Economic crisis: it’s only the end of the beginning
While there has been much speculation about ‘green shoots’ of recovery, it is how we shape the economy after the recession that really matters.
There’s been much talk in the past week or so about signs of an economic turnaround. The hunt has been on for so-called ‘green shoots’ of recovery. But even if the decline in the major Western economies is slowing down, it still leaves us with the far more pertinent question of what happens after the recession.
All recessions come to an end eventually. After all, the definition of a recession is merely a fall in economic growth for two quarters or more. Given that economic activity is unlikely to decline ad infinitum, we can assume that sooner or later this recession will be over, too. Whether or not we really are at the beginning of the end is anybody’s guess because the evidence is somewhat contradictory.
For example, The Times (London) reported on Tuesday that the ‘worst of recession is past for factories’ in the UK (1). Manufacturing output fell by 0.1 per cent in March. Normally, such a fall would not be greeted positively, but since production fell by 12.3 per cent between January and March, the sharpest drop since 1948, the suggestion is that we’re at the bottom of the cliff. There’s also been a significant rise in share prices, suggesting that traders believe the worst is over.
Other examples of a turnaround were rather more absurd, amounting to little more than observations that ‘more people looked through the windows of our estate agent this month’. Such clutching at straws will be of little comfort to the extra 57,000 people who joined the dole queues in April, with UK unemployment now standing at 2.2million and likely to rise much further in the coming months. The Bank of England’s latest projections, released yesterday, suggest any recovery will be slow and painful.
Nowadays, there are two seemingly wildly different interpretations of where the recession will leave us. The first interpretation is the optimistic view that the worst of the recession is over, so in other words ‘if we’re all cheerful, then things will get better’. On the other hand, there is the doom-laden decree that our future is one of blood, sweat and tears, public spending cuts and pay restraint. This view is best encapsulated by UK Conservative leader David Cameron’s speech to his party’s spring conference last month, where he invited us into the ‘age of austerity’ and leaner, meaner living.
Both perspectives are influenced by the school of behavioural economics in seeking to sway our thinking either through half-empty promises or apocalyptic proclamations. Commenting on optimistic projections about the recession, Chrystia Freeland of the Financial Times has pointed out: ‘Since mid-March, President Barack Obama and his economic team have mounted a sophisticated effort to brighten those “ideas and feelings”, reassuring the nation with “glimmers of hope across the economy” and the assertion that “we’re starting to see progress”.’ (2)
Equally, Cameron’s ‘age of austerity’ rhetoric is also trying to influence our thinking, except it is trying to ‘nudge’ us into accepting that things can only get worse before they get better.
What this apparently schizophrenic approach to the economy reveals is a basic failure to grasp what the real problems are and an unwillingness to face facts. While optimism is generally better than pessimism (although I’m generally a ‘glass half empty’ person myself), there are limits to how far being upbeat can help us to tackle the big problems at hand.
In an excellent recent article on the Great Depression (see So is this another Great Depression?), Sean Collins makes the point that every recession is different; while there may be common factors running through different periods of economic contraction, every recession has a unique combination of causes and can only be properly understood in its historical context (3). In a similar vein, we can make the point today that every recovery from a recession will also be different.
Take China, for example, which had a very productive export-led economy before the recession. With the collapse in world trade, it has responded by stimulating demand at home to the tune of $700billion. As soon as there is any revival in world trade, China will no doubt be in a much stronger position than before the recession. It will have less reliance on exports, while still retaining its export dominance in global markets.
The UK, on the other hand, went into the recession dependent on credit-fuelled retail spending and bubbles in the financial sector and the housing market. UK prosperity and growth over the past 10 years has been based on two things that may never return in the same way: the growth of the UK financial services industry and, connected to it, the vast expansion of credit funded by the Chinese and others. Coming out of the recession, there is no guarantee that the financial services sector will recover, nor that the housing bubble will re-inflate. So the UK’s post recession prospects are not so rosy.
Those who are expecting an automatic recovery for the UK economy base it on little more than the ‘what goes down must come up’ school of thought. Doubtless there will be a recovery of some kind, but the problem with this approach is that it assumes the future will look like the past. In fact, there are very important factors at work globally and nationally which suggest the future will be very different. One is the rise of China, another is the unresolved nature of the international financial crisis. On the domestic front, we still have to deal with the fallout from the bursting of various bubbles.
However cheerful President Obama is, he cannot change the fact that the growing weight of China in the world will lead to a changing balance of power. This will manifest itself in different ways, not least in the way world institutions are run. As the economist Andy Xie pointed out recently, the Chinese, who are heavily invested in the dollar, are worried that ‘the Fed may be forced into printing dollars massively, which would eventually trigger high inflation or even hyperinflation and cause great damage to countries that hold dollar assets in their foreign exchange reserves’ (4).
Chinese money is propping up the US economy. China has become so concerned that its investments will be devalued by rising prices as the US tries to deal with its huge deficits that it has proposed replacing the dollar as the world currency with a basket of currencies instead. So far, the Chinese have been very temperate in their demands, but they are becoming increasingly insistent on playing a bigger role in global financial institutions such as the International Monetary Fund. Any reorganisation of the world at this level is likely to leave second-level nations like the UK in a much weaker position, with negative consequences for influence over trade and other aspects of the global economy.
The global financial crisis has, for the moment, been contained through massive state support of banks and other financial institutions. But the truth is that most of these institutions are technically bankrupt. The policy of Western states has been to prop them up, partly through nationalisation and partly through state guarantees. The general hope seems to be that once the recession is over, the devalued asset bases of these banks will gradually recover their value, thus putting the banks back into the black. Western states are thus gambling that they can re-inflate some of the bubbles which burst in the recent past, or encourage new ones. The danger here is that they are effectively putting the financial crisis off for a later date, when it could come back in an even stronger form.
On the domestic front, even skipping and hopping with glee cannot disguise the fact that, as Martin Wolf has pointed out (5), the proportion of the economy which goes to state spending will reach 52 per cent of UK gross domestic product (GDP) next year, while taxes are projected to be only 38 per cent of GDP, leaving a gaping hole in public finances. The need to fill this gap has prompted the ’age of austerity’ rhetoric from Cameron. But there are alternatives to austerity, the main one being a focus on economic growth and innovation (6).
Faced with the false alternatives of blind optimism or an age of austerity, I would prescribe a dose of economic realism. Let us face the facts of the problems we face, but not accept that the future is out of our control.
Rob Killick is CEO of cScape, and is speaking in the session ‘Investing in the Future: what are the opportunities and barriers for growth?’ at the Institute of Ideas one-day conference The Battle for the Economy on Saturday 16 May at Goodenough College, London. Read Rob’s blog, UK after the recession.
(1) What a feeling: how emotions may yet drive the recovery, Financial Times, 8 May 2009
(2) See The ‘credit crunch’: another Great Depression?, by Sean Collins
(3) If China loses faith, the dollar will collapse, Financial Times, 5 May 2009
(4) Tackling Britain’s fiscal debacle, Financial Times, 7 May 2009
(5) Timid Britain must look to its risk-takers, The Times (London), 13 May 2009
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