Sunday, December 20, 2009
Bad, but this year could have been a lot worse
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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We have all lived through a remarkable time. As we approach the end of 2009, we are also preparing to say goodbye to a year that will go down as the worst for the global economy and world trade since the second world war.

It has also been, by a margin, the worst year for the UK economy since the Depression. Even if the figures are eventually revised up, as I expect them to be, that record will not be affected. On the Treasury's estimate of a 4.75% slump in gross domestic product this year, that is more than twice the decline recorded in the previous worst year, 1980.

For the global economy, the International Monetary Fund estimates that world GDP has fallen 1.1% this year. That does not sound much but is the first drop recorded on the IMF's database, which stretches back to 1970. Before that we had the post-war "golden age" of the 1950s and 1960s.

Advanced economies have seen a GDP fall of 3.4% this year, the IMF says. World trade has slipped before, falling 2.7% in 1975 and 0.9% in 1983, but this year's fall, 12%, takes us into new territory.

It may seem odd then to say that things could have been a lot worse. Part of my mission is to take the "dismal" out of the dismal science of economics.

The first thing to say is that the worst of the downturn happened quite a long time ago. The period between October 2008 and April 2009 was when global growth, world trade and the UK economy "fell off a cliff". Economies then stabilised and started on a modest path of recovery. That is true of the world economy and, notwithstanding the official GDP figures, of Britain.

The improved economic tone, and the rise in markets, has happened as we have come out of that sickening dive. Anything could have happened to the banking system, from nationalisation of every bank to the cash machines running out. Instead, as the Bank of England's financial stability report pointed out on Friday, the banks are a long way from being back to normal but an even worse crisis was averted, for which credit is due to the authorities.

In March, the world was looking at "mark-to-market" financial losses of 24.3 trillion. The recovery in markets has cut that to 6.3 trillion. House prices, expected to fall by up to 25% at the start of the year, will end with a modest rise. Sterling rose over the course of 2009 too.

There is other good news. Last week saw a flurry of concern about inflation, as headline consumer price inflation rose from 1.5% to 1.9% and retail price inflation turned positive (by 0.3%). There will be further rises over the next two to three months, before inflation comes down again.

Why is that good news? The dangers of prolonged deflation were exaggerated but the risk was there and has been averted. Had this crisis been followed by a prolonged period of deflation, comparisons with the 1930s might indeed have been justified. As it is, I would much rather have Britain's problems than those of Japan.

Best of all is the job market. Employers and employees have shown huge flexibility to get through this recession. Wage freezes, cuts and shorter working weeks mean employment has fallen by only a third of what it was reasonable to expect.

The government deserves a little credit for its labour-market policies, including job and training guarantees. Aggressively expansionary monetary policy and modestly expansionary fiscal policy have helped.

Last week brought news of the first drop in the claimant unemployment count since February last year. The wider Labour Force Survey measure held below 2.5m for the fourth month running, against high-profile predictions of something like armageddon in the job market.

One of the worst labour-market forecasters, interestingly, has been Danny Blanchflower, formerly of the Bank of England's monetary policy committee, who was appointed to the MPC for his labour-market expertise.

In January he predicted that unemployment would rise to 3m, or worse, over the following 12 months. In May, even when it was clear from the data that the claimant count was rising much more slowly than expected and that the wider jobless measure could be expected to follow suit, he predicted monthly unemployment rises of 100,000 for the rest of the year. Even as lower numbers came through, he insisted it was the lull before the storm.

It may still be, though it would be an odd recovery that saw job losses accelerate. Unemployment probably has further to rise and will be slow to fall. The Treasury expects the jobless total in 2014 to be some 50% above its pre-recession level.

Only if there is a "double-dip" in the economy, however, would you expect a big unemployment surge. The job-market numbers suggest the economy has been recovering for some months. The risk of that recovery running into a roadblock will be one of the key issues for next year.

There will be more to be said on this but let me just leave you with a couple of quick observations. We are clearly not yet out of the woods. The Bank, in its report, noted renewed worries about the vulnerability of the financial system to sovereign risk, because of Dubai and Greece. Many high-deficit countries, including the UK, have yet to announce the "credible fiscal consolidation plans" the Bank thinks necessary.

The banking system has to wean itself off emergency financial support and needs to get on with it. The Old Lady has taken the banks to her bosom but wants them to stand on their own two feet.

Banks should be doing more to help themselves. By reducing pay bills by 10% and cutting dividend payments by a third, they could rebuild capital by 70 billion over five years. They face big challenges, of big losses on commercial property and rolling over funding in the markets, though the Bank sees these as bumps in the road rather than roadblocks.

The debate about whether banks are lending enough to businesses or whether the demand for loans has just shrunk will continue. The return to normal interest rates (which the Bank thinks is 5%) will pose problems, though it will not happen over the next 12 months.

Having said all this, it is very difficult for Britain not to have a recovery if the world economy is growing. The UK is an open economy and 3% global growth next year, which is what the IMF expects, will lift Britain. Most recoveries are V-shaped and the strong likelihood is that this one will be, though there are any number of alternative shapes, including W, square root and saxophone, to debate.

But as we look forward to those debates and say farewell to a fascinating year, probably never to be repeated, we can breathe a sigh of relief that it was not even worse.

PS: We may be getting close to wrapping up 2009 but the excitement is not yet over. Next week will be my annual forecasting league table, which will make some people's Christmases and ruin a few others. This year's competition, as much a part of the seasonal ritual as mulled wine or carols from King's, has an added twist. Readers were invited to submit their own forecasts and some will have done well in comparison with the professionals. There will be prizes.

We are in an online age but the forecasting league table is best viewed on good old-fashioned newsprint. So make sure to get a copy of the paper, even if it means trudging through shoulder-high snowdrifts. Until then, I offer you my best wishes for Christmas.

From The Sunday Times, December 20 2008