Foundations of growth

There are signs that the recession is easing. Policymakers should plan now to deal with structural weaknesses that will remain resistant to recovery

The global economy is far from reaching the sunlit uplands, but the Depression-era dustbowl is receding from view. This week we have seen the first signs that, regarding the financial crisis at least, the worst is over. There are many long months of rising unemployment, depressed consumer demand and crimped business confidence ahead. But it is clear that Britain is not heading for a repeat of the 1930s.

“Actual happiness always looks pretty squalid in comparison with the overcompensations of misery,” wrote Aldous Huxley. Prognoses of doom are ever popular. And the collapse in industrial production and the contraction of trade do bear comparison with the Great Depression. Yet the past week has been discomforting for commentators who predict a prolonged slump. There is a palpable shift in expectations for recovery.

Stock markets have performed strongly in recent weeks. David Miles, a leading economist who will shortly join the Monetary Policy Committee of the Bank of England, argued this week that there were reasons to be “guardedly optimistic” about the UK economy. Alistair Darling, in his Pre-Budget Report last November, slashed official economic forecasts. The Chancellor is likely to project in next week's Budget that the economy will contract by around 3 per cent in 2009; but he will also forecast recovery in the first half of 2010. Most significant, corporate results for the first quarter offer tentative signs that the worst of the recession may be receding.

Nokia, the mobile handset company, and Harley-Davidson, the motorcycle manufacturer, have reported good results this week. The banks appear - with much help from the taxpayer - to be weathering the economic storm. Goldman Sachs has reported strong profits and announced plans to raise fresh capital. JP Morgan Chase has reported record revenues. Both banks expect to be able to repay shortly the money received from the US taxpayer last autumn. And Citigroup reported yesterday its first quarterly net profit for nearly two years.

There are signs, and consistent ones, that the collapse in demand is tailing off. The question is no longer so much whether the pit of the recession has been reached. It is about the pace and shape of recovery. The recession is so deep that a V-shaped recovery, in which output and investment surge back, is less likely than an L-shape, at least for some months, in which the economy merely stabilises. But the prospect of a deflationary spiral and economic stagnation, as happened in Japan through the 1990s, is now the least likely scenario. Whereas monetary and fiscal policy in the Great Depression were far too tight, and thereby intensified the slump, governments and central banks now have acted quickly to stem financial panic and stimulate demand.

When the economy does recover, growth is likely to be uneven. There are structural weaknesses that the Government ought to anticipate. First, the massive accumulation of public debt will need to be offset by cuts in public spending. Growth will have to come from the private sector; there will be scant resources for public investment. Second, manufacturing output has collapsed in the past year. The sector is likely to be a drag on growth for some time yet. Much depends for recovery on growth in services. Third, there has been a steep rise in unemployment. More than two million are out of work. Regardless of the eventual recovery, there will be large social and economic costs in dealing with a swollen residue of unemployed workers.

For all this, the economic prospect is no longer bleak. Market economies are resilient and policymakers have tools to stabilise them. The recession is a tremendous dislocation, and is causing much hardship. But the spring will come.