The long road to recovery

By Mark Berrisford-Smith, senior economist, HSBC Bank

The past few months have brought strong signals that the worst of the recession is behind us. But while there is a good chance that the economy will start to grow again within the next few months, the economic landscape that will unfold over the next few years will be markedly different from that which we enjoyed in the run-up to 2007

We’re not going to  be able to heave a collective sigh of relief that the nightmare is over, and then resume economic life as we knew it.

After a truly awful six months in which the world has endured its deepest recession since the Second World War, indicators of economic activity and of consumer and business sentiment are no  longer in free-fall. What we’ve seen since September has been a savage process of de-stocking as product supply chains, which often span the globe, have been emptied of surplus goods. That brought about massive contractions (often upwards of 20%) in industrial production and in cross-border trade.

But with Japan’s industrial output registering a small revival in March, and Germany’s output flat in the same month, there are now grounds for optimism. Moreover, the monthly Purchasing Managers’ Index surveys for April showed that in both the manufacturing and services sector activity is contracting at a much slower pace than it was between October and February. Indeed, in the UK, and in America, where President Obama’s stimulus package is starting to ki ck in, it is not beyond the realms of possibility that economic growth will return to positive territory in the second quarter.

That the recession has been shorter than those of the mid-70s, the early 80s and the early 90s is in no small measure due to the vigour with which solutions have been sought by politicians and central bankers here in Britain and around the  world. There has been a general recognition that only concerted action could prevent a slide into prolonged depression. For Britain, the contrast between this recession and the last three is especially stark. In those instances, the room for manoeuvre was limited by persistent inflation and/or participation in exchange rate regimes. That we were in good shape when this recession struck turns out to be very important.

And now for the not-so-good news. The UK is unlikely to make a speedy return to the sort of growth rates seen in the decade prior to 2007. Having enjoyed the age of prosperity, the next decade is more likely to be the age of austerity, as our financial system is rebuilt, as the government’s coffers are refilled, and as people deal with the shock of recent events.

Even assuming that our financial services sector continues to heal, a return to the plentiful and cheap supply of credit that was a hallmark of the years before 2007 looks most unlikely. It is true that thoe banks that are now majority-owned by the government have given binding undertakings about increasing the flow of lending, but it remains  uestionable to what extent that will fill the gap left by the withdrawal of secondary and foreign players from the market.

Alistair Darling’s recent Budget contained no surprises, but was nonetheless significant in that it began to spell out the long-term consequences of nursing the economy through a deep recession and bailing out some of our biggest banks. Even on projections that assume that the growth of public spending will be pared back to just 0.7% in real terms from April 2011, the ratio of the outstanding national debt to the country’s GDP is not likely to peak until around 2015. Without still more radical measures to curtail spending, boost receipts (by raising taxes) or both, the effects of the recession of 2008-09 will be written large across the public finances until well into the 2020s.

It would also be unwise to expect a return to the spend-free consumer atmosphere of recent years. It isn’t just a matter of credit conditions being tighter; the experience of the past two years is likely to make many households reassess the spending-saving balance. For one thing, the trust in constant, strongly rising house prices has been shattered, as has the notion that property can be relied upon as a substitute for a pension.

All this adds up to an austere picture of life in post-recession Britain.  Economic growth that averaged nearly 3% between 1997 and 2007 is likely to be slower, perhaps averaging less than 2%, which means that unemployment rates will also tend to be higher. The challenge is to neutralise these negative forces by improving our productivity and competitiveness. That sounds very similar to policy priorities of governments during the 70s and 80s before we discovered the superficially easier route to growth of spending and borrowing by households. It hardly sounds like fun, but it will be our best chance of remaining in the economic Premier League.