Recession: from fantasy to reality
How a nervous business world has talked itself into a recession.
- Today’s economic slowdown is seen as a precursor to the biggest recession in 20 years. But in historical terms, the economic contraction is not as severe as some would have us believe.
- The boom of the 1990s was more of a ‘financial bubble’ than a runaway real economy – where frenzied investment in information technology did little to generate much real productive growth. However, the decline in the real economy is greater than is justified merely by the fallout from the bursting of this bubble.
- The descent into economic slowdown has the character of a self-fulfilling prohecy.
At the end of November 2001, the US economic recession became official. The National Bureau of Economic Research (NBER) – a committee of six wise economists considered to be the official arbiters of the US business cycle – declared that recession had started in March 2001.
NBER defines a recession as a widespread decline in economic activity lasting more than a few months. At the same time, the popular definition of a recession – two or more quarters of declining Gross Domestic Product (GDP) – is almost certain to concur with NBER’s determination when the estimates of fourth-quarter GDP are released in January 2002. We are likely to see another decline following on from the 1.3 percent annualised decline in the third quarter – which included the immediate contractionary impact of the terrorist attacks of 11 September.
There are two widespread assumptions about the current economic slowdown. First, that it is an unusual one in comparison to most recessions of the past 50 years. In industrialised countries, we are used to recessions being ushered in by a spurt of ‘overheating’ and inflating prices precipitating an activity-stunting hike in interest rates. But this time the immediate features are different – many prices are falling and central banks in America and elsewhere have been cutting interest rates repeatedly over the past year.
The problem now is said to be too much, not too little capacity – with some observers seeing this as a return to the ‘classical’ recessions of an earlier era of capitalism that were brought about by over-investment and falling profitability.
The second assumption about the current slowdown is that it is shaping up to be a pretty serious contraction – not least because of the synchronisation of recessions, or near-recessions, across the largest three economies of the USA, Japan and Germany. The reputed economists from the Organisation for Economic Cooperation and Development (OECD) talk of the world plunging into recession for the first time in 20 years, and speculate that 2001 and 2002 taken together could represent the worst economic performance since the Second World War.
Such grim and gloomy comparisons between today’s economic slowdown and those of yesteryear are common. And the fact that the UK Treasury and other forecasters anticipate that the UK will escape recession over the next few months is rightly seen as being of little global economic significance, due to the UK’s small size. A little bit of uncharacteristic British sunshine is not expected to brighten the global storm clouds.
But both these assumptions need reposing. This slowdown is different, but not for the reasons that have been given. And the contraction in the USA at least, and therefore in global terms too, is not as severe in historical terms as some would have us believe.
The backdrop of economic fundamentals, which helps explain the specifics of the current US slowdown, is that the record length US expansion from 1991 to 2001 was neither as strong nor as wide-ranging as it was talked up to be. Overall, average annual GDP growth over the 10 years was about 3.6 percent, weaker even than the expansion years of the troubled 1970s (4.5 percent) and the 1980s (4.0 percent).
The latest business cycle has been notable for its unusual flatness and its absence of volatility. Also, much of the 1990s growth that did occur can be attributed to the boom in the information technology (IT) sector – the bright spot of the decade, but which still only accounts for about one tenth of total US GDP.
Market economies always tend to grow unevenly. But the special thing about the 1990s imbalance was the extent to which it was driven by the hype of a technology-led New Economy – yet had a very limited impact outside of the IT sector. Now it is generally recognised that a disproportionate amount of the much-talked-up productivity revival of the late 1990s was actually down to gains within the production of IT equipment rather than in the use of IT equipment in the rest of the economy. The enormous potential of economy-wide benefits from IT investment remains elusive.
The hyped frenzy of the internet and IT ‘revolutions’ spurred the late 1990s spending by the IT sector and by others on IT products and services. But the hype didn’t cause the bubble. The real explanation for this lies in the new finance economy that took off during the 1990s.
In the finance economy, money was free flowing and cheap to get, and businesses of all kinds reoriented from productive operations to various forms of financial activities. The excess of liquidity through most of the 1990s fuelled the boom in share issues, mainly by new technology companies.
Credit was easy for companies to get and to give – and therefore easy for consumers to take on and spend. (Hence the recent obsession with consumer confidence reports and how much more consumers can be expected to spend.) Businesses moved into financial deficit in 1996, and households have been in financial deficit since 1998.
US and other Western firms were not only able to do lots of new things with credit instruments to stimulate the wheels of the economy – like ‘vendor financing’, where they directly lent money to their business customers to buy their products. They also spent a lot more of their day-to-day energies in financial forms of activity. So the 1990s saw record levels of mergers and acquisitions, with subsequent bouts of financial restructuring and cost-cutting.
This financial spiral also partly fed on itself. The bubble of rising expectations pushed up share prices to historic highs, giving companies another paper currency to make use of and do business with.
So the late 1990s was much more a financial bubble than a runaway real economy. Many companies used the easy money available to buy IT hardware and services and to build extensive new communications networks. But it is now becoming clear that all this spending had a limited effect on generating any dynamic of growth in the economy’s underlying productive potential. In recent years, for example, US telecommunications companies spent tens of billions of dollars to lay tens of millions of miles of fibre-optic cables – but only 2.6 percent of them are being used (1).
We should note that in the real world, contrary to the fashionable dotgloom-mongers, web use by companies and individuals continues to grow despite the economic slowdown. But this is far removed from the hyped forecasts of world transformation from the heady years of 1998 to 2000.
The 1990s obsession with spending on IT and the relative importance of this category within overall investment obscures the fact that, for the most part, US business investment levels were nothing exceptional in the 1990s. Indeed, if we strip out this unusually fast depreciating chunk of IT spending – with its limited productive impact – then the rest of business investment on equipment and structures was historically weak.
As economist Anatole Kaletsky noted, ‘every other category of US investment [apart from information processing and software] has actually been lower recently than at almost any time in the past four decades’ (2). So ironically, at a time when the much-quoted financial researcher Andrew Smithers and others point to a nineteenth-century style crisis of over-investment, today’s slowdown probably has fewer features of a classic crisis of over-accumulation as any other slowdown of the past 150 years.
The excess of investment and over-capacity that everybody is talking about is mainly concentrated in those IT businesses that were the main beneficiaries of the financial bubble – and which are now among the main casualties of the bubble bursting. So IT equipment companies, which had been projecting 40 to 50 percent a year growth in production into the far future, are having to adjust to the real world of sensible forecasts of ‘only’ moderate double digit annual growth.
Of course, the economic slowdown is serious for those affected by businesses going down and for people who are losing their jobs. But the slowdown does not herald the widespread destruction of physical capital and resources that is typical of recession times. Because the economic boom was never as great or extensive as was believed, the fallout of the financial bubble should have its limits in the real economy. This explains some of the peculiar features of this recession that were noted by the NBER – with real incomes continuing to rise and employment levels, so far, falling less than usual in a recession. But this still leaves two other problems.
First problem: the current slowdown has a large element of self-generation to it. What started as a financial collapse sparked off a descent into a self-fulfilling lowering of expectations. Once the internet bubble burst in March 2000, it catalysed the unleashing of economic anxieties that had been kept under wraps by that same bubble. Such anxiety has rippled across the economy to have real consequences in lost economic activity and jobs.
To misattribute the words of the late George Harrison, by the start of 2000 the mood about the long US boom was already one of ‘All things must pass’. With businesses acting after the bubble burst, and especially since Autumn 2000, as if the US economy was on the verge of recession – by postponing non-essential spending, slowing recruitment and holding back investment plans – the slowdown got into motion, and fed upon itself.
The final impetus towards recession was the impact of the events of 11 September on business expectations. We will never know for sure, but NBER member and chair of economics at Princeton University in New Jersey Ben Bernanke was probably right when he said that without 11 September the US economy might have skirted recession altogether (3). The problem is, there is no limiting this spiral of descent when it is driven as much by sentiment as by economic necessity.
To counter this declining trend, it is worth noting that 11 September also led to a reinvigorated government economic policy that could have a stimulating effect. Some argue that 11 September expresses the limits of the ‘small government’ crusade. For both Congress and the White House, expansionary fiscal policy is back on the agenda, even if they have had difficulty agreeing the specifics of what form the spending and handouts should take. And while it is unlikely that we will see a full and explicit return to the Keynesian demand management of the post-Second World War era, more state intervention and spending – on armaments, ‘homeland defence’, aid to industry, or something else – should help to buoy up the US economy in 2002.
The second problem is to remember that the US economy was not doing as well as was assumed in the first place. Lots of economic opportunities, not least from new technologies, have been and are still being wasted. And because today’s slowdown should have a less destructive impact than previous recessions, the economy won’t benefit from a subsequent post-recessionary clearout stimulus.
It is too early to tell where the next locus of financial excess will fall. But while this climate continues, it is likely to have as little positive impact on intensive productive development as the last bubble did.
Phil Mullan is the author of The Imaginary Time Bomb: Why an Ageing Population Is Not a Social Problem, IB Tauris, 2000 (buy this book from Amazon (UK) or Amazon (USA))
Beyond the internet bubble, by Phil Mullan
spiked-issue: Don’t blow IT
(1) Wall Street Journal, 7 November 2001
(2) The Times (London), 14 August 2001
(3) Wall Street Journal, 27 November 2001
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