Is it time to plan for the next downturn?
12 April 2018
It is nine years now since the UK economic downturn triggered by the Global Financial Crisis came to an end – in the second quarter of 2009. As long as economic growth continues into the second half of 2018, which is highly likely, we will move into the tenth year of the current economic recovery this summer.
By historical standards, we are in a relatively long period of sustained growth. Economic expansions which last for 10 years or more are rare events in the UK. If the current period of economic expansion continues until the end of this year, it will overtake the 1980s period of economic growth under Margaret Thatcher and become the third longest post-war period of economic recovery.
Indeed, in the past 200 years, there have only been four previous periods of continuous economic growth in peacetime lasting a decade or more: 1827-1836; 1863-77; 1948-73; and 1993-2007. If this recovery continues past the ten-year mark next year, it would become only the fifth UK peacetime expansion of ten years or more since the early nineteenth century.
That possibility will be surprising to many businesses and individuals. Economic growth over the post-crisis recovery has been slow and the rise in living standards has been very modest. There may not be a widespread feelgood factor, but we are still experiencing one of the longer periods of continuous economic growth in the UK’s economic history.
As this growth phase continues, it becomes more important to factor in the possibility of another economic downturn. The economic cycle has not been abolished. Indeed, it has been with us since Old Testament times. In the book of Genesis we read how Joseph interpreted Pharaoh’s dream as signalling seven good years followed by seven bad years.
Predictions that we have seen an “end to boom and bust” invariably turn out to be false. Before the financial crisis, there was a widespread view that the UK and other major economies had entered a period of “Great Stability”. That line of thinking, however, led governments and central banks to miss the warning signs that ultimately led to the 2008/9 recession.
Most forecasts still point to continued economic growth in the short-term – both globally and here in the UK. But it would be quite surprising if we reached the mid-2020s without some form of significant economic disruption – even though it is hard to predict when this might happen and what form it might take.
Recessions are “shape-shifters”, changing their shape and form as the nature of the economy evolves. But there are some common characteristics we can identify from previous experience.
First, the conditions which lead to an economic downturn are often linked to excesses in the period of growth which preceded it. The mid-70s and early 1980s recessions were precipitated by the inflationary excesses which built up over the long period of growth in the 1950s and 1960s. The early 1990s recession was a correction after the build-up of personal and corporate debt following the financial liberalisation of the 1980s. The Global Financial Crisis had its roots in the build-up of debt in the preceding period of strong global growth in the late 1990s and 2000s.
Second, the immediate cause of a downturn can appear to be a series of random and unexpected events, which conspire together to puncture the optimistic mood of the upswing. Big oil price shocks helped to trigger the recessions of the mid-1970s and early 1980s and the Iraqi invasion of Kuwait and the first Gulf War contributed to the downturn which kick-started the early 1990s recession.
Third, economic policy misjudgements often play a part in the build-up to recessions, and/or in triggering them. Tolerating inflationary excesses in the 1960s and 1970s contributed materially to the recessions of the mid-70s and early 1980s. The 1990s recession was the unintended consequence of financial liberation in the 1980s, which then required a policy of high interest rates to rein in excessive spending, debt, and inflation.
The Global Financial Crisis was triggered by a very sharp rise in US interest rates over two years, from 1 percent in mid-2004 to 5.25 percent in mid-2006. The US Federal Reserve left interest rates too low for too long in the early 2000s and then decided to catch up very quickly – with disastrous financial consequences.
Fourth, in the highly integrated international economic system we now inhabit, economic cycles tend to be driven by global events – not purely domestic factors. All the UK’s post-war recessions – the mid-70s, early 80s, early 90s and 2008/9 – have been associated with a major downturn in the global economy.
Looking down this list of common ingredients, it is not difficult to see possible ways in which the current economic upswing might ultimately come to an end.
The globalisation of the world economic system has been an important underpinning of growth since the late 1980s, but a protectionist backlash is building up – with the Trump presidency threatening a raft of tariffs and trade restrictions. In the UK, Brexit is a more specific threat to our most significant trade relationships - with other European economies.
Technological progress has also been a major driver of recent economic growth, but technology companies are now facing major challenges around privacy of information and their role as a channel of influence in politics and society.
The recovery of the world economy has been built on a platform of very low interest rates. If this regime of easy money cannot be reined in gradually and slowly, there might need to be a much more abrupt policy change, triggering the economic downturn central banks have been trying to avoid.
The world economy is performing strongly at the moment, even if the UK is lagging behind because of the impact of Brexit. But the longer a period of growth continues, the more likely it becomes that complacency sets in and the warning signs of a coming downturn are missed.
After nearly a decade of recovery, governments, businesses and individuals need to be preparing to weather the next period of economic turbulence – even though we may not know yet exactly where it is coming from or when it might hit us.
This piece was first published in The Times on the 11/04/2018 .