Over the past three years, the debate over the coalition’s deficit reduction plan and the sluggishness of the subsequent recovery has dominated the agenda. On almost all sides, this debate has been framed in a way that implies that, had we adopted marginally different policies, the fallout from the crash need not have been anywhere near as painful.
We point to the duration of the crash compared to other post-war recoveries as evidence. A useful bulletin by the Centre for Policy Studies last week, for example, showed that, of four post-1945 recessions and recoveries, our current performance is by far the worst. Six years after the onset of the 2008-09 recession, real GDP is still 1.3 per cent below its pre-crisis peak. After an equivalent duration, real GDP by 1979 was 8 per cent above the level seen prior to the onset of recession in 1973, even allowing for a double-dip recession. Little wonder we talk of making up on lost ground. If the economy had grown at the historical growth rate seen between 1965 and 2000, and the recession was avoided, it would be over 17 per cent larger today.
Economic indicators have now by and large turned positive. Yet within the good news, we risk deluding ourselves about the scale of the shock we went through. Were our expectations for a quick, strong bounce-back ever likely?
The economists Kenneth Rogoff and Carmen Reinhart have been criticised for their work suggesting growth is much more sluggish after debt-to-GDP ratios exceed 90 per cent. But their work on financial crises across history is widely respected, and they made a splash with their 2009 book This Time Is Different. This month, a follow-up paper, 'Recovery from Financial Crises', makes this even more explicit. It argues that comparing our current recoveries with post-war recessions, rather than historical instances of financial crises, is a huge mistake.
If one had followed their rule of thumb from analysis of 100 systemic banking crises – that it takes about eight years on average to get back pre-crisis levels of real per capita income (controlling for population growth) – you’d have been much closer to the UK’s actual performance than some forecasts from the Office for Budget Responsibility or other august bodies in recent years. IMF figures, for example, suggest that UK real income per capita in 2013 was about 6 per cent below what is was in 2007. Rogoff and Reinhart remind us that ‘only Germany and the US (out of 12 systemic cases) have reached their 2007-2008 peak in real income.’
So if this time is different, why is our conversation by and large the same? Of course, general economic stabilisation arguments are important. But what matters is working out the mechanism through which these crises undermine economic performance – be it the structural impact per se, or the extent to which policy responses to deal with financial crises impair the recovery. My new colleagues at the Institute of Economic Affairs have highlighted, in a UK context, how structural factors risk impairing the economy’s sustainable growth rate, with profound implications for public debt and living standards.
Thus far, governments in advanced countries have implemented fiscal consolidation and marginal reforms to try to deal with the crisis. But Reinhart and Rogoff’s historical narrative shows that, in the absence of doing what is necessary, post-crisis periods often led to more overtly extreme measures like significant restructurings, capital controls, inflation and financial repression. For countries with the most significant problems, their paper seems to suggest that these measures may still be adopted. Given how right they’ve been over the shape of the recovery, this warning seems worth bearing in mind.
This article was originally published in City AM.