Sunday, May 10, 2009
After the fall - how steep is the climb?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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It may be better not to say, for fear of jinxing it, but even before the recession ends, thoughts are turning to recovery. What kind of upturn can we expect when this is over vigorous or insipid?

And, just as we are being programmed to expect really serious swine flu in the autumn, how big is the danger of a second wave of recession, the dreaded double-dip?

That the worst of the recession is over, a year after it began, is becoming the consensus, though the Bank of England, announcing an extension of its quantitative easing programme from 75 billion to 125 billion on Thursday, clearly believes that "promising signs that the pace of decline has begun to moderate" need further nurturing.

The monthly purchasing managers' surveys, produced by Markit for the Chartered Institute of Purchasing & Supply, get less attention than much official data, but are closely watched by economists. The latest tells us that the three main sectors of the economy manufacturing, construction and services saw the worst of their declines between November and February. For services, the earliest to perk up, the index tells us that the sector is within a whisker of a return to growth.

One of the interesting questions raised by these surveys is whether the current picture painted by the official statisticians is too bleak. Economists at Goldman Sachs think so, and expect the very weak gross domestic product reading for the first quarter, when there was a drop of 1.9%, to be revised up significantly.

There is a general point here. Bloodcurdling comparisons being made between the current recession and its predecessors, on the basis of the statistics now and in earlier episodes, are so badly flawed as to be almost useless. That will not stop people making them, and it probably will not stop me making them, but let me explain why.

Official statistics get revised, and they usually get revised higher. In late 1998 and early 1999 we appeared to be on the brink of the first recession of the New Labour era, with GDP first flat then down by 0.1%. Revised data now show the economy grew strongly then, up more than 1% in one quarter, and did not even flirt with recession.

Statistical revisions do not make recessions disappear, and there is no way this will be anything other than a bad year, which could retain its title as the worst in the post-war era. But it will look different in time. In March 1992, Norman Lamont had to admit Britain had suffered a 2.5% GDP decline in 1991. Current data show the fall was much less than that, 1.4%. Something similar happened in the early 1980s.

This is one to watch. Of rather more interest is the recovery. The National Institute of Economic and Social Research (NIESR), in its latest quarterly review, concurs with Alistair Darling that the economy will show year-on-year growth in 2010. But it thinks it will be weak, 0.9%, followed by a tentative 2.3% growth rate in 2011.

On that basis, it will take until the spring of 2012 to get back to where we were in the first quarter of 2008, before the recession began. The period between the Beijing and London Olympics will have been lost years for the economy.

It could be worse. Washington's Peterson Institute last month brought together two former International Monetary Fund chief economists, Michael Mussa and Simon Johnson, to debate global recovery.

Johnson said the world faced an L-shaped "recovery", the sharp downswing being followed by no upturn in 2010 and not much of one after that.

Mussa, in contrast, was in the V-shaped camp. "We will observe, as we have many times before, the Zarnowitz rule: deep recessions are almost always followed by steep recoveries," he said. Victor Zarnowitz, who died in February in his ninetieth year, was one of America's leading experts on the business cycle an an official arbiter of the length of recession. Mussa's pronounced "V" looks unlikely now, but then so did a deep recession a few months ago.

Could it be a double-dipper, in which growth appears to return, only to fall away again? Some say the chances this time are greater than usual, because governments and central banks have adopted aggressive, recession-ending measures. These, by their nature, can provide a one-off boost, but to sustain a recovery the "animal spirits" of the private sector have to take over. If they do not, economies could get a temporary lift before sagging back down again.

Double-dip recessions do occur. Based on the statisticians' current understanding of the 1970s, there were four false dawns between the onset of recession late in 1973 and the start of a sustained recovery in 1976. GDP often flattered to deceive, temporarily picking up before slipping back.

Lamont's famous green shoots were there in the autumn of 1991. But they wilted in the winter and it was not until spring 1992 that the recession was over, and a long time after that before it felt like it.

So what will the upturn be like? The Zarnowitz rule just about works in Britain. As I pointed out after the budget, UK recoveries tend to be pretty robust and there was a slightly stronger upturn after the deep recession of the early 1980s than after the milder one of the early 1990s, though in both cases average annual growth rates over five years exceeded 3%.

This time it might be different, but there is no good reason why. The recovery from the early 1990s recession was against the backdrop of rising taxes, a squeeze on public spending, a stagnant or declining housing market and a shell-shocked consumer.

The economy bounced back after the early 1980s recession, despite the loss of a fifth of manufacturing capacity proportionately much more important than the recent damage to financial services.

When people ask what sectors will drive the recovery, the process is inevitably more dynamic than that, which is why central planning does not work. Sectors currently below the radar screen will emerge. Accountants Price Waterhouse Coopers recently had a go at picking winners from the existing crop, citing business services, high-value engineering, post and telecommunications as the likely growth leaders.

There is a double-dip risk, though not if the world economy returns to robust growth, something even a gloomy IMF expects during the course of next year. Britain is an open economy and rarely struggles when the world is doing well.

That said, unwinding the current policy stimulus will require care. If the Bank raises rates and reverses its quantitative easing programme too slowly, it could risk allowing inflation back in, though recessions are great destroyers of inflation. If it is too quick off the mark, it will risk snuffing out the recovery. Not for the first time there is a fine balance to be struck.

PS: What's worse, paying more tax, cutting public spending to the bone or working a bit longer? People will have different views but the NIESR has come up with a good scheme to close the gaping hole in the public finances.

Ray Barrell, Ian Hurst and Simon Kirby, in a paper, How to Pay for the Crisis, calculate that each year of additional working life would cut the budget deficit by 1% of GDP after 10 years and in time reduce government debt by 20% of GDP.
Boosting average working lives by three years would pare back the budget deficit by 3% of GDP and cut government debt by 60% of GDP, which the institute estimates is the cost of the current crisis.

As an analysis it makes sense. Practically, it may run up against difficulties, namely the tendency of employers to get rid of older workers first, particularly in a downturn. We saw this in the 1980s and 1990s. So far this time, employment among older workers (above 60 for women, above 65 for men) is holding up better than for other age groups.

From The Sunday Times, May 10 2009