The Nineties - you never had it so good

Click to follow
The Independent Online
One of the enduring facts of economic life is the business cycle. If you doubt that, consider this. The 1987 election took place in a boom. The 1992 election took place during a slump. The present election is taking place during a boom. And who knows, maybe the next one will take place in a slump.

Anyone involved in business will have experienced the effects of the cycle, and I suppose anyone who bought a house in 1988 will be all too aware of it too. But surely the present boom is pretty tame stuff compared with the booms of most previous cycles, and surely there is an implicit assumption by most people that the next recession will be a lot less painful than the last?

Well, yes. But therein lies an intriguing - and somewhat disturbing - proposition. Certainly the present period is unusually stable by historical standards. But unless something radical has changed, should we not therefore expect rather greater instability in the future? It may not feel like it but maybe we will come to look on the early 1990s as a golden age.

This is enormously important, and of course not just for people here in the UK. Not only does a more stable growth profile tend to reduce the economic misery caused by high inflation and high unemployment; the present experience of relative stability seems to be underpinning high share prices, particularly in the US, and if it is wrong, financial disruption might lie ahead.

That disruption would be global, for the level of economic volatility is really a global phenomenon. One country might, by skilled economic management, achieve a slightly smoother path than others; or maybe a slightly less smooth one, for the UK has a relatively poor performance on this front. But no one would doubt that, in an interconnected world, it is a sight easier for one country to achieve stable growth if other countries are doing so too.

The relative stability of the 1990s is shown in the graph on the left, which shows the volatility of growth in the industrial world since the First World War period. It measures the amount by which growth diverges from a longer-term trend, demonstrating that with the possible exception of the 1960s, the 1990s have been the calmest period for the best part of a century. The work behind this comes from the economics team at UBS here in London, and the team reckons that there is less than a 10 per cent chance of continued stability to the year 2001. If, as the team also estimates, half the global re-rating of equities since 1992 has been based on an investors' belief that the business cycle is dead, this suggests that investors will be in for a disagreeable surprise.

More about that in a moment. Why have the 1990s been so stable? There are two possible explanations. One is that the global bond markets have imposed greater stability. If a country starts to grow too rapidly, and inflation starts to climb, the bond markets push up long-term interest rates which tends to dampen down that growth. There may well be something in this, but that explanation fails to explain why the late 1980s boom was so marked. The markets may be more savvy now, but they were pretty powerful then and they still failed to cap the excesses.

The other is that during the 1990s the big economies' cycles were not synchronised. That is largely true, for as the graph on the right shows, though the US, UK and Canada all bottomed in the first half of 1991, France, Germany and Italy all bottomed a full two years later. (Japan is not shown - it bumped along the bottom, not really achieving a recovery until last year.)

Why did the big economies move out of time with each other? UBS believes it was a fluke, resulting from the spur to growth in Germany from unification which then spread to its neighbours. It is certainly notable that just as the three Anglo-Saxon economies were in recession Germany was enjoying 6 per cent growth.

UBS believes that this decoupling was the main reason for the overall stability: the world had a lucky break. So what happens next? We know that there will be another cycle. We have no idea what will trigger it.

We can have some ideas. There is a "round up the usual suspects" approach, which would bring forth some obvious candidates. One would be a growth spurt, with the US carrying on its present recovery, Japan picking up on the back of the cheap yen, a continual European recovery also driven by exports ... and so on. A version of this could include a continental boom, based on the introduction of a weak euro. Both these booms would be followed by slumps, with the general proposition being that the bigger they came, the harder they would fall. The fall could be further magnified were there to be a world-wide stock market collapse.

UBS rejects this approach, and simply argues that if the present stability is very unusual commonness would suggest that it will not continue. It sees a decade half-way between the stability of the 1960s and 1990s and the volatility of the 1970s. It acknowledges it may be wrong and has looked at some other possibilities, but it feels a sensible conclusion. When in doubt, apply common sense.

It is an interesting piece of work, as much for making us think about the proposition that the business cycle is still alive as for the conclusions that UBS draws. It naturally focuses on the investment lessons: in particular that while one should be fully-invested, it is prudent to rebalance investment towards Europe rather than the US. But one could go further and think about the political and social consequences of the coming recession. A word about each.

Politics first. This is not a British issue, though the winners of this coming election might like to temper their exuberance a little with the thought that next time round they will be defending themselves against what may be seen as a record of economic failure. The big issue here is surely that voters around the world, already grumpy about the quality of political leadership, will be even more grumpy if the present reasonably benign global economic environment deteriorates. What will they do?

Will they blame big government and call for it to downsize, just as commerce, industry and unions have had to do? Or will they react against the powers of the market and call for more intervention, more controls, maybe more protectionism?

In any case during the next 20 years it will be difficult for western democracies to increase their living standards by very much, for their economies will be leaning into the headwind of deteriorating demographic patterns. Meanwhile the vast deficits build-up during the 1980s will have to be reduced. So each downswing of the cycle will accordingly be tougher to bear.

This will have an impact on social attitudes. Greater fluctuations in the economic cycle would require people to have a larger buffer against bad times: a financial buffer in the form of more savings, but also a professional/career buffer in the sense of marketable skills, and I suppose a psychological buffer in the sense of being resilient in the face of job volatility. It looks as though the rise in economic volatility will reinforce several trends already evident in people's behaviour not just here but pretty much throughout the developed world.

Is there an alternative, or do we just have to take higher volatility as a given and learn to live with it? In theory it might be possible to even out the cycle by effective counter-cyclical fiscal policy, but it is hard to see governments being able to do that given the less-than-optimal way budgets are set at present. Some countries will doubtless try. But maybe the most effective response is simply to plan for uncertainty: to plan to be nimble.

Comments