Learning to live with recessions

We may, here in the UK, manage our way through the early 2000s rather better than most
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The Independent Online
THIS WEEK is just the moment for a book called Major Recessions* to be published, for of course it is also the moment at which we all fear we might be heading into the next one.

It is not just whether the early 2000s downswing is going to be like the 1930s, or the early 1980s or early 1990s - or maybe like the more benign slowdowns of the 1950s. There are also the fascinating "why?" questions. What causes recessions? Are they inevitable? Can we predict their timing?

The book is by Christopher Dow, an economist who, amongst other posts, has been an executive director of the Bank of England, assistant secretary- general of the OECD, and deputy director of the National Institute - and who sadly died last week. Because it tackles one of the most important issues facing policy-makers, the book will reach a wider audience than that received by the usual economic tome. It deserves to.

The three main conclusions can be put very simply. One: major recessions happen when there is a sharp fall-off of demand for goods and services - the problem is lack of demand, not a fall in supply. Two: these declines are the result of demand shocks which can be identified, amplified by swings in consumer and business confidence. And three: (sorry about this one) major recessions are not predictable.

Remember we are talking about major recessions, not regular swings in the business cycle. The cycle was evident during the 1950s and 1960s but there have only been four major recessions since 1920: the British element of the world-wide 1930s depression, the post-oil-shock recessions of the middle 1970s and the early 1980s, and one we all remember best, the early 1990s recession.

There is a vast amount of economic literature about economic cycles, both here and elsewhere; the interesting thing about the Dow book is that it deals with the crucial issue of whether the downward swing of the cycle develops into a serious recession.

This is surely the most important thing for policy-makers in Britain now. What happens in the world economy is beyond our national control. What we can hope to do is to mitigate the impact of something going wrong in, currently, East Asia, in the way in which Britain managed to mitigate the impact of the US-led depression in the 1930s - and failed to do very well in the last three recessions of the 1970s, the 1980s and the 1990s.

Professor Dow's view, put broadly, is that there are things governments can do to ride with the punches, so to speak. For example, they can manage expansions so that they are neither too slow nor too fast. By doing so, they reduce the likelihood of a sudden collapse of business and consumer confidence.

Shocks will happen: the trick is to respond deftly to them. Professor Dow notes that UK economy policy was clumsy in the 1989-93 period - a point on which most economists would agree, though to what extent sterling's membership of the ERM (and the earlier shadowing of the mark) made such clumsiness inevitable is open to debate.

Can one say anything sensible about the way we might manage the UK economy through the world downswing now? Professor Dow was writing a book about past experience, and the shortcomings of policy then, rather than setting out a blueprint for action now, but a couple of thoughts come to mind.

One is that we may, here in the UK, manage our way thought the early 2000s rather better than most developed countries. We obviously are not in the mess that Japan is in, but we also have advantages over both the US and continental Europe.

We have not had the excesses of the present US business cycle, which, while it has not led to a surge in inflation, has led to a surge in imports and a collapse of exports. You may recall that in the late 1980s a rapid rise in imports supplied the goods demanded by UK purchasers and accordingly prevented excess demand from creating as much inflation as would otherwise have happened.

In addition, we have the ability to have a flexible monetary and fiscal policy. Unlike the euro 11, we still have national control over monetary policy, and thanks to strong tax revenues there is some leeway for fiscal reflation - we have in effect something very close to a balanced budget, while most of the Continent will be struggling to keep the deficit below the 3 per cent Maastricht limit.

In other worse, we have policy flexibility. Of course we may fail to use it, or use it in a misguided way. But at least we have options.

The other thought came from a graph in the book, reproduced here. It shows how countries that had very high productivity in 1870 have had relatively slow growth of productivity since then, and vice versa.

Australia had the highest productivity in the world, while in Japan productivity then was very low. Subsequently Australian output per head grew slowly, while Japanese has, until recently, shot ahead. The graph demonstrates both the opportunities for catch-up and how hard it is for the front-runners in the productivity league to stay ahead. Look at the way in which Japan is now lagging again.

Since the late 1970s Britain has been catching up - not very quickly, and probably not quickly enough for foreign employers like BMW. But at least the gap is narrowing, which suggests that some sort of corner has been turned.

If that is right it is very important. Not only might we have a cyclical advantage - the scope for independent policy - but also a structural one - the potential for faster growth in productivity. This might give us a double advantage.

Might we still "talk ourselves into recession" - the phrase heard increasingly often among business people? Yes, the experience of the past three recessions has undoubtedly made us more recession-conscious than other developed countries. But maybe that is a strength rather than a weakness. We can see what might go wrong. Had Japan had any perception of the scale of the disaster it faced, maybe it too could have weathered the current recession better.

We do have one clear advantage over Japan, which is that we have a government with clear political authority. Professor Dow notes that a strong government is more likely to be able to tackle recession than a weak one. Of course that does assume that the strong government will not head confidently off in the wrong direction.

There are no clear answers here as to whether we will indeed come though this next phase in decent shape. It would be wonderful to be able to predict major recessions, but unrealistic to expect us to be able to do so. The more modest ambition of coping competently if and when the shocks occur is surely a reasonable objective and we should be grateful for Christopher Dow for reminding us of that at this time.

* "Major Recessions - Britain and the World 1920-1995", Christopher Dow, OUP, pounds 55.