Jeremy Peat: Setting a course for recovery
In LOOKING to the future, we must first look to the past and the present. This present recessionary period in the UK and Scotland is different from any other such period experienced by anyone reading this newspaper.
It has lasted longer than even the “Depression” of the 1930s and is not over yet. The outlook remains uncertain; just yesterday we saw the Purchasing Managers’ Index for Scotland for September suggest that the private sector had entered negative territory for the first time since December 2010. We do not know when we will exit recession; nor do we know how long it will take to recover the economic ground that we have lost since 2008.
What we can expect is that recovery will be slow and protracted. Further, the post-recession world will be very different from the immediate pre-recession period. We will exit recession into continuing tough times as households, businesses and governments continue to be cautious while they return their balance sheets to sustainability. Also, given the trauma caused by past excesses, we must expect policymakers’ assumption regarding “trend growth” to be significantly more cautious than pre-recession. And this prognosis of tough times post-recession is before we take account of the adverse effect on public finances and households resulting from demographic change, the cost of reducing greenhouse gas emissions and coping with social tensions resulting from the extended recessionary period. Continuation of difficult economic times will be associated with very difficult decision-making on economic policies and tough choices on the public finances.
We will look back with wonder at the period spanning the turn of the last century. How was this “Nice” – non-inflationary continuous expansion – phase achieved; and how did it all go so horribly wrong? The generations entering the world of work this century will have cause to be mighty jealous of their predecessors – and also more than a mite upset. The economic future is, by definition, uncertain. However, logic suggests it will be a very different economic world over the next couple of decades. Households, businesses and governments in Scotland will not have their troubles to seek.
This latest recession is different and more severe. Although it is more than 50 months since the recession started in 2008, we have yet to see a return to a continuing upward path and output is still 5 per cent below the pre-recessionary peak. In the series of “normal” recessions at the back-end of the last century, full recovery was under way within 30 months and after 50 months output was in each instance markedly above the level at recession’s outset. Note also the comparison with the Great Depression of the 1930s. Even back in those dim and dark days, recovery was under way within three years and a new peak in output was attained in 45 months. The latest downturn is more enduring – and has yet to come to an end.
We now know that the decline into recession was in large part due to the massive build-up of debt across the economy – by households and businesses (not least banks) prior to recession and by government during the downturn. We now face the conundrum of having to rebuild personal and corporate balance sheets, thereby severely constraining demand across the economy while attempting to recover from recession, a feat that will require recovery in demand. This poses huge challenges for policymakers, getting the balance right so as to return to sustainable debt levels while not cutting off the potential for even a gentle pick-up.
The priority has to be to contain and reduce the structural deficit in our public finances, while acknowledging there is a cyclical element that should be left well alone. This cyclical deficit can be seen as “natural” as tax revenues decline with the cycle, while welfare-related public expenditure rises as the economy stagnates. Economic recovery should help sort the cyclical deficit; it is the structural element that policy must diminish.
Strong growth around the turn of the century was certainly in part a result of improved decision-making on monetary policy, culminating in the independence of the Bank of England and its monetary policy committee. However, the nation was also unduly sanguine about debt. Belief that inflation was sorted for the duration led to a view that the “sustainable growth rate” of GDP was higher than previously supposed – say 2.5 per cent or even 3 per cent, rather than a mere 2 per cent. Policy and the public finances were re-based according to this view. As house prices and perceived wealth rose steadily at double-digit levels each year, so households thought it safe to build up debt – and household and business debt to GDP ratios rose dramatically to new peaks.
It all ended in tears. Now the expectation is that the sustainable trend growth rate was over-stated. Perhaps it should be 1.5 per cent, or at most 2 per cent per annum. Policy in the future will be far more cautious. Also, post-recession, households and businesses will still not have returned their debt ratios to comfortable levels. It takes far longer to reduce debt than to build it up.
This combination of a slower trend growth rate, more cautious public policies and more cautious households will mean that this post-recession world will be very different from the “Nice” days of yore. Interest rates look set to stay very low for many years. Taken as a whole, equity prices are unlikely to zoom upwards. The economy will be more subdued.
On top of this, we face the demographic time bomb. The share of the total population accounted for by the 65+ age group (my lot) is expected to increase by six percentage points over the next two decades, while the shares of the 20-64 groups fall away and that of the 0-19 plummet. These data are for the UK, but the position in Scotland – subject to migration trends – will, if anything, be marginally more worrying. Estimates suggest the dependency ratio (the ratio of those aged 65 plus to those in the standard working age, 16-65) will be 4 percentage points higher in Scotland by the 2030s than elsewhere in the UK.
Inevitably, there will have to be adjustments in working patterns as a result of such change – future generations will work longer and take such pensions as are available later. But there will also be problems for the public finances with relatively fewer taxpayers and relatively more consumers of age-related welfare services. The financial impact of an ageing population can be diminished by working to ensure a growing proportion of post-work years are healthy years; but, as yet, there is no clear sign of such a desirable trend emerging.
This is not a pleasant state of affairs that my generation is leaving for those now entering the labour force. Whatever may happen as far as constitutional matters are concerned, the public finances face many years of constraint. Robert Black called last week, in his David Hume Institute seminar and an article for this newspaper, for a standing commission on resources and performance, independent from government and informing parliament, and also a “safe place” in which policy can be discussed without the limitations imposed by party politics. The Royal Society of Edinburgh, in its latest submission to Holyrood’s finance committee, suggested various moves to place “the [Holyrood] finance committee … in a much stronger position to fulfil its remit of examining the Scottish Government’s spending plans” and also “facilitate more informed, higher quality debate on the draft Budget by MSPs”.
In this more difficult world, post-recession macro policymaking will be complex and critical; so too will decision-making on the public finances. I believe fundamentally in transparency; and in evidence-based policy making. We must know where we wish to head and make the best fist we can of moving in that agreed direction. The suggestions from Bob Black and the RSE merit serious attention.
• Jeremy Peat is director of the David Hume Institute, but is writing in a personal capacity
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