Sunday, July 27, 2008
Can the economy grow as consumers wilt?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


Summer holidays are here, a good time to reflect on the past and on what is to come. After seven months of being battered by the twin shocks of a global credit crunch and surging oil and commodity prices, should we brace ourselves for an even grimmer autumn and winter?

The fall in the oil price from farcical to merely ridiculous levels, with other commodity prices easing in tandem, is good news, though it needs to drop a lot further to take one of those twin shocks away.

Evidence of an easing of the credit crunch is harder to find, despite slight reductions in mortgage rates, better news from some American banks and signs that predatory buyers are following Santander's example and circling some of Britain's troubled mortgage providers.

This may, however, be just clutching at straws. The record low for new mortgage approvals reported by the British Bankers' Association last month, two-thirds down on a year earlier, shows an unprecedented squeeze on credit availability.

Retailers, if you believe the official figures, have gone from boom to bust in a month, May's record 3.6% surge in sales volume being followed by June's unprecedented 3.9% plunge. The consumer trend, with sales up 0.6% in the second quarter, is plainly slowing. That is also true for the wider economy, which recorded its 64th consecutive quarter of growth in the second quarter, but of a mere 0.2%.

One good way of looking forward is with the National Institute's latest economic review. The National Institute of Economic and Social Research (NIESR) is the oldest of Britain's economic analysis and forecasting bodies, founded 70 years ago when John Maynard Keynes was still in his prime. At times during the Thatcher years, though not now, it was a kind of Treasury in exile.

Its latest forecast is interesting and not good news for retailers. Britain, it says, will have an outright consumer recession, with household spending dropping 0.8% next year after expected growth of 1.9% this year; 2010 will not be much better, with a spending rise of just 0.6%. Not for a long time have consumers been so squeezed.

Yet this predicted consumer recession will not result in a general recession, the institute says, despite the fact that household spending is roughly two-thirds of Britain's gross domestic product.

Over the 2008-10 period the economy will have its weakest run since the recession of the early 1990s, with growth rates of 1.5%, 1.4% and 1.9% respectively. But this will still be a slowdown rather than a recession. The NIESR's main forecast does not even have a quarter of declining GDP, so maintaining the record expansion that started as long ago as the spring of 1992.

Is it possible for the economy to grow while the consumer is in recession? NIESR acknowledges the risk of an outright recession a fall in GDP next year at just over one in 10. Sticking with its main forecast, however, where does growth come from?

One source is the government. While public spending is targeted to slow this year to 2% real-terms growth, from an average of 4% to 5% over the past few years, this is still enough to contribute half a percentage point to growth annually. Another contribution comes from investment and inventories, predicted to add at least half a percentage point in 2009 and 2010. The biggest effect, however, comes from trade.

NIESR is not forecasting an export boom. Growth in overseas sales over the next three years is below 1.5% annually, but it expects an import slump, because of falling consumer demand. This improvement in "net" trade, with a halving of the current-account deficit from 60 billion last year, 4.3% of GDP, to 1.9% in 2010, makes the biggest contribution to keeping the economy's head above water.

Other economists, I should say, see both a consumer recession and a wider recession, or at least a few quarters of GDP decline. NIESR's route is preferable, not least because a period in which the economy is driven by investment and net trade is overdue. It would still feel pretty grim to the man in the street, though unemployment is predicted to rise only modestly.

Perhaps the consumer squeeze won't be quite as intense as NIESR predicts, particularly if oil and food prices continue to ease. Still, that would deprive us of a useful experiment; the ability of the economy to grow even during a consumer recession.

One thing that would guarantee an even grimmer time for consumers, and the wider economy, would be if the Bank of England were to raise interest rates. The minutes of the meeting of the monetary policy committee (MPC) this month showed a split. Seven members were happy to leave Bank rate on hold at 5% but one, David "Danny" Blanchflower, wanted a quarter-point cut and another, Tim Besley, favoured a quarter-point hike.

Experts disagree but this left me troubled. Blanchflower and Besley are academics with high reputations but no business or financial-market experience, or background in monetary policy. You might say this means they are freed from the yoke of convention, and one of them may turn out to have blazed a trail for the rest.

But "feel" is vital for monetary policy, as is knowledge of the consequences for the financial markets of unexpected votes either way. I think this should be a condition of employment when it comes to future MPC appointments in what we are promised will become a more transparent process.

Faced with conflicting pressures from slowing activity and high inflation, the MPC was right to leave Bank rate at 5%. It remains the sensible course until there is decisive evidence of inflation easing, and this should come before the end of the year.

PS: When the economy turns down, you can bet the name of Nikolai Kondratiev will not be far away. He was the Russian economist who, before being executed in 1938 in Stalin's purges, advanced the theory that the global capitalist economy was subject to long cycles of 50 to 60 years. Long upswings are followed by long downswings, in which case we should prepare for decades of misery.

George Soros recently went one better with his idea of a 60-year "superboom" in leverage and debt since the second world war. If there is a Soros cycle it is even more gloomy in its implications than Kondratiev's downbeat prognosis, implying an extended "superbust", and you don't see those very often.

Kondratiev has his fans, particularly among followers of what Keynes memorably described as a "barbarous relic", gold. I am aware the great man was talking about the gold standard rather than the metal but many gold bugs would like to see a return to the gold standard.

The trouble is these long cycles don't fit the facts. Many believed Kondratiev's time had come in the 1970s, with the apparent end of the post-war global age of prosperity. Since then, despite tough moments, the global growth trend has been up, not down. Gold has done well in the past few years but would have been a lousy investment over the past 30.

What about a Soros cycle? He is big enough to admit he cried wolf in 1987, in The Alchemy of Finance, and in 1998 in The Crisis of Global Capitalism. Is he crying wolf again? Probably. But we'll see.

From the Sunday Times, July 27 2008