Hamish McRae: The recession may be over, but the recovery could lag behind for years
Sunday 14 June 2009
The end of the recession? The National Institute says yes and Alistair Darling says no. So who are we to believe? I think both are right, and if that is just another confusing and infuriating economist-type comment, bear with me and let me try to explain.
The National Institute of Economic and Social Research has a solid record for economic forecasting, but like all forecasters makes mistakes. It has based this claim, which unsurprisingly created a stir when it was made last week, not on a forecast but on an assessment of what is actually happening. We get official GDP figures every quarter, and some weeks in arrears – with the first estimate quite often changed as more data is accumulated – but the NIESR does its own monthly estimates of GDP, which come out more quickly and have proved pretty accurate in the past.
It is these estimates that show GDP has been rising for two months, which, while it does not confirm the recession is over, is undoubtedly most encouraging. The pattern of the economy at the beginning of last year showed growth petering out by the second quarter, going through a nasty autumn, then having a really dreadful start to this year, before nudging back into a very modest recovery.
What should we make of this? The first thing to say is that these estimates won't be far out. After that awful first quarter, you would expect some sort of bounce; in any case, this evidence that things have turned up a little is confirmed by other data. The housing market is no longer falling and may be rising a bit; companies are becoming notably more optimistic (or maybe, more accurately, notably less pessimistic); and separate evidence suggests that the service industries may be growing again.
The trouble is that this does not say anything much about the future. The accepted definition of recession is two quarters of negative growth. There is, as far as I know, no formal definition of recovery, but it would not be sensible to declare one until we have had two quarters of positive growth – and we are a long way from that. However, if this does indeed turn out to be the bottom, then the present downturn will have been more serious than the early 1990s but less so than the early 1980s in terms of the peak-to-trough decline.
Conveniently, the NIESR has produced a chart comparing this downturn so far with those two, plus that of the 1930s for good measure, as you can see above. Looking at it, two other things stands out. One is just how long it takes after a recession to recover the ground lost, ie, just to get back to the previous peak of GDP. The other is that if growth were to resume now and continue steadily, this would turn out to be a much shorter recession than the 1980s. Indeed, it would be unusually short. You might want to conclude that it is much more likely that we will bounce along the bottom with slow growth, and maybe even the odd negative quarter, rather than seeing a fast, and sustained, surge out of the blocks.
That, I think, would be the view of Alistair Darling, who has gone out of his way to downplay expectations of an early recovery. That is wise politically, as the worst thing for the Government would be for the economy to stage an aborted recovery: it would have borrowed all those billions for nothing. But it is also wise in economic terms, since all past experience suggests that large chunks of the economy will lag behind, even if the total figures say that growth is under way.
There are two probable laggards. One is the housing market. It took several years during the last recession for the market to catch up with economic growth. Indeed, growth began in 1992, but prices did not really recover until about 1997. The other is unemployment, and though the latest suggestions have been more encouraging than the early dire projections, you would expect the turn to take place at least 18 months after growth resumes. While the housing market remains quiescent and unemployment continues to climb, it won't feel like much of a recovery, whatever the figures say.
Another element is the nature and timing of the payback. The fiscal and monetary boost that has been pumped into the economy carries long-term costs, which will have to be paid. Fiscal first: we will be coming out of this recession with a national debt double the size of the one when we went in. Partly as a result of government borrowing around the world, long-term interest rates will rise, as they are starting to do. So not only must we pay back the debt; the debt we have accumulated will cost more to service. So we will have to run a surplus, and go on running one for years – putting a drag on growth.
As for the need to unwind the monetary stimulus, we are heading into new territory, having never gone down the road of "quantitative easing" before. We have no map to help us back, but common sense says if the Bank of England has taken securities on to its own books in return for pumping money out, then at some stage those securities must go back to the private sector and the money taken back – a further drag on growth.
Put those together and it is hard to see anything other than a lacklustre recovery, which you may say is a good thing, as the excessive consumerism of the past decade was unhealthy and unsustainable and if people want to buy something, they have to save up first. That is indeed what has to happen; but the move by the Government to pay back some of this debt and the Bank of England to claw back the billions it has put into the economy will coincide with the need for individuals to correct their own finances. We will all be doing it at the same time.
My worry is not that the economy will keep on heading down. The bottom of the economic cycle will, in all probability, come some time this year, and we may have passed it already. My worry is that the next four or five years will be painful, as growth repeatedly disappoints.
People will react to this in a number of ways. Some will be angry. The hunt for scapegoats has already started, and that will intensify. Others will simply reflect on the changed conditions and adapt, rather as German and Japanese consumers have adapted to experiencing little improvement in their living standards for a decade. Companies are certainly adapting, as they have to. But the greatest need to adapt will be in the Government, which will face the possibility of no increase in tax revenues year after year, in real terms and, for a while, in money terms too. That will happen despite higher tax rates. This awkward message is just starting to emerge and will utterly change the whole political rhetoric. Alistair Darling understands this, which is why he now urges caution.
It's China – not the US – that is growing the world's green shoots
What sightings of green shoots elsewhere in the world? It is wrong to regard our own economic futures as being determined by ourselves because, as an open trading nation, we are profoundly affected by what happens elsewhere.
The news is not encouraging. Continental Europe is in at least as much trouble as the UK, with Germany still suffering from an export slump, Spain from the end of the construction boom and Eastern Europe from a speculative bubble. The US still seems to be contracting. A bounce in consumer confidence is ofset by the rise in petrol prices, plus mounting unemployment, threatening another dip. And that rise in fuel prices may be a reaction to the prospect of rising demand again in China.
Then there is the most interesting story. We still think of the US leading the world into recession and so being the economy that will lead us all out, and that still holds broadly true. But the earliest green shoots seem to have sprung in China – now almost certainly the world's second largest-economy, passing Japan this year. New lending there doubled in May; industrial output was up more than 7 per cent; and car production rose by 29 per cent, reinforcing its position as the world's largest car maker. In fact the bounce is so strong that people are starting to worry that money being pumped in might result in another asset-price bubble.
From a distance it is hard to make a judgement about that. The big point worth making, though, is that this growth, plus a similar pace in India, will make global growth turn up overall before the recovery in the developed world gets going. Statistically, China is leading the world out of recession. The problem is that this boosts demand for commodities and energy and pushes up prices there, without helping exports from the West. So China is helping the raw-material producers, not the developed countries. In the short term, by helping push up the oil price, strong growth in China may actually hold back the rest of the world economy. Growth will spread out, but I'm afraid this will all take time.
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