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Analysis - Tony Travers

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The Northern Rock episode has come as a nasty shock

The sight of queues of people waiting to withdraw their cash from a British high street bank will have struck many as alarming. And it was. Societies like ours rely on fundamentals like a sound banking and a fully-functioning legal system. Indeed, a developed democracy cannot function without banks, property rights and public order.

Chancellor Alistair Darling made attempts to calm the situation at the start of the week. Given the low esteem in which leading politicians are held, this was a brave strategy. Money continued to haemorrhage out of Northern Rock, requiring a second, copper-bottomed, government commitment to guarantee savings. Initially, savers ignored the advice of the chancellor, the governor of the Bank of England and Northern Rock's own chief executive. No one trusts anyone in power these days.

The Opposition has attempted to pin the blame on the government. If the UK economy takes a hit as a result of troubles in the domestic and US capital markets, there will almost certainly be an impact on economic growth. Indeed, it is almost certain now that house prices and the economy more generally will face an uncertain winter.

Of course if, as ministers argue, the "fundamentals of the economy are sound", Britain may escape with no more than a small dent to its output. But some commentators believe the country is facing its first recession for over 15 years. The consequences of such a contraction, if it occurred, would be profound.

Several spheres of public policy now operate on the assumption of continuous economic growth. For example, the regeneration of declined industrial areas depends on developers wanting to undertake projects to build offices, shops and flats. Local government has been able to encourage the rebuilding of large areas of older towns and cities in this way.

A recession would delay or kill many developments. Unemployment would rise, creating additional problems, particularly in places which had never reached full employment. The government's efforts to increase house building could also be left high and dry, though a fall in house prices would improve affordability.

A slump would also increase pressure on the government to cut public expenditure. State spending as a percentage
of gross domestic product has increased sharply since 2000. An economic downturn could increase the figure to 45% or more, which would be uncomfortably high by recent UK standards. There would be demands to cut central and local programmes. Of course, it may not come to this. The British economy has proved remarkably robust in recent years. But it has also been lucky - particularly when the Blair government's hike in public spending coincided with a global slow-down in 2001-02. However, 'events' eventually catch up with all governments.

The Northern Rock debacle may not yet be Labour's Black Wednesday, but it has been a nasty shock for the government and the economy.

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