Macro AND Microeconomic Effect Of 2008 Recession On The UK Economy AND Tesco Essay

Introduction

The Great Depression of 2008 was one of the most impactful among all the recessions that took place in the world till date. The subprime recession of 2008 can only be compared with the Great Depression of the 1930s in terms of negative GDP (gross domestic product) growth, job loss, deterioration in wage rate, and decrease in total economic value for private and public organizations. The impact of the 2008 recession was felt all across the globe even though the recession started in the USA. The United Kingdom that largely followed the same expansionary fiscal policies like the USA witnessed boom in the housing prices similar to that of the USA. Also, due to poor financial credit checking mechanism available in the financial market, banks were able to disburse loans even to financially distressed borrowers. This certainly resulted in housing and economic boom in the early 2000. However, when the housing prices stagnated, some of the borrowers were unable to repay loans on time, which created distress among banks and mortgaged underwriters (Cadman, Bernard and Pearson). Some of them started defaulting because of liquidity crunch. Due to the huge size of the real estate market, the overall economy plunged into recession. Many nations have used different fiscal and monetary policy measures in response to the global recession. Starting from government spending and tax cuts, nations have used both monetary policies and austerity measures to address the situation with varying results. The United Kingdom mostly stuck to a discretionary monetary policy followed by an expansionary monetary policy.
Retail segments often closely follow the economic movement of a country. Almost all micro and macroeconomic parameters directly or indirectly impact big retailers. Tesco is the largest retailer in the UK. It certainly felt the impact of 2008 subprime recession. The government monetary and fiscal policies also affected the operation and profitability of Tesco. This essay will primarily examine different fiscal and monetary policies undertaken to reduce the effect of 2008 subprime recession and it will also explore the effect of different micro and macroeconomic parameters on Tesco.

Micro and Macroeconomic Economic Policies Post-recession

Before the Great Depression of the 1930s, it was believed that monetary policies could alone address the recessionary conditions. However, upon going through several recession cycles over the last 80 years, most of the economists now agree that monetary policies cannot often create a long term solution to a recession. A combination of fiscal and monetary policies is required to address the short term needs and create an infrastructure for long term sustainable growth (Cadman, Bernard and Pearson). The government uses macro and microeconomic policies such as taxation, government spending, adjustment of prime interest rate, and adjustment of custom duties to steer economy in the right direction.

Possible Fiscal Policy Approaches

After the recession of 2008, the UK government could have taken two different approaches to restore the economy to a normal growth path; expansionary approach and austerity approach. Though expansionary measures would have worked well in the short term, they would have increased the government debt in the long run (Cadman, Bernard and Pearson). On the other hand, if the government would have employed a policy that mainly focused on austerity measures, then in the short term, the GDP would have shrunk and the unemployment rate would have gone up. However, in the long run, recovery from the recession would have been more robust and marked based (Cadman, Bernard and Pearson).

Macroeconomic Policies

Like the USA, the UK also used an expansionary fiscal and monetary policy immediately after the 2008 recession. One of the first things the UK government did was to increase the basic taxation slab from £34,800 to £37,400, thereby reducing the overall tax by £150 for people earning basic wages. Additionally, the government also reduced the value added tax by 2.5%, thereby reducing the price of goods and services so that even with decreased income level, people are able to buy products. This ensured that the demand of products remained at the same level. Many banks started defaulting immediately after the 2008 recession, which brought down the liquidity of the market. In order to improve upon the overall and liquidity and cash availability in the market, the UK government announced an investment worth £3 billion between 2009 and 2010.

Microeconomic Policies

Apart from the abovementioned macroeconomic measures, the government took several microeconomic measures to ensure that the rate of unemployment did not go up drastically. Small and medium size enterprises employ more than 90% people in the UK economy. To ensure the protection and survival of these industries, the government announced a loan scheme worth £20 billion (NIESR). Additionally, the UK government also declared a budget worth £5 billion for training the unemployed youth. Automobile is one of the largest industries in the UK. Therefore, the demand for automobile is an essential indicator of the UK economy. To keep the demand of automobiles at a healthy level, the government announced car scrappage scheme in which people were given £2,000 subsidy if they scrapped their 10 years old car and bought a new one. From a GDP growth rate of about 3% before the recession, the UK GDP shrunk by 4.3% in 2009 (NIESR). However, due to the expansionary fiscal policies, the UK economy bounced back quickly and posted about 2% growth in 2010 (OECD). The UK continued to post positive growth rates in the subsequent years.

Policy Changes in Recent Years

However, the abovementioned fiscal policies were not sustainable for the long run as they created huge financial stress on the government budget. Immediately after the recession, due to the government stimulus packages, the government debt increased by £175 billion in 2010 from the previous year. The government debt continued to grow in the next three years as well. Currently, the UK government debt stands at approximately 88% of the GDP, which is deemed very high (OECD). To reduce the government debt and the budget deficit from 2013 onwards, the UK government has terminated fiscal discretionary actions. The government eliminated 2.5% cut in VAT, did not announce any more stimulus package, and decreased the basic tax rate slab to £31,785 (even lower than the pre-recession level) (Ivanov).

Effect of Macro and Microeconomic Policies on Tesco

Effect of Economic Policies from 2009 to 2012
Tesco is the largest retailer in the UK with operations in twelve countries across the globe. It is the second largest retailer in the world only next to Wal-Mart. Founded in 1990 by Jack Cohen, Tesco currently has 29% market share in the UK market. Unlike most other companies, Tesco showed a different growth story immediately following the recession and in recent years (Tesco#2). Most of the companies in the UK, including retail giants such as Asda, Sainsbury’s, and Morrisons, witnessed stagnant growth immediately following the recession. However, Tesco showed an impressive growth even in the years following recession. In fact, the years 2010, 2011, and 2012 were the most successful years for Tesco in terms of revenue and profit (Tesco#1). The company was consistently able to maintain a gross margin of over 8%. Macroeconomic policies helped the company post huge profit during this period. Reduction of 2.5 VAT helped decrease the input cost of the company, thereby increasing its operating margin. Due to stagnant demand growth, Tesco was able to negotiate with its suppliers more vigorously, thereby reducing the input cost. This increased the overall gross margin of the company. Additionally, during this period, due to high unemployment rate, Tesco was able to find many employees at a minimum wage rate. During this period, the union and the government never put any pressure on Tesco to increase the wage rate of its employees. This helped the company keep a healthy operating margin of over 6% from 2010 to 2012 (Tesco#1). During this period, the company expanded into the US market through fresh and easy retail outlets. Tesco’s high profitability at this time depended on favorable macroeconomic policies. The company was able to secure loans at a low long term interest rate and expand into new territories. The company was also able to purchase real estate property at a relatively low price during this period. All these led to stellar performance of the company from 2010 to 2012.

Effect of Economic Policies from 2012 to till date

However, the Tesco management failed to understand that between 2010 and 2012, Tesco’s profitability mainly issued from favorable macro and microeconomic policies existing in the economy and not from the superior operational performance of the company. In fact, during this period, the management of Tesco was so confident of Tesco doing so well that it started investing the profit generated from the UK market to other unexplored markets or non-profit making markets for Tesco such as South Korea and the USA. From 2013 onwards, several macro and microeconomic conditions started changing in the economy. First of all, the UK government started reverting on its expansionary fiscal policies. For instance, the basic tax rate slab was reduced from £37, 400 in 2011 to £31,785 in 2015 (Ivanov). Therefore, the overall disposable income in the hands of middle class people in the UK reduced substantially. This increased the price elasticity of demands significantly.

Strategies Deployed in Recent Years

In a typical high-growth economic condition, price elasticity of retail goods is loosely connected with demand as there are many different types of buyers some of which are price sensitive, whereas some others are willing to spend more money for high quality luxury products. On the contrary, when the overall disposable income comes down, then in order to reduce the overall expenditure on the retail products, customers become more price-sensitive. Even a small deviation in price of a product can significantly alter the demand for that product. Owing to changes in the tax slab, the demand in the retail segment stagnated and in some cases, the overall demand saw a decline. This stagnated the sales growth for Tesco. Making matters worse, low cost players such as Aldi and Lidl started offering products similar to that of Tesco at a deep discount to retain market share (BBC). Tesco being a big retail giant and having a fairly stagnant cost structure was unable to compete with the deep discounters. It started losing its market share from 2013 onwards primarily to these two rival companies. After seeing decrease in revenue, the company tried to lower its cost to win back customers. However, Tesco does not have a typical image of a discount store like that of Aldi and Lidl. Therefore, this move was not successful in increasing the revenue of the company. In fact, by cutting costs and not generating enough footfalls, the company’s revenue and profit decreased. In 2015, Tesco posted a loss of £6.7 billion, which is one of the highest in the corporate history of the UK (BBC). Due to acute low capacity utilization, the company was forced to shut down 40 of its superstores, especially in small towns.

External Prospect of Tesco in the Immediate Short Term

Tesco’s major market is the UK market. The retail market is predicted to grow at a rate of about 1.5-2.0 % in the next few years (IMF). Other markets in which Tesco operates such as South Korea, China, Ireland, Thailand, Malaysia, and Hungary are also not witnessing a huge growth rate. In fact, the second largest market for Tesco is South Korea, which is witnessing a negative growth in the retail market (Tesco#1). Therefore, from the macroeconomic perspective, Tesco does not have a positive growth outlook in the UK and other markets in which it operates. Economic recovery in the European Union region, including the UK, is predicted to be sluggish mainly due to economic and political uncertainties. Although inflations and interest rates are presently at a low level, they will go up in the coming years. In order to reduce the balance of payment, the UK government can further introduce austerity measures and contractionary monetary policies that will put pressure on the overall demand in the retail segment. Therefore, Tesco will not be able to benefit from the micro and macroeconomic parameters in the coming years. If it wants to do well, it needs to either diversify its portfolio or win back customers from its competitors through cost leadership or differentiation.

Tesco’s Long Term Strategy

Tesco is one of the most identified brands among the UK customers. It has always done well in the UK market. However, in recent years, for the first time in its history, it is encountering serious challenges from its competitors as well as from recessionary micro and macroeconomic conditions. Although the UK economy is in a more stable state than it was in the period between 2009 and 2010, still the economy is slowly recovering. Before 1992, Tesco projected itself as a discount retailer. However, during the recession of the early 1990s, Tesco realized that the use of only cost based strategy made it business susceptible to economic recession (Armstrong). Therefore, after the recession, Tesco created two range of products; value and finest. Its value range of products still catered to the cost sensitive customers, whereas its finest product line attracted quality conscious customers. During this period, Tesco expanded its product portfolio by including food, beverages, home, mobile, clothing and financial services in its offerings. In the next twenty years, Tesco continued to do well using this strategy. However, presently, it seems that the application of this strategy is confusing customers. Cost sensitive customers view Aldi and Lidl as low cost options and not Tesco, whereas quality conscious customers still consider Tesco as a discount retailer (Armstrong). Therefore, in the long run, the company needs to decide on its branding strategy for success. For survival in the long run, Tesco first needs to create an operation model that is more lean than most of its competitors, if not all. Instead of creating large supercenters in a low growth economy, Tesco can employ the strategy of creating Tesco small express stores instead of building big supercenters incurring huge overhead cost and capital expenditure. Especially in small towns where the demand is not big enough to draw in a lot of footfalls, small express stores will see more capacity utilization. To employ this strategy, Tesco needs to completely overhaul its current business model, which will require significant capital investment as well as sales of current properties. Implementation of this strategy will require many years, but the company will be more agile in the long run and will be able to sustain recessions and demand changes more effectively.

Conclusion

The 2008 recession was one of the worst recessions of all time. The UK government used an expansionary fiscal policy immediately after the recession to salvage the situation. However, once the economy returned to normalcy, the UK government is adopting austerity measures to reduce its overall dent and balance of payments. Being a retail giant, Tesco is closely connected with the macro and microeconomic conditions of a country. Favorable macro and microeconomic conditions helped the company between 2010 and 2012, but in recent years, Tesco is performing poorly due to sluggish macroeconomic conditions, increased wage rate, and increased competition. Tesco needs to revise its current strategy and restructure its business for the future success.

Works Cited

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