Hamish McRae: A short, sharp recession - but recovery is already on the way

'Our system may be vulnerable, but its resilience is surely more remarkable still'
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The Independent Online


The economic impact of 11 September 2001 is just beginning to become a little clearer. Sadly, it does look inevitable that the United States will experience a recession this autumn and winter and that recession is likely to spread to other parts of the world. To say so is not just to react to the recent swings on Wall Street or the foreign exchanges. It is more a common sense assessment of what is likely to happen to US and world economic demand in the coming months, despite the interest-rate cuts of this week and those further cuts to come.

The economic damage comes in three stages. There is, first and foremost, the blow to the parts of the economy that are directly affected by the terrorist attacks: airlines, financial institutions and so on. That is already evident as airlines cut back schedules and lay off thousands of staff, holidays and meetings are cancelled, hotels have empty rooms, and take-overs are shelved.

Second, there is the blow to consumer confidence. This is partly because many people feel that this is not quite the right time to spend a lot of money, partly because people fear job losses, and partly because of the effect falling share prices have on people's wealth.

And third, there is, or rather there will be, the knock-on effects from one and two above on other countries: the blow, for example, to German or Japanese exports and the consequential impact this will have on those economies.

The disruption is enormous. Travel and tourism is about 11 per cent of world GDP. That is a wide definition and of course not all sectors will be stuck as hard as airlines. But given its size and given the dramatic decline that is evident at present, even a 10 per cent fall in activity would knock 1 per cent off growth. The blow seems to be global. Early evidence suggests that air travel, at least, may turn out to be almost as hard hit in Asia and Europe as in the US.

The first estimates of the impact on American consumer spending are starting to be published. A typical one, from the bank JP Morgan, expects it to fall by a little less than 1 per cent for the next six months, whereas previously it expected a rise of 2.5 per cent. That would be enough to tip the balance of the US into recession.

As for the knock-on effects, here it really is guesswork. We know there are direct links between different parts of the world economy and ahead of 11 September, some parts of the world had been thrown into recession by a fall in US demand. Singapore was the first to suffer in this way. The forecasters are beginning to come up with suggestions as to how the rest of the world might perform with reduced growth (but not yet recession) on the continent of Europe, confirmation of recession in Japan, and still some growth in the UK. But I don't think one can take these forecasts any more seriously than the ones nine months ago that had the US boom continuing this year. We just don't know.

But nothing goes down forever. From a purely economic perspective one of the most intriguing and indeed hopeful issues is the timing and scale of recovery next year.

Recovery? Next year? Well, yes. Before the events of 11 September, the general expectation was that the US would work its way slowly out of the imbalances that had built up. Consumers would slowly rebuild their savings, companies would gradually repair their finances, markets would gradually recover. Now everything is going to happen much more quickly. So instead of the recession having the shape of a U or maybe a W, it may look much more like a deep V.

Such a recovery requires a period of political stability and realistically, whatever happens, that is not likely for many months. Things can never be "normal" again after so dreadful an event. But assume that whatever happens in the coming months will be comparable in scale (though, of course, different in scope) to the Gulf war. If that were so, a year from now some sort of normality could be achieved.

Besides, the very horror of it all will stimulate economic activity. US government spending will rise, for there will have to be support for industries in crisis as well as for reconstruction. Military spending will rise; there will be a drive to find technical ways of providing Americans with increased security. And – as is happening – the interest rate weapon will be fired again and again.

The links between public spending, interest rates and the world economy are subtle and complex. Public spending in Japan has failed to boost the economy in the way the textbooks suggest it should. Cuts in interest rates seemed to have failed to head off recession in the US even before 11 September. But, Japan's experience notwithstanding, cheap money usually stimulates growth because indirectly and eventually it builds confidence. The time-lag before the medicine works may be quite long and scale of the effects uncertain, but eventually the economy responds.

Think of the UK. People do not suddenly rush out and borrow money to buy a house because mortgage rates have come down by a quarter per cent. But interest rates are now the lowest that they have been for 40 years and almost certainly will come down further. If you can borrow for, say, 3 per cent, the risks of buying a house are much lower than if you borrow at around 6.5 per cent. In the 1930s, cheap money created the housing boom that enabled the southern half of Britain to escape the ravages of depression.

The uncertainties right now are enormous and they will continue to be for several months to come. The economic news is likely to be bad: there will be many further reports from companies of falling demand and they will respond by cutting capacity and shedding labour. This is going to happen and it is going to happen everywhere in the world.

But it is just at this moment that the seeds of recovery are sown. Think of what has not happened, for the financial centre of the world's largest economy is still operating with an extraordinary degree of normality. If the world's financial system keeps functioning and public policy is cautious and sensible then the world economy, after a pause, duly recovers. One lesson of the past week may be the vulnerability of our system, but its resilience is surely more remarkable still.

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