakup. If that happens there would be a serious recession. But that is the worse-case scenario.”

But Howard Reed says while there’s been talk of things starting off slow and picking up, “the truth is, people don’t really know how bad it might get.”

Political commentator Neal Lawson thinks the problem is this is not a “cyclical occurrence” which can be examined, but a “systematic crisis of capitalism”, one which could affect every government department, not just the Treasury.

“There are underlying issues. The gap between output and wages means wealth is concentrated at the top, investment for the rich is mismatched between demand and supply. In the 1920s the same thing happened before the depression, there was too much wealth at the top.”

Lawson expects 2012 to see a meaningful rise in antipathy towards the coalition as cuts really begin to bite. “People will feel increasingly alienated and all political parties will be tested. Members of the public feel disconnected from politics, as evident from the activities of Occupy London. There needs to be a bigger push. I am not sure how things will pan out, there could be more riots or a rise of the hard right.”

And with such a bleak picture, if we listen to economic forecasts, what should we expect from the next recession, if it comes?

Chief forecaster at the National Institute of Social and Economic Research, Simon Kirby, said: “The economic output in the UK means that growth will stagnate at the start of next year and return later in 2012”.

“One of the main things affecting our forecast is business investment. Business investment will fall because of uncertainty about the future. People are uncertain about what will happen in the euro area and this could lead to a longer recession.”

Howard Reed thinks a short shallow recession is more likely, lasting for the first six months of 2012. “The idea is that you would then get a return to growth later in 2012, but I think it might be worse than that”, he said.

“It seems in the current conditions we aren't thinking about bouncing back. The austerity cuts have taken the demand out of the economy, people don't want to spend money and businesses don't want to invest.”

“Even if things pick up slightly in 2012 I think there will be fairly sluggish growth,” he commented.

The honest answer to what will happen with the economy next year is that nobody knows. Forecasting involves risk and uncertainty it is by definition an estimation of the unknown. All of 2011’s forecasts - domestic and international - were revised down during the course of the year. But will the likely double-dip mean Osborne's forced to take some form of remedial action in next spring’s Budget on the 21st of March?

Vicky Pryce, former head of the government’s Economy Service, thinks the Chancellor still has options, but some of them will come at a heavy political cost.

“He will have to introduce temporary tax cuts, as long as they’re sold as temporary. It could well be VAT because you can do that quickly. He could also accelerate the cut in corporation tax. He did it last year, he can do it again,” she told HuffPostUK.

Her assessment is that Britain is in a relatively strong position, despite the uncertainty. “Osborne can borrow more if we wants to, because the markets see the UK as a relatively safe haven, given what’s happening in the eurozone,” says Pryce, who argues that there is a case for more public spending if it’s properly targeted.

“Construction has a substantial impact on the economy because all the money is spent here in the UK, and it has a high economic multiplier. More public spending on infrastructure could be the only area of public spending he could look at.”

But Pryce believes this will come at a high price politically. “The ringfences around health and international development may need to be looked at again. I can’t see how the ringfence on health can be maintained because it’s just too expensive.”

Cutting the NHS? A key election pledge broken? Surely impossibly politically. But Vicky Pryce believes this will be the year that election promises may have to be broken. “When you’re in an economic crisis you have to be absolutely focused on getting growth. Everything needs to be looked at again.”

Not everyone expects such radical action, though, even if it were desirable. Andrew Goodwin, senior economic adviser at Ernst and Young ITEM Club, expects Osborne to adopt a steady-as-she-goes approach, even though he agrees a recession in early 2012 is highly likely.

“They’ve placed such a great emphasis on the credit rating and the austerity package they won’t want to deviate unless the recession is significant,” he told Huffpost UK. “We don’t think the VAT cut had a big impact when it was tried by Alastair Darling. It’s incredibly costly and not really an effective weapon. You’d add £10 billion a year to the borrowing costs and it would make the credit rating agencies nervous.”

But Goodwin agrees that 2012 is going to give the government a rough ride, even if the eurozone crisis resolves itself reasonably well.

“Politics is going to get ever harder,” he said. “Were we to go into recession and if growth forecasts were not met again, the Office of Budget Responsibility might force the Chancellor to look at other ways of scaling back. That gets harder politically as we go further into the parliament and the next election nears.

“Obviously if things get significantly worse and we have a disorderly default in the eurozone then things will have to be changed. There are whole range of different possibilities, from one country leaving the eurozone to four or five of them exiting the single currency.

“Each of those will have different effects, and will have a wide variance of shocks to GDP growth in the UK. If it’s just Greece leaving the eurozone it would have a fairly small effect on our economy. If it’s four or five countries leaving then it would be a shock similar to the 2008 recession, and would need a major policy response.”