gipa69
collegio dei patafisici
January 10, 2008
Slowdown, but not crash and burn
Apart from the impossibility of defining a recession, it's impossible to predict if Britain is going to have one
Anatole Kaletsky
Will Britain suffer a recession in 2008? Before I tell you my definitive answer (and regular readers may not be surprised if I give away my punchline by admitting that I really don't know) let me follow a time-honoured Rabbinical technique when faced with an impossible question and ask another whose answer I do know.
Should we devote so much attention to this ugly abstract noun “recession”? Who cares whether the R-word turns out to be a valid description of the year ahead? Everyone knows that the world economy is still in the midst of a financial crisis. By the time the US mortgage mess is cleared up, millions of people will lose their homes or jobs, banks will suffer losses adding up to hundreds of billions and economic activity will surely weaken around the world. So what does it matter whether the slowdown that lies ahead is formally described as a “recession” - especially since economists, true to their indecisive reputation, cannot even agree on how a recession is defined?
Some say that it takes two successive quarters of negative GDP growth to make a recession; but on that basis there have been no recessions at all since 1992 in Britain, America or France. Other economists define a recession as a year of declining annual GDP but that would have meant no recessions in any leading country apart from Japan since 1993. The real meaning of a recession, like most useful knowledge in economics, is frustratingly imprecise. The National Bureau of Economic Research, the body charged with dating US business cycles, uses the following definition: “A recession is a significant decline in activity spread across the economy, lasting more than a few months. A recession influences the economy broadly and is not confined to one sector. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.”
If this official definition is so vague and subjective, why should anyone care whether a recession is in store? What does it matter whether the learned professors of the NBER decide - months or years after the event - that 2008 was or was not a recession year? Surprisingly, the answer is as clear as the notion of recession is imprecise. The statistical line between a recession and a mere slowdown may seem fuzzy, but for businesses and workers the two conditions are as different as night and day. If we compare periods of slow economic growth, such as 2005, 2002 and 1984 in Britain, with those of outright recession, as officially identified in America by the NBER or informally defined in Britain by two quarters of negative growth, we find dramatic differences in economic and financial conditions.
For example, stock markets and house prices always slump in recessions, while they often rise in periods of weak growth. Thousands of business go bankrupt in recessions, whereas they merely lose money in periods of slow growth. The most important difference is in unemployment, which has never risen by as much as one percentage point in ordinary slowdowns, but normally jumps in a recession by three points or more.
Moreover, a market economy almost never manages to avoid a recession by a narrow margin, just crawling along with near-zero growth for a year or so. Whenever GDP growth dips below 1.5 per cent, even for a single quarter, the economy must either bounce back quickly (after at most another quarter), or it is almost certain to tip all the way into negative growth. It seems that a market economy is rather like an aircraft: it needs a minimum speed to keep flying; if it moves any slower it stalls and is likely to crash.
Having established that the difference between a recession and a mere slowdown genuinely is important, let me return to my original question: does a recession lie ahead for Britain in 2008?
The truthful answer is that nobody knows. Recessions, because they occur so rarely, are literally impossible to forecast with any confidence. An IMF study of economies around the world that suffered recessions during the 1990s showed that forecasts published in October of the year before recession managed to predict only 4 out of 74 recessions. Even in April of the recession years themselves, only a third of forecasts identified the economic collapse that was going on.
Economists do not miss recessions because they are stupid, but because recessions are, by definition, unusual periods when the normal relationships that drive all market economies and underlie all “scientific” economic models temporarily break down. So what is my answer now that I have run out of excuses?
My hunch is that Britain will avoid an outright recession, but that is an easy answer because recessions are statistically always a low-probability bet. I can, however, add something more informative and surprising, which I also happen to believe with greater confidence: if a recession occurs in America this year (which many commentators are now predicting, though I disagree) then an even worse recession is almost certain to hit Britain.
Britain is more vulnerable than America to a recession for four reasons. First, our economy is far more dependent on investment banking and other high-value financial and business services. So if the present banking crisis continues to deteriorate to the point where it tips the US into recession, the damage it does to Britain's fastest growing and most profitable industry will be even more severe.
Secondly, house prices have risen much higher in Britain than they have in America. While Britain's banks may not have indulged the equivalent of America's “Ninja” borrowers (No Income, No Job, No Assets), the average level of mortgage debt here is higher than in the US. It seems probable, therefore, that house prices and cash released by mortgage borrowing will ultimately fall farther in Britain than in the US.
Thirdly, the public sector has been the other great engine of Britain's growth for the past decade, but public employment has now stopped growing and real spending power for government workers will probably be squeezed substantially this year.
Fourthly, Britain cannot expect a boom in exports of the kind that America is now enjoying thanks to the undervalued dollar. The pound is one of the most expensive currencies in the world, implying that accelerating exports are unlikely to offset weaker construction and finance in Britain, as they have (so far at least) in the US.
Finally, then, let me offer the best answer I can to the recession question. On balance, a recession this year is still unlikely, whether in Britain or America or the world as a whole. But if a recession does happen, Britain will suffer more than other main economies.
Slowdown, but not crash and burn
Apart from the impossibility of defining a recession, it's impossible to predict if Britain is going to have one
Anatole Kaletsky
Will Britain suffer a recession in 2008? Before I tell you my definitive answer (and regular readers may not be surprised if I give away my punchline by admitting that I really don't know) let me follow a time-honoured Rabbinical technique when faced with an impossible question and ask another whose answer I do know.
Should we devote so much attention to this ugly abstract noun “recession”? Who cares whether the R-word turns out to be a valid description of the year ahead? Everyone knows that the world economy is still in the midst of a financial crisis. By the time the US mortgage mess is cleared up, millions of people will lose their homes or jobs, banks will suffer losses adding up to hundreds of billions and economic activity will surely weaken around the world. So what does it matter whether the slowdown that lies ahead is formally described as a “recession” - especially since economists, true to their indecisive reputation, cannot even agree on how a recession is defined?
Some say that it takes two successive quarters of negative GDP growth to make a recession; but on that basis there have been no recessions at all since 1992 in Britain, America or France. Other economists define a recession as a year of declining annual GDP but that would have meant no recessions in any leading country apart from Japan since 1993. The real meaning of a recession, like most useful knowledge in economics, is frustratingly imprecise. The National Bureau of Economic Research, the body charged with dating US business cycles, uses the following definition: “A recession is a significant decline in activity spread across the economy, lasting more than a few months. A recession influences the economy broadly and is not confined to one sector. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.”
If this official definition is so vague and subjective, why should anyone care whether a recession is in store? What does it matter whether the learned professors of the NBER decide - months or years after the event - that 2008 was or was not a recession year? Surprisingly, the answer is as clear as the notion of recession is imprecise. The statistical line between a recession and a mere slowdown may seem fuzzy, but for businesses and workers the two conditions are as different as night and day. If we compare periods of slow economic growth, such as 2005, 2002 and 1984 in Britain, with those of outright recession, as officially identified in America by the NBER or informally defined in Britain by two quarters of negative growth, we find dramatic differences in economic and financial conditions.
For example, stock markets and house prices always slump in recessions, while they often rise in periods of weak growth. Thousands of business go bankrupt in recessions, whereas they merely lose money in periods of slow growth. The most important difference is in unemployment, which has never risen by as much as one percentage point in ordinary slowdowns, but normally jumps in a recession by three points or more.
Moreover, a market economy almost never manages to avoid a recession by a narrow margin, just crawling along with near-zero growth for a year or so. Whenever GDP growth dips below 1.5 per cent, even for a single quarter, the economy must either bounce back quickly (after at most another quarter), or it is almost certain to tip all the way into negative growth. It seems that a market economy is rather like an aircraft: it needs a minimum speed to keep flying; if it moves any slower it stalls and is likely to crash.
Having established that the difference between a recession and a mere slowdown genuinely is important, let me return to my original question: does a recession lie ahead for Britain in 2008?
The truthful answer is that nobody knows. Recessions, because they occur so rarely, are literally impossible to forecast with any confidence. An IMF study of economies around the world that suffered recessions during the 1990s showed that forecasts published in October of the year before recession managed to predict only 4 out of 74 recessions. Even in April of the recession years themselves, only a third of forecasts identified the economic collapse that was going on.
Economists do not miss recessions because they are stupid, but because recessions are, by definition, unusual periods when the normal relationships that drive all market economies and underlie all “scientific” economic models temporarily break down. So what is my answer now that I have run out of excuses?
My hunch is that Britain will avoid an outright recession, but that is an easy answer because recessions are statistically always a low-probability bet. I can, however, add something more informative and surprising, which I also happen to believe with greater confidence: if a recession occurs in America this year (which many commentators are now predicting, though I disagree) then an even worse recession is almost certain to hit Britain.
Britain is more vulnerable than America to a recession for four reasons. First, our economy is far more dependent on investment banking and other high-value financial and business services. So if the present banking crisis continues to deteriorate to the point where it tips the US into recession, the damage it does to Britain's fastest growing and most profitable industry will be even more severe.
Secondly, house prices have risen much higher in Britain than they have in America. While Britain's banks may not have indulged the equivalent of America's “Ninja” borrowers (No Income, No Job, No Assets), the average level of mortgage debt here is higher than in the US. It seems probable, therefore, that house prices and cash released by mortgage borrowing will ultimately fall farther in Britain than in the US.
Thirdly, the public sector has been the other great engine of Britain's growth for the past decade, but public employment has now stopped growing and real spending power for government workers will probably be squeezed substantially this year.
Fourthly, Britain cannot expect a boom in exports of the kind that America is now enjoying thanks to the undervalued dollar. The pound is one of the most expensive currencies in the world, implying that accelerating exports are unlikely to offset weaker construction and finance in Britain, as they have (so far at least) in the US.
Finally, then, let me offer the best answer I can to the recession question. On balance, a recession this year is still unlikely, whether in Britain or America or the world as a whole. But if a recession does happen, Britain will suffer more than other main economies.
)
