How strong will the recovery be?
Things may be starting to look up, but we're hampered by huge debts. Before we get too carried away we need to understand the 'Honda effect', says Sean O'Grady
Tuesday 08 September 2009
If you want to understand the British economy – and therefore whether we are about to undergo a "W", "V", "U" or any other shaped recession – you have only to think for a moment or two about our car industry. A few months ago, makers such as the BMW-owned Mini, Honda, Toyota and Vauxhall were announcing job loses and plant shutdowns. There was, if you recall, a feeling of the apocalypse in the air.
To economists though, it was a rather mundane-sounding affair: destocking, or the "inventory recession", or what the Governor of the Bank of England, Mervyn King, called "the Honda effect".
Imagine that you sell cars for a living. You usually keep a proportion in stock, replenishing with orders from the importer or factory every so often. Then, you notice a sudden loss of punters wandering into the showroom. They may have heard that their neighbour or colleague has lost their job, and perhaps become spooked by that, as well as the torrent of bad news that flowed after the US Federal Reserve let Lehman Brothers go bust a year ago.
Car sales fell about 30 per cent on the year earlier at their worst point; you, as a retailer, sold all you could from your stock as there was little need for you to order any new cars from the factory. Thus an admittedly substantial fall in demand at the retail end resulted in a more catastrophic 100 per cent fall in demand from the manufacturing end. And that is broadly what happened.
But now most of that destocking is over, and things are getting back towards equilibrium. Indeed, we may well see some superficially robust, bouncy figures in the economy coming through as that effect is reversed: a sharp, "V-shaped" resurgence. So if a few more customers make enquiries and you order a few cars, that will have a dramatic effect on the output statistics. If a car factory made, say, one car in a month as a result of the shutdown and then went back to making 1,000 the next month, that would be a stratospheric monthly rise in output, and we might be forgiven for declaring that the boom was back on. No matter that the factory normally made 10,000 cars a month, we would still see this statistical effect confusing our view of what is going on in the economy.
We have to try to see through that technical aspect of economic adjustment and see what is really happening. All economists, in fact, agree on that, but their interpretation of the underlying trends is necessarily difficult. You should have some sympathy for them.
The second unknowable factor – given that it is partly political – is what will happen to the economy when official support is taken away.
This support has taken three forms. First, the direct support to the banks through loans, "toxic asset" insurance and recapitalisation. That seems likely to stay for as long as it is needed, and there are encouraging signs that some of the banks may not need as much help as they did. Still, the financial system will remain on life support for some time.
Second is the boost to public spending, the cut in VAT, and schemes such as the scrappage subsidy. They will all be reversed over the next year or two, with every possibility of a more severe assault on public spending from 2011 onwards. That will certainly hold the economy back: some think by so much as to push it into a "double dip" or W-shaped recession, or, at least, it will weaken any recovery – the U-shaped path.
Third, the Bank of England will reverse its programme of quantitative easing sooner or later and begin to raise rates. Most economists think that too will begin next year, and again will stymie the bounce back. This explains the row at the G20 about how fast other governments round the world will wind down their spending and borrowing plans – their "exit strategies". After all, if the UK does not have the funds to carry on stimulating its economy, it will need more help from elsewhere.
Therefore, we have been begging the German, French, Japanese and other governments to boost their economies so that they will buy our exports, including, for example, our excellent Minis, to help keep us from a "relapse", or double-dip. Whether they will – and what good it will do us – is a very difficult judgement call.
So the key question is: how much momentum is really behind the signs of recovery we have seen so far (and we are not yet officially back in positive growth). We know that the scale of our debts – public and private – is the biggest in the advanced world, taking account of the size of our economy. The signs are that households, companies, and soon the Government will be paying off more of their debts, which will leave less room for spending and investment. That means lower output and fewer jobs. All economists agree that this is the biggest single fact about our economic life and, whatever the shape of our recovery, it will be weaker than it would have been without that debt overhang.
Recovery mode: How we're shaping up
U says Philip Shaw, Chief economist, Investec
*The economy is more likely than not out of recession now, but is Britain set for a rapid recovery? Probably not. A lack of available credit and the need to tighten fiscal policy look set to constrain growth, perhaps for the next year or two.
V says Simon Hayes, Chief UK economist Barclays Capital
*Recent data builds a strong case in favour of the V-shaped recovery, though the UK's may be less acutely angled than elsewhere. Indicators suggest that a US labour market recovery is around the corner, with bullish implications for spending.
W says Howard Archer, UK economist, IHS Global Insight
*We favour a "skewed W" shaped recovery. We expect modest growth in the second half of this year. However, we suspect that growth will falter in the first half of 2010 as VAT rises back to 17.5 per cent and the car scrappage scheme ends.
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