Sean O'Grady: The words may be expensive but this time it really is different

In a typical banking crisis, the economy stumbles and never gets its old pace back
Click to follow
The Independent Online

'This time it's different". As is well known, these are the four most expensive words in the English language. Usually they are applied, erroneously of course, to describe some or other "new economic paradigm" – from the supposedly revolutionary investment possibilities represented by the South Pacific in the early 18th century, going on and off the gold standard, then the manias for lending to Third World potentates, through to the dot.com and mortgage-backed securities debacles of our own times.

For those now given the task of safeguarding "financial stability" – including the Bank of England which has lumbered itself with this legally binding obligation without the necessary powers – the regularity with which we succumb to the idea that "this time it's different" should tell them something: that, try as they might, financial crises can never be eradicated from human progress. Like the poor, crises will always be with us, no matter what we do to bankers' bonuses, capital and liquidity ratios and whatever we end up doing with credit derivative swaps.

But dangerous though it may be to suggest it, it might well be that this time the recovery is indeed different.

This recession, unlike any of the others since the Second World War, has not come about as a result of a conscious attempt by the Government to tame rampant inflation. It is, as we know all too well, a much more old-fashioned downturn, arriving at a time of low-ish inflation by UK historical standards, and the result of a credit contraction, or crunch, brought about by a banking crisis.

According to recent IMF research on the subject, that is bad news indeed. For while even the most badly squeezed economy can bounce back reasonably quickly from the more conventional type of anti-inflationary squeeze, returning to anything approaching normality after a credit crunch is a much more dicey affair. The Fund's researchers have examined some 88 banking crises, from Argentina to Sweden, and discern the same dismal pattern; output goes through a sort of step-change downwards, after which it never returns to the pre-crisis trend. The economy stumbles, and never entirely gets its old pace back. As the IMF staff put it: "On average, output falls steadily below its pre-crisis trend until the third year after the crisis, and does not rebound thereafter."

The patterns are many and various, but that is the basic message. On a global scale the same picture can be seen in the graph you see here – truly a long view. You might expect the arrival of German industrial strength, the internal combustion engine, the jet, the personal computer and the internet to create a more volatile growth path over the centuries – but they do not. Since around 1870, the world's GDP has grown by 3 per cent a year fairly steadily. What really throws growth off its long-term track is a collapse of the financial system – as in the panic of 1907, just before the Great War in 1914, the post-Wall Street crash period, the Second World War and, possibly, now.

However, there are reasons why – to use that infamous expression – this time it is different. First, though, why it might not be different. The reasoning here is pretty simple. Economies grow through productivity improvements, through newer machinery and computers, better and more energy-efficient buildings, innovations, that sort of thing; investment in other words. And a financial crisis is especially good at clobbering investment – cutting off funds and closing off profitable opportunities to invest simultaneously, exacerbated by a debt-deflation cycle, if it's allowed to take hold.

The fall of about a fifth, or £32bn a year, in investment in the UK is a case in point. For the next few years our public and private infrastructure – your computer at work, the train you commute in on, the lorry that delivers your firm's products – will all be getting older and tattier and less productive compared with the latest kit that they ought to have been replaced by. Think too of the reduction in capacity seen in the shakeout in the banks; that is a permanent loss of a predictive asset, symbolised by those highly skilled staff stumbling away from Lehman Brothers Canary Wharf office with their belongings in cardboard boxes a little over a year ago. Economy-wide, productivity suffers, and so does growth in the long run. It is the lingering legacy of every recession, but especially pernicious after a credit crunch. It is one reason why you see that step-change pattern in the graphs.

I would also throw in the loss of potentially thriving small businesses, the wealth generators of the future. How many potential FTSE 100 companies of the year 2029 were wiped out because the bank refused to lend them the money now to keep going? One shudders to think.

That is pretty much where we are now, and it worries policy makers. For it means higher interest rates than we might otherwise enjoy, because the economy will be less able to run at full pelt before generating price rises. In economies with really high investment levels before a crisis – like Japan in the 1980s and, whisper it, China today – the permanent damage is much worse, as they're left with lots of in-built overcapacity and inefficiency that takes years to scrap and clear, and meantime depresses company profitability.

So why might it be different this time? Well, because governments and central banks have indeed recognised the lessons of the past and have taken those bold actions agreed at the G20 summits in Washington last year and London in the spring, and reaffirmed and celebrated at the Pittsburgh gathering a few weeks ago. As the G20 Communiqué said then so brusquely: "It worked."

We did indeed spend our way out of recession, and we have, so it seems, avoided a 1930s-style Depression. We have, to be sure, lost investment, lost capacity, lost good companies, and we will have put up with stagnating living standards for some years to come while we pay off our debt overhang. That much is not different.

As the crisis of 2008 recedes into the distance, it is becoming increasingly clear that it could have been so much worse if people such as Gordon Brown hadn't shown some leadership. This is an unfashionable view, and he can be fairly blamed for helping to get us into the mess. But, for that reason this time was different, and we ought to be extremely thankful for that.



Stephen King is away

Comments