Comment: The doctors fail, self-healing begins

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The Independent Online
It is hand-wringing time in Munich, and the financial markets know it. The gloom in the G7 meetings about the state of the world economy is mirrored by the gloom in the London and New York share markets. But, while there is considerable political pressure for the G7 leaders to 'do something', the markets know there is very little that can be done, certainly in the short term.

The dull outlook for equities contrasts sharply with the optimism in London and New York a couple of months ago. This contrast, the essential background to the Munich meetings, deserves some explanation.

To explain the change of mood in Britain is easy - prospects for economic growth have deteriorated. After the Conservative victory it was assumed that there would be sufficient pent-up demand to kick-start the economy into a strong second half. To some extent this did happen for, judging by things like the car sales figures, April was a good month. But for reasons that are not yet clear May seems to have been much worse than most businesses expected, and June was only a little better.

The result is that, while the bottom of the cycle has been reached, growth in the second half will be very sluggish, so sluggish that many City forecasters now expect that 1992 overall will turn out to be another year of negative growth.

Goldman Sachs has just downgraded its forecast to minus 0.5 per cent, while Robert Thomas, head of research at NatWest's capital markets group, reckons that its minus 0.25 per cent forecast may now be too optimistic. Slower growth means a slower recovery of profits and a longer period of pressure on the banks and other financial institutions.

Explaining the change of mood in the US is more complex. To be sure there is evidence of hesitancy in the recovery, most particularly in the poor employment figures that coincided with the cut in the discount rate last week.


But until a few weeks ago any such information would have been regarded as bullish, for the market realised that it would be met by a fall in interest rates. Now the market gets the fall in rates but still heads south. What seems to be happening is a gradual realisation that the conventional levers on the economy do not work any more.

Thus the G7 leaders have to confront the fact that if neither cheap money nor a very loose fiscal policy can lift the world's largest economy, maybe those policy tools would not work in the other countries either. Conventional wisdom holds that Britain desperately needs lower interest rates, and were we not members of the ERM that is what would happen.

There may well be a case for some easing, particularly in view of the state of the housing market. But that ignores the fact that lowering short-term rates might have the perverse effect of increasing long-term ones because of fears of higher inflation. At the moment UK and US real long-term rates are almost identical. Besides, low short-term rates might have very little impact on demand.

What can the G7 leaders do? They can work on confidence. The one thing that would do most to boost the confidence of industrialists would be a successful end to the Gatt round.

This is something, unlike economic growth, that is in the power of political leaders to deliver. It will not, however, happen in the next two days, for the necessary element of identity of interest is not perceived by the heads of state to be there. But the holding operation, for that is what is happening at the moment, needs to be credible enough to lead to an adequate deal later on.

Beyond that, the main guiding principle behind economic management will be the avoidance of mistakes like failing to check the great economic boom of the 1980s. Indeed, we can catch a feel now of the way economic policy is going to operate over the next two to three years as the uneven recovery gets under way.

Governments and central banks will go through the process of fixing their budgets, changing short-term interest rates and so on, but this will not have much effect on the process of recovery. The world economy is in the early stages of a self-healing process, and there is not much the authorities can do to speed it.


There are several facets of self-healing. One is the gradual working off of debt by companies and individuals. (Britain's personal savings ratio is up to 11.5 per cent, more than doubling in three years.) Lower short-term rates might speed the process a little, but not much.

Another facet is the extraordinary ability of economies to improve their performance. Year in, year out, the private sector manages to produce more from less - better goods with fewer people. This recession is the first since the Second World War when British manufacturers have actually increased productivity.

In the current recession the focus has also shifted to service industries, which are under similar pressure to improve performance, while governments around the world are seeking to increase the productivity of the public sector too.

Self-healing takes time. Left to themselves consumers do gradually recover their confidence and start to spend money, but they do so very slowly. Investment recovers more slowly still, often just in time for the next recession.

All recessions feel as though they are never going to end, and different parts of the economy turn up at different times. It is only quite a long time after the event that the turning point can be identified. Some parts of the economy are growing but it would be astounding, given that the recovery is in its early stages, for others not to be still in decline.

For most of the G7 political leaders this is deeply frustrating, and the formal statements from Munich will reflect this. They will be full of defensive bluster.

But the fact that politicians talk rubbish about economics is unimportant. What matters is that the self-healing process is not impeded. The way to read Munich is not to worry about failure to agree on specific measures, such as a concerted cut in interest rates. Rather it is to look for progress on issues like the Gatt, and wait for self-healing to take its course.