A useful global recession?
November 16, 2019
Forecasters have become less gloomy over world growth recently. I was expecting such a turnaround in forecasts, largely a bout of wishful thinking. When it came, though, I started to feel sorry. Wouldn’t a recession be good, after all? Obviously, a recession is generally painful. Large numbers of people lose their jobs, firms go bust, incomes vanish, useful investments are postponed and much wealth is erased as stock markets plunge. Is there a silver lining?
There is a whole literature about the cleansing effects of recessions. This is when bad business decisions meet their fate and zombie firms are finally eliminated. People who were in wrong jobs are forced to look elsewhere and eventually are happy they did. Overvalued assets are adjusted to their true values, clearing the air for a less worrisome future. Loans that could not be reimbursed are given up one way or another. Unrealistic expectations of the past are brought back down to earth. In the end, the economy emerges ready for a new phase of sustained growth. As we go through one of the longest expansion phase ever recorded, a cleansing recession has much to recommend to it. Yet, other aspects, specific to these times, come to mind.
The first obvious one is that a serious recession in the US could remove the spectrum of another four years of Trump in the White House. Rising unemployment and widespread business failures stand to break Trump’s magic in the eyes of the beholders. Inasmuch as this would be the consequence of the trade wars that he singlehandedly launched, a sufficient number of his aficionados might see him as a failure. In spite of the misery that a recession would bring upon, it is a price that is worth paying, I believe. In addition, it would make those policymakers around the world who do not fear trade wars much realize how wrong they have been. After all, the postwar architecture is a consequence of the trade wars of the 1930s. Those who thought that this time is different would learn a useful lesson, one that is likely to be remembered by a generation or two.
In Europe, governments have become fixated on a curious orthodoxy, that less public debt is always and everywhere better than more. Here again, this orthodoxy is not new, it made a bad situation much worse in the 1930s. Since then, we have learned that judgments about the size and evolution of the public debt must be carefully nuanced. This knowledge has often been ignored by policymakers, not all of them for sure, so a lesson is well overdue. It is sad that it takes misery to get the message heard, but it may have become necessary.
Then look at stock valuation. Many financial analysts think that stock prices are generally high. Even firms have not rushed of late to issue shares, which suggest that they agree. True, rock-bottom interest rates expected to prevail over a long period imply that asset valuation is based on realistically low discounting. Maybe, then, assets are not overvalued. Yet, these valuations do not seem to factor in a recession, so they stand to be reassessed if a recession does occur. Financial markets have been on a glorious roll, which suggests that investors have become excessively optimistic, as they usually rare at the end of an expansion phase. Part of their optimism is driven by the post-2008 experience, whereby central banks have innovated in many ways as they prevented a remake of the Great Depression and maintained financial stability during troubled times. The financial markets still seem to expect that central banks will be able and willing to continue doing so even though they are running out of ammunitions. Risk, it seems, is underestimated, which may lead to excessive risk-taking.
Finally, a new view has emerged and seems to be widely shared: we are living through a long-lasting period of secular stagnation, characterized by low growth and low interest rates. One reason is that technological progress has declined. This view is controversial. It does not square with widespread reports about the presumably amazing changes brought about by the information and artificial intelligence revolutions, which are shaking all aspects of production and everyday life. They also are boosting research advances, not only in fast-moving fields of research. Can both views be simultaneously true? It does not seem so. At the same time, globalization has also led to fast technology transfers that are raising productivity and growth in many parts of the world, including in populous China and India. How can this historical transformation not raise global productivity and speed up growth?
The second reason behind the secular stagnation hypothesis is that the world is saving more than it needs to borrow to finance productive investment. Even though population aging encourages saving, global saving does not indicate a rising trend and it remains unclear whether we face a lack of investment opportunities or whether we are still stuck in the lingering impact of the global financial crisis which deters lending. We just don’t know for sure. The cleansing effects of a recession could turn the page on the residues from the crisis and allow the world economy to return to faster growth, more investment and higher interest rates.
We are probably going to escape a recession in the near future, which is undoubtedly good news, if confirmed. Yet, somehow, there is a case for wishing one, a wish that I may come to regret, of course.