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The UK's economic capacity - instinctive optimistic contrarianism

Written by Giles Wilkes

Thursday, 14 May 2009 17:13

The Bank of England provided its quarterly inflation report yesterday. Watch the video, it's really amusing. Chris Giles of the FT, arguably the best financial journalist in the country, was particularly punchy in the way he interrogated Merv, and as ever zeroed in on the most important fact: whether the economy's economic capacity has been permanently impaired by this crunch, or rather, by how much.

The Bank's answer was: "The governor and Charlie Bean, his deputy, confirmed that the Bank has lowered estimates of the level of output that the economy could sustain without triggering inflation. Mr Bean said the credit crunch had cut working capital to companies, restricting their ability to supply goods and services, and would reduce investment and hence the buildings and machinery necessary to produce output. It would also hit research and development and might lead to some destruction of skills from rising unemployment."

This question is hugely important, as the answer determinesthe shape of the recovery, and with it pretty much everything else that will matter in politics. An optimistic view might see a financial-crash inspired recession as similar to a household losing the use of its credit card for a few weeks. Then the household spends less for a while, but can spend more afterwards, and is broadly unaffected in the long run. The pessimistic view sees the crash as more like bits of the house being destroyed in a storm. The house has to work hard just to get back where it was before.

The Bank's view is understandable, and admirably conservative. It is hardly prudent to assume that all of the loss in GDP - almost £100bn between the PBR 2007 projections and the lateset Budget- will be merrily regained once we start growing again.

But I would like to pose a contrarian view. Recessions can be good for long term growth, because they cause poor companies, that had been buoyed by easy conditions in the boom, to fail. Average productivity increases. Crashes unfreeze various markets and opportunities by allowing the previously unthinkable to happen - the revamped department to be revamped, the useless guy in marketing to be fired, the pointless entertainment expense to be cut.What Schumpeter called 'creative destruction' works its magic. So although the costs of recessions are real, the stuff of economic productivit. The 1930s were not a bad time for innovation, and opened up huge economic capacity that butressed the expansion of the 1940s to 60s

How the next decade's growth will actually happen is a mystery to anyone; the catallaxy cannot be analysed. Think back to 1994. Could anyone have anticipated the role that the Internet and China were due to play in the boom? No - even the mighty IFS thought the economy was booming out of control. Growth in the future was a classic 'unknown unknown'. It usually will be.

The mid to late 1990's were a great time to be starting work, despite - or because of - the government's fiscal retrenchment. It was a good time for innovators and risk-takers.

Now the Guardian is gloomy. So was Rees Mogg in the 1990s:

“We are heading for an appalling four-year economic depression in which crack-crazed armed gangs will roam the streets, the value of your house will fall to a third of its present level, terrorists will ransom the West with nuclear weapons, anybody worth more than £100,000 will employ an armed bodyguard and everybody else will carry a handgun . . .
“If you are badly in debt, you’re dead; forget it, walk away, sleep in a cardboard box if you can find one. You are about to be totalled by economic history.”

Was that your memory of the 1990’s?

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German's have experienced less hardship than the British in the current recession because they live in a social democracy. The upturn they're experiencing matches some of the positive figures that have come out of this country - they aren't ahead of us or coming out of things any better.
Whether the upturn will last when restocking and government measures disappear is anybody's guess - personally I expect the automotive industry to fall off another cliff when scrap schemes are phased out.

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