Economic View: Scars inflicted by recession will not fade with growth

 

Whether you're an economic hawk or a dove, we can all agree on one thing: at some point growth will return and Europe's recession will be over. But what sort of growth will it be? The fear is it will be a distended, deformed growth. Much of Europe's economy – the UK included – has been starved, in a dark place, for several years – it will eventually emerge into the light but it won't be the same as before: the vigour will be missing.

Click HERE to view graphic

Recessions – particularly a double-dip one like this – tend to leave scars far wider and deeper than first thought. Consider the early 1980s when the North of England was devastated by a de-industrial policy enacted by the Thatcher government. Productivity in what were once working class areas in great swaths of the North and West was incredibly slow to recover – in some cases it never has.

Now draw this on a Europe-wide scale today. We have massive unemployment in the PIGS (Portugal, Italy, Greece and Spain) and former professional people in Madrid searching supermarket refuse for food, in echoes of Argentina and its crash of 2001.

The young are at the forefront of this, with youth unemployment rates above 50 per cent in Spain and Greece, while in the UK the number of Neets (not in education, employment or training) stands at about 23 per cent. Their youth is being spent on the dole, their skills, confidence and capacity to learn ebbing away, leaving them economically old before their time.

This is more than a tragedy for individuals. It has huge economic consequences for us all. A report to be released today by Ernst & Young highlights the way in which recession does potentially permanent damage to the economy's capacity to grow. As you can see from the chart, the likes of Italy, Spain, Ireland and Portugal, which have all experienced horrible recessions, are also the most damaged in their ability to put on growth.

Portugal, for instance (there are no figures for Greece as it is, frankly, a volatile case apart) has had its potential future output due to the recession reduced to the tune of 9 per cent, Ireland by 8.5 per cent, Spain 8 per cent and Italy 6.5 per cent. Even Germany – which exceeded growth expectations in the last quarter – has had close to 4 per cent knocked off its future growth potential.

The UK, not being in the eurozone, is not covered by this assessment but there is no reason why it would be in a better position than, say, Germany.

The authors of the Ernst & Young report outline ways in which future growth becomes distended. Firstly there is collapsing capital investment – so machines age and are not replaced, they break down more often, less can be produced when the orders eventually come in.

Second, innovation takes a back seat. This means competitors move ahead with their products and services, seizing market share. Third, there is the sheer wastage of human capital and workers becoming permanently detached from the labour market. Then, finally, there is migration – the brain drain – which is particularly true in the case of Ireland.

UK policymakers are becoming increasingly aware of this wasting away of economic vigour. Paul Fisher noted this week that either the official growth stats were "so far wrong" or the supply side of the economy "has shifted to a degree that is unprecedented."

In the UK's case, the depths of the recession have probably been overestimated, but the supply side, which was successfully transformed in the South and East of the country in the Thatcher, Major and early Blair governments, has been damaged.

That means future growth forecasts are likely to be too optimistic. Governments will not raise sufficient taxes, deficits will not reduce – without far more radical cuts in spending – and the spectre of a future sovereign debt crisis is locked-in.

In a rare moment of maturity at the LibDem conference, it emerged that Nick Clegg et al are looking at ways to knock another £15bn off the deficit after the next election. Now, mansion taxes, means-testing winter fuel payments and bus passes will have a minuscule effect on this, but at least it is out in the open now that beyond 2015 the UK Government is going to need to undertake further fiscal tightening because of the damage to the supply side wrought by the recession.

An even more serious consequence of the damage to the supply side in the UK and Europe is inflation. When the demand comes there won't be the supply – immigration can offset this to an extent, but Adam Smith knew it and even the Romans knew it: too much money chasing too few goods means higher prices.

The level of growth these distended economies can muster without suffering inflation will be lower. That is the ultimate conclusion of the Ernst & Young report. From the perspective of the Chancellor and his fellow big spenders in Europe, a dose of inflation may, on the sly, be no bad thing as it reduces the real worth of the stupendous debt that we have all built up over the past decade.

But with inflation we all get poorer. In the 1960s and 1970s the UK was branded in the German press "the sick man of Europe" because its economy could not grow at a meaningful rate without inflation and was beset by supply side weakness. Now, nearly half a century later and after a double-dip recession, it seems that Europe is now the sick continent. I think that is something doves and hawks alike can all agree on.

Start your day with The Independent, sign up for daily news emails
Sport
Murray celebrates reaching the final
tennis
Arts and Entertainment
'The Archers' has an audience of about five million
radioA growing number of listeners are voicing their discontent; so loudly that even the BBC's director-general seems worried
Life and Style
tech
News
people
PROMOTED VIDEO
ebooks
ebooksA year of political gossip, levity and intrigue from the sharpest pen in Westminster
Arts and Entertainment
Henry VIII played by Damien Lewis
tvReview: Scheming queens-in-waiting, tangled lines of succession and men of lowly birth rising to power – sound familiar?
Sport
Harry Kane celebrates scoring the opening goal for Spurs
footballLive: All the latest transfer news as deadline day looms
Arts and Entertainment
Master of ceremony: Jeremy Paxman
tvReview: Victory for Jeremy Paxman in this absorbing, revealing tale
News
Sir David Attenborough
people
Life and Style
Young girl and bowl of cereal
food + drink
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Compliance Assistant

£13000 per annum: Recruitment Genius: This Pension Specialist was established ...

Ashdown Group: Market Research Executive

£23000 - £26000 per annum + Benefits: Ashdown Group: Market Research Executive...

Recruitment Genius: Technical Report Writer

£25000 - £35000 per annum: Recruitment Genius: A Technical Report Writer is re...

MBDA UK Ltd: Indirect Procurement Category Manager

Competitive salary & benefits!: MBDA UK Ltd: MBDA UK LTD Indirect Procurement...

Day In a Page

Isis hostage crisis: Militant group stands strong as its numerous enemies fail to find a common plan to defeat it

Isis stands strong as its numerous enemies fail to find a common plan to defeat it

The jihadis are being squeezed militarily and economically, but there is no sign of an implosion, says Patrick Cockburn
Virtual reality thrusts viewers into the frontline of global events - and puts film-goers at the heart of the action

Virtual reality: Seeing is believing

Virtual reality thrusts viewers into the frontline of global events - and puts film-goers at the heart of the action
Homeless Veterans appeal: MP says Coalition ‘not doing enough’

Homeless Veterans appeal

MP says Coalition ‘not doing enough’ to help
Larry David, Steve Coogan and other comedians share stories of depression in new documentary

Comedians share stories of depression

The director of the new documentary, Kevin Pollak, tells Jessica Barrett how he got them to talk
Has The Archers lost the plot with it's spicy storylines?

Has The Archers lost the plot?

A growing number of listeners are voicing their discontent over the rural soap's spicy storylines; so loudly that even the BBC's director-general seems worried, says Simon Kelner
English Heritage adds 14 post-war office buildings to its protected lists

14 office buildings added to protected lists

Christopher Beanland explores the underrated appeal of these palaces of pen-pushing
Human skull discovery in Israel proves humans lived side-by-side with Neanderthals

Human skull discovery in Israel proves humans lived side-by-side with Neanderthals

Scientists unearthed the cranial fragments from Manot Cave in West Galilee
World War Z author Max Brooks honours WW1's Harlem Hellfighters in new graphic novel

Max Brooks honours Harlem Hellfighters

The author talks about race, legacy and his Will Smith film option to Tim Walker
Why the league system no longer measures up

League system no longer measures up

Jon Coles, former head of standards at the Department of Education, used to be in charge of school performance rankings. He explains how he would reform the system
Valentine's Day cards: 5 best online card shops

Don't leave it to the petrol station: The best online card shops for Valentine's Day

Can't find a card you like on the high street? Try one of these sites for individual, personalised options, whatever your taste
Diego Costa: Devil in blue who upsets defences is a reminder of what Liverpool have lost

Devil in blue Costa is a reminder of what Liverpool have lost

The Reds are desperately missing Luis Suarez, says Ian Herbert
Ashley Giles: 'I'll watch England – but not as a fan'

Ashley Giles: 'I'll watch England – but not as a fan'

Former one-day coach says he will ‘observe’ their World Cup games – but ‘won’t be jumping up and down’
Greece elections: In times like these, the EU has far more dangerous adversaries than Syriza

Greece elections

In times like these, the EU has far more dangerous adversaries than Syriza, says Patrick Cockburn
Holocaust Memorial Day: Nazi victims remembered as spectre of prejudice reappears

Holocaust Memorial Day

Nazi victims remembered as spectre of prejudice reappears over Europe
Fortitude and the Arctic attraction: Our fascination with the last great wilderness

Magnetic north

The Arctic has always exerted a pull, from Greek myth to new thriller Fortitude. Gerard Gilbert considers what's behind our fascination with the last great wilderness