Shooting down the loose talk
Monday 11 April 1994
The United States, we are told, is making a strong recovery. Here in the UK we are in the middle of a recovery and every economic statistic released triggers speculation that the recovery is 'weakening' or 'strengthening'. In Continental Europe and Japan, recovery, according to commentators on monthly statistics, is about to begin. As a matter of fact it has been about to begin for the past year. What does it all mean? What is a recovery?
The normal situation for a healthy economy in the modern world is one of growth. All mature industrial economies have an average growth over the past few decades of about 2 per cent (yes, even the UK). Emerging, middle- income economies tend to grow rather faster. There is a widespread belief that an economic cycle exists around those growth trends that automatically gives rise to recessions and booms. In fact, that is probably not true, at least not for European economies.
The US shows some signs of a spontaneous cycle but Europe does not. Most European economies had no recession of any sort from 1950 to 1973 and the recessions of the mid-1970s and early 1980s were triggered by outside shocks - a massive rise in oil prices and government response to inflation.
The 1990 recession in the UK was induced by the aftermath of financial liberalisation and the credit binge, and in the rest of Europe it was imported - trade with the 'Anglo-Saxon' economies fell away - and made worse by the German policy response to reunification. The ERM tied other countries to German monetary policy. None of it was inevitable; it need not have happened.
No doubt we shall always have recessions but they will be the result of random shocks or policy errors; their timing will therefore be unpredictable. There is no normal period for a cycle. But if there is no normal cycle there is no normal recovery either. Recessions don't last for ever. At some point even an abused economy stops shrinking and starts growing.
The UK has been growing for over a year now. Is that a recovery? Call it one if you like, but some people mean more than that. They assume that if an economy dips below trend growth of 2 per cent, and even shrinks for a year or two, it is bound to grow at faster than the trend 2 per cent for a while. Such above-trend growth would be necessary for capacity utilisation to move up smartly to pre-recession levels, without too much equipment being junked, and for unemployment to fall genuinely and significantly. Regrettably, this above-trend recovery can happen but it is not inevitable.
The chart shows GDP in Germany since the 1960s, with a forecast for the next two years. Note the recession in 1980-82 but then note how growth resumed at a trend rate and for four years or so showed no tendency to return to the peak-output trend line. It was not until the growth boom of 1987 and 1988 that the German economy began to grow faster than 2 per cent and to move to a higher rate of capacity utilisation.
Many other European countries had a similar experience. Recovery in the sense of positive growth began in 1982. Recovery in the sense of above- trend growth - a boom - happened years later.
In the UK the initial early 1980s recovery was a bit livelier but unemployment still kept rising and peaked only in 1986. In France it peaked only in 1988.
Economies are complicated organisms and there were many reasons for that period of mediocre growth out of recession. One important one was fiscal policy. Government deficits rose in recession, as they always do, and in the early 1980s governments tried to get their houses in order by cutting expenditure and raising taxes. Those moves restrained the growth of domestic demand.
In the UK Geoffrey Howe's tight budget of 1981 has gone down in history as not halting the recovery. OK, but contrary to subsequent propaganda, it certainly did not speed up the growth of domestic demand.
Meanwhile in Germany, the government embarked on a four- year programme of fiscal tightening that reduced the general government deficit from 41 2 per cent of GDP to about 11 2 per cent in the mid-1980s. During that time domestic demand in Germany grew at much less than 1 per cent a year in real terms.
Does that sound familiar? The British government has just begun a three-year programme of higher taxes and restrained spending growth. Since 1991, the German government has implemented a programme of tax increases culminating in next year's surcharge on income tax of 71 2 per cent.
Many other European countries are similarly attempting to reduce their deficits. In the circumstances, a replay of the early 1980s period in Europe looks quite likely. Interest rates are lower than they were in the early 1980s but inflation is a lot lower too so the situation does not look promising for a surge of private borrowing and spending.
That is particularly true in the UK, where consumer debt levels remain over 100 per cent of income, twice the early-1980s ratio.
Everyone is praying for exports. GDP growth looks very fast in the United States, creating hopes that it could act as a locomotive for European growth through taking our exports. That works up to a point.
The US was also a locomotive in the early 1980s, when it grew by 4 and 6 per cent in real terms during 1983-84. But that did not create a global boom. And then the dollar was much higher than it is now, making the US less competitive and more prone to import. Fast US growth will help, but with less than 10 per cent of European exports going there, it will not be decisive.
So some growth we shall have, but a whizzbang 'recovery' with output growth much faster than trend is by no means inevitable. The obsessive data-watching, waiting for such a 'recovery' to start could get very boring.
The author is chief economist at Lehman Brothers
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