27 Apr 2013

What does "Economic Recovery" mean in the present.

The 2013 GDP estimates were out this week. 0.3% growth for the quarter is OK for an economy in crisis. Hardly a vindication of the coalition government's economic acumen, but it might have been worse. However the figure is historically low.  During the 1990's for example quarterly growth averaged about 0.65%.

The pattern of recessions in the past was that a relatively brief period of contraction was followed by above trend growth that returned the economy to trend. We can see this in NIESR's chart showing the path of recession and recovery in various previous downturns, updated for their estimate of monthly GDP, published March 12, 2013.

from Not the Treasury View

The black line is the present. What it looks like is that zero growth is the new trend. Indeed there was growth in the period 2009-2010 that looked like a recovery, but since then growth has averaged about 0.04%. With margins of error this is zero. Though I have yet to find a margin of error figure for GDP estimates, the figures are stated to the nearest 0.1% and anything less that that is probably noise.

And why is growth so low? Well it's widely acknowledged to be because demand is low - both consumer and business, in the UK and Europe. Now why demand is low is the subject of debate, but those economists who take note of levels of private debt point out that it is still high. Household and business debt are very high. Thus spending is low while people pay off their debts.

To be sure, other people are saving and have piles of cash or capital waiting to be invested. But while demand remains stubbornly low it doesn't make good business sense to invest. Because effectively what is meant by "investment" is an expansion of supply of goods and services. And when demand is low it is counter-intuitive to argue for increasing supply. So an investment led recovery is a non-starter.

Though of course the government have been banking on this for 3 years now. Indeed the government are keen to make the banks lend more. But with so much debt in the system, and the disastrous results from too much debt, the banks (newly sober) are reluctant to lend. Lending to business in a chronically depressed economy is a high-risk enterprise. So even with a great deal of carrot and stick government has failed to get banks to lend more. A debt led recovery is also a non-starter.

Ideally consumers would start to spend more and demand would rise and everyone would become optimistic and start investing again. But this is wishful thinking. Consumers as an aggregate have very high debt levels. What's more real wages are falling at present. So a consumer led recovery is also a non-starter.

What's left? There really is only one sector of the economy that can invest under the present conditions. That is the government. If the government continue to pursue austerity and make only token gestures towards investment then nothing is going to change. Indeed rather worryingly the reduction of debt stopped in 2012. Debt levels in the private sector remained static at 440% of GDP.

So the way things are looking zero growth will be the new trend. Some people have described this as a plateau, but really this is a valley floor - we're still below the peak of 2008. And we're bumping along the bottom. Present government ideology driven economic policy is now widely perceived outside the Treasury to be harming the economy. Even that bastion of monetarism, the IMF, is having second thoughts about the austerity that has crippled Europe and the UK. While the mainstream continue to ignore the role of private debt in the economy nothing much will change.

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Keep is seemly & on-topic. Thanks.