Soft landing may be bad news

There seems to be a consensus that the world economy is heading for a “soft landing”. The problem is that it is not clear what the term means.

If all it refers to is that global growth next year looks set to be slightly slower than in 2005 then that is probably correct. In its latest Economic Outlook, the Organisation for Economic Cooperation and Development forecasts growth in the OECD area of 2.5% in 2007 compared with 3.2% in 2006. But even the OECD is sceptical of the idea of a slowdown. It says it might be better to see current developments as part of a rebalancing of growth. America and Japan have slowed while Europe has picked up speed.

However, there are more fundamental objections to the “soft landing” concept. It assumes that an economic cycle still operates. But the experience of the past two decades suggests things are no longer so clear-cut. Several writers have written about the “great moderation”, in which the business cycles of the developed economies have become more muted. These include figures as eminent as Ben Bernanke, now chairman of the Federal Reserve.*

The volatility of both output and inflation has declined considerably since the mid-1980s. This shift is not just a quantitative one; the character of the business cycle has changed too. It is easy to forget that violent restructurings of the economy used to be relatively common. Inflation surged, firms went bust and unemployment rocketed.

Although this pattern is often derided as “boom and bust”, it had a good side. For a start, economic growth in the developed world in the 1950s and 1960s was, on average, faster than now. Also, recessions provided a way of restructuring the economy to lay the basis for a new round of rapid growth.

This process was dubbed “creative destruction” by Joseph Schumpeter (1883-1950), a Harvard economist. Competition, sometimes painful, created the basis for radical innovation. The long-term benefits of this process exceeded the short-term hurt that it caused.

From this perspective it should be clear that the current period of economic stability is not entirely positive. Few can enjoy recessions, but they serve a useful purpose. Certainly, rapid economic growth, even if volatile, has enormous social benefits. If downturns spur technological innovation then the advantages could be even greater.

A soft landing could be more of a mixed blessing than many realise. Although a harder landing could be unpleasant, it could potentially provide a better basis for future growth.

*”Remarks by Governor Ben S Bernanke at the meetings of the Eastern Economic Association, Washington, DC”, February 20, 2004. Available at www.federalreserve.gov.