Email this article	Comment on this Article	Print this article

The bad news is punctuated by a positive surprise now and then

Following a period of continued negative news, recent international economic statistics have started becoming more mixed.

Some people see the improved statistics as reflecting a budding economic recovery. Others see it simply as proof that the economy is no longer in free fall but is stabilising, albeit on a lower level.

At least it is an indication that the rate of decline is moderating.

The debate on the shape the expected economic recovery will take is therefore slowly gathering momentum, with widely divergent views the order of the day.

A former chief economist of the IMF, Michael Mussa, a senior fellow at the Peterson Institute for International Economics in Washington, firmly believes the recovery will be V-shaped, in other words it will be just as steep as the decline.

His main reason is what he calls the "Zarnowitz rule", referring to the thinking of one of his tutors of business cycle studies, Victor Zarnowitz, namely that history has shown that deep recessions are nearly always followed by a sharp recovery, which is usually underestimated by forecasters.

However, another former chief economist of the IMF, Simon Johnson, currently of the Massachussets Institute for Technology (MIT), takes a different view, namely that the recovery will be slow and difficult as the current downswing is not a normal cyclical downswing such as usually follows a tightening of monetary policy in response to increasing inflationary pressure.

Without mentioning Mussa by name, Johnson says the argument of people like him is based on nothing more than a belief in a reversion to mean, in other words that the economy will always revert to its mean after having deviated from it for some time.

An important shortcoming of this type of argument, says Johnson, is that the proponents thereof do not explain the mechanism by which this reversion to mean will take place.

I must confess that I can identify more with Johnson's argument than with that of Mussa.

The fact is that the economic recovery, when it does come, will not be simply a normal cyclical upswing, but the start of a new era in the economic history of the world that will be different from the system that existed prior to the financial crisis.
 
In the IMF's review of the global economy just released, the researchers analysed economic declines in 21 countries and the subsequent recovery since the Second World War.

They come to two very important conclusions that are crucial to the current crisis:

• In all cases where the downswing followed on a financial crisis, the recovery took longer than normal and it was accompanied by weak demand conditions and tight credit. It did not start until the problems with bad debt in the banking system had been resolved.
• In all cases where the downswing was of a global nature rather than limited to a specific country or only a few countries, the recovery also took longer than normal as countries could not rely on exports to get them out of their predicament.

Therefore the worst is yet to come, and the V-shaped recovery of Michael Mussa and his supporters is likely ultimately to be L-shaped. Or perhaps rather in the shape of a square root sign, with a sharp bounce-back from an excessively low level, followed by a slow recovery.

Judging by the medium-term forecasts for the South African economy, it seems as if local forecasters are also to a large extent guilty of Mussa's blind faith in an unavoidable reversion to mean, even if they do not accept the possibility of a V-shaped recovery.

The question is whether the South African economy can detach itself from the global economy and generate its own growth momentum. After all, there is a strong historical connection between South Africa's economic growth rate and that of the G7 countries, with a correlation of 47% since 1960.

On the positive side there is, firstly, the fact that South African banks need not undergo the same contraction of their balance sheets as banks in the US and elsewhere.

The contraction in credit extension in South Africa is a normal cyclical phenomenon, to which should be added the once-off adjustment to the new National Credit Act.

Secondly, South Africa's policymakers will be able to follow normal anti-cyclical policy in the next few years, unlike their international counterparts who will be facing the challenge of reversing in an orderly manner the extraordinary stimulatory measures they have implemented.

For some countries it will be especially difficult to normalise their fiscal position.

Thirdly, South African households need not make such a major adjustment in spending as in the Anglo-Saxon countries in particular.

Domestic asset prices, notably property prices, have not declined to the same extent as prices in those countries and the balance sheets of South African households therefore do not require such a drastic increase in savings to repair the damage.

However, they are also labouring under an intolerable debt burden and the domestic savings rate is negative, which will require a similar adjustment.

However, two factors in particulars argue against a return to the average growth of recent years.

In the first place the recent growth performance of the economy was not sustainable, bearing in mind the sharp rise in debt levels and the resultant current account deficit.

In other words, the potential growth rate of the South African economy has not improved to the extent recent history would indicate.

In the second place, owing to its openness the South African economy cannot evade the implications of lower global growth.

In 2008 exports accounted for 27% of GDP and it is unlikely that global trade will achieve the growth rate of the past 20 years again very soon.

Although South Africa's international trade is better diversified geographically nowadays with a larger contribution from emerging-market and developed countries, not one of its trading partners will be able to escape from the negative impact of low growth in the developed countries.

So, even though South Africa is in a better position than many other countries, one should take another look at its growth prospects, and a simple reversion to the mean of the past 5 years appears unlikely.