Hamish McRae: Honesty and the 'R' word

Click to follow
The Independent Online

So at last officialdom is being honest. Last week was a great turning point in the battle against the global recession. Until you recognise you have a problem, you cannot begin to fix it.

So at last officialdom is being honest. Last week was a great turning point in the battle against the global recession. Until you recognise you have a problem, you cannot begin to fix it.

For months, it has been increasingly clear that the official forecasts of the various economies have been absurdly optimistic. The terrible events of 11 September made them even more so. But it is only in the past few days that the potential scale of the economic catastrophe has been rec-ognised. Meanwhile, government officials have prattled on about business as usual.

Thus Paul O'Neill, the US Treasury Secretary, has been so bullish he has been accused by The Wall Street Journal of "televised cheerleading". The Japanese authorities have insisted the economy will grow this year when it has become increasingly apparent it is shrinking. Germany had a 2 per cent growth target that everyone knew was for the birds. And Britain; well, we will come to that in a moment.

But now, in the space of four days, the tone has completely changed. Sir Eddie George, governor of the Bank of England, warned that the world could expect two or three years of below trend-growth, even if Britain might escape actual recession. The importance of that was to counsel against the people who expected a V-shaped downturn, with a sharp decline followed by an equally sharp recovery.

Next, Hans Eichel, the German finance minister, cut the forecast for growth this year to 0.75 per cent. Then the new OECD forecasts were leaked, showing growth this year for its members at 1 per cent, not the 2 per cent previously expected, and little better growth in 2002. The OECD members account for 80 per cent of world output, so this is not a bad proxy for the world as a whole.

There are still pockets of complacency but they are rapidly being washed over by wave upon wave of bad news. Even the European Central Bank (ECB), one of the more complacency-prone zones of officialdom, is expected to cut interest rates next week in response to the eurozone's deteriorating outlook. Let's hope it moves fast enough for there is mounting danger that Germany will become the new Japan.

As for Britain, the OECD's forecast this year is 1.9 per cent, with 1.6 in 2002, below the current consensus of 2.0 and 1.9 per cent. In relative terms this is encouraging. Britain may well be the best-performing of the large developed economies this year and next, for reasons outlined by Bill Robinson on this page. But it is relative success in a world experiencing its most serious downturn since the first oil shock of 1973/4.

You can catch the long-term perspective on all this by looking at the graph on the left, which shows changes in industrial production since 1965. The central point here is that production was heading very sharply down before 11 September. But cycles go up as well as down. While the cyclical indicator for world output shown in the right-hand graph has not yet turned definitely (it started to climb but fell back), you can be reasonably sure that in a year's time it will be heading securely north. That does not signal a great recovery but a recovery of sorts.

It is possible to say that much more confidently now than it would have been a week ago because officials are being honest. There are at least five reasons why it is better to have the world's finance ministries and central banks being frank, even if what they have to say is pretty depressing.

First, when they try to talk up economies, it gives the impression they are either unaware of the scale of the problems or that by assertion to the contrary they can alleviate them. Paul O'Neill seems guilty of the latter but our own Chancellor risks seeming out of the loop too. His line that spending plans can be maintained in the face of the slowdown looks pretty ragged, raising the possibility that he will be forced into an unwanted rise in taxation at just the wrong stage of the cycle.

Next, not acknowledging the problem means financial weaknesses cannot be rectified. The best example is Japan, where the failure of financial institutions to write down their bad debts (because it would show many were bust) means they are unable to take on the new loans that might help the economy revive.

Third, finance ministries and central banks are more liable to make macro-economic mistakes. The obvious examples are the ECB and the Bank of Japan, the latter having made clear errors in the past and the former probably making them now.

Fourth, governments also make structural mistakes. The German administration was lulled into complacency last year by falling unemployment and shelved labour market reforms. These would have been much less painful then than they would be now, for unemployment is soaring now and will rise much higher. But because until recently the country failed to acknowledge it would miss its growth targets, it was not in a frame of mind to push though controversial measures.

And finally there is that imponderable dominating all matters economic; confidence. The harsh experience of financial markets leads them to distrust finance ministries and be cautious towards central banks. OK, Alan Greenspan at the US Federal Reserve did generate a high level of trust, probably too high. But in the main, anything said by officialdom is taken with a pinch of salt. When statements or forecasts are absurd, the blow to market confidence is all the greater. That in turn de- presses business and consumer confidence.

Everyone knows the next year will be hugely difficult for the world economy. Now at last, the world's governments are starting to admit it. That is progress. Now they say they're frightened, we don't need to worry so much.

Comments