It is easy to forget how much the economic discussion has shifted since the collapse of Lehman Brothers a year ago. Back in July 2008 the oil price hit a high of $147 a barrel as demand from an apparently robust world economy ran ahead of supply. Today it is less than half that amount.
Also in July 2008 the International Monetary Fund (IMF) slightly raised its forecast for global economic growth in 2009 from 3.8% to 3.9%. In contrast, in July 2009 it forecast a fall of 1.4%.
New terms have also emerged in the past year to help discuss the crisis. Outside the geek community few were familiar with quantitative easing or exit strategies.
It is true that some problems were already apparent before the Lehman collapse. For example, Northern Rock had already been nationalised in February 2008 and Bear Stearns, a small Wall Street institution, collapsed in March. But these seemed like isolated incidents rather than symptoms of a crisis.
Over the past year a coherent narrative has emerged to explain the crisis. In the most popular version of events greedy financiers, abusing lax regulation, destabilised the global economy through their reckless actions. From a British perspective the government has long argued that a generally healthy domestic economy has suffered as a result of an externally imposed global shock. In this self-serving view the government has done well to handle an immensely difficult crisis which was not of its own making.
To explain in full how the conventional wisdom is wrong is beyond the scope of this article. I have covered some of the key points elsewhere. For example, in 2001 my book Cowardly Capitalism argued that the appearance of extreme risk-taking in the financial markets was misleading. In reality a culture of risk aversion has reshaped the markets. More recently, in the Fund Strategy cover story of August 17, I discussed the debate about global imbalances.
But leaving these points aside, and focusing on Britain, there is a key element missing from the discussion. That is that Britain is not just suffering a recession but three related although distinct sets of problems. In addition to the recession there are chronic long-term economic weaknesses as well as a crisis of political leadership. These three factors combine to create the difficult economic environment.
To go through the factors schematically:
Recession. It is uncontroversial to suggest that Britain has suffered a recession. Economic output fell from the second quarter of 2008 to the second quarter of 2009. It looks as though the economy could start to grow again this quarter but the decline in output certainly conforms to the technical definition of at least two quarters of falling GDP.
However, the numbers tell only part of the story. Although this is a cyclical downturn it is different in character from the typical downturn. For a start, it can be characterised as a consumption-led downturn, with consumption suffering before the rest of the economy.
More fundamentally, this recession does not have the same dynamic as many previous ones. A typical recession generally involves a radical restructuring of the economy.
After a heavy round of investment, unprofitable companies collapse while the way is opened for stronger firms to flourish and new firms to emerge. It is an economic “cleansing” process which Joseph Schumpeter, a leading early 20th century economist, called “creative destruction”.
But in recent years the business cycle has become much flatter in a process dubbed by some “the Great Moderation”. Some even hopefully declared that the business cycle was over.
This flattening of the cycle meant that economic growth had become more stable. The regular pattern of boom and bust became less pronounced. But as the downside of crises became muted, so did the upside. Economies did not receive the restructuring they needed to allow for a new bout of concerted growth.
To the extent there was growth, it was largely based on the credit expansion. There was not much of a trend towards organic growth. To the extent it did exist it was also held back by the overwhelming desire to ensure that growth would be “sustainable”. Strong growth was viewed with anxiety.
So this recession is different from most earlier ones. It is consumption-led and there is less of a dynamic towards restructuring.
Chronic decline. Although it is true that Britain has experienced a recession of sorts, it needs to be understood in the context of a long-term economic decline. Britain’s industrial sector has shrunk to a rump of the economy, while capital spending is weak.
Manufacturing output fell from 34% of GDP in 1970 to 13% in 2006. Even accepting that there are some productive areas of the economy that are not classified as manufacturing, this still shows a dramatic shrinking of the industrial base.
Similarly, as figures from CrossBorder Capital show, the level of capital investment in the developed countries, including Britain, is abysmally low. Asia enjoys far higher levels of real investment (see August 17 cover story).
Britain’s overdependence on financial services should be seen in this context. The City has become over-inflated as a result of a lack of investment in the real economy. This has made Britain more vulnerable than it would otherwise be to the impact of recession.
Lack of political leadership. It would be a mistake to separate the past year’s economic crisis from the political crisis.
Politicians have proved woefully unequal to the task of dealing with the recession. First they denied there was a problem, then they implemented panic measures to quell instability. Typically, they have shied away from discussing the difficult measures needed to put Britain back on a path to growth.
Over the long term they have also failed to take action to arrest economic decline. Indeed, their emphasis on sustainability has only hindered the process of generating growth.
After a year of crisis it looks as though Britain is on the verge of escaping from recession. But putting it on a path to strong growth, with the political leadership that requires, will be another matter.
Email Daniel Ben-Ami at email@example.com with your comments on this article.