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financial crisis that swamped the US and flowed over
to the rest of the world was expected by all to adversely
affect the real economy. But the speed and extent of
the transmission of those effects was a matter of disagreement.
It now appears that most observers had underestimated
the impact that crisis would have.
The recession in the US, reports indicate, has not just
arrived but has been with us for quite some time. Short
term indicators are disconcerting. Preliminary estimates
of GDP growth during the third quarter of 2008 point
to decline of half a percentage point. But GDP growth
during the previous two quarters was positive at 2.8
and 0.9 per cent respectively. The only other quarter
since early 2002 when growth was negative was the fourth
quarter of 2007. Thus, going by the popular definition
of a recession-two consecutive quarters of decline in
real gross domestic product-the US is still to slip
into recessionary contraction.
But the independent agency which is the more widely
accepted arbiter of the cyclical position of the US
economy is the Business Cycle Dating Committee of the
National Bureau of Economic Research. This committee,
which adopts a more comprehensive set of measures to
decide whether or not the economy has entered a recessionary
phase, has recently announced that the recession in
the US economy had begun as early as December 2007.
That already makes the recession 11 months long, which
has been the average length of recessions during the
post-war period.
Yet, unemployment figures suggest that at the moment
the recession is only intensifying. On December 5, 2008,
the Bureau of Labour Statistics in the US reported that
employers had reduced the number of jobs in their facilities
by 533,000, taking the unemployment rate in the US to
6.7 per cent. This reduction-which is the highest monthly
fall in 34 years-comes after job losses of 320,000 in
October and 403,000 in September. What needs to be noted
is that the official unemployment rate underestimates
the extent of the problem because in a situation where
there are more job seekers and less jobs to find, many
of those who had been working earlier or had been seeking
for work choose to opt out of the search for employment.
This reduces the reported size of the labour force and
therefore the rate of unemployment. The number of those
who “left the labour force” despite being part of it
amounted to as many as 420,000 in November. Adjusting
for such factors is estimated to take the unemployment
rate to above 12 per cent.
Total job losses through this year, which corresponds
more or less with the recessionary period as identified
by the National Bureau of Economic Research, are 1.9
million. This means that the 2.5 million jobs that Obama
is promising to deliver through his promised fiscal
stimulus package would just about recover the jobs lost
during the recessionary period preceding his swearing
in, and leave untouched the backlog of unemployed and
those entering the labour force during this period.
The intensity of the recession is reflected in the precarious
state of the US auto industry, which has always been
a lead indicator of the point on the business cycle
the economy is on. Chief executives of the big three
auto makers, General Motors, Ford and Chrysler have
been repeatedly rushing to Washington to lobby for as
much as $34 billion in support to save their firms from
bankruptcy. While Congress is unhappy with companies
they think had not done enough to modernize and cut
costs during the boom, Democrats at least do not want
to add to the unemployment numbers before Barack Obama
takes office. In the event expectations are that the
industry would receive billions of dollars in short
term loans, to help these firms stay afloat. As Representative
Barney Frank put it, aid for automakers would possibly
come in the form of a bill that nobody likes.
But these are all temporary measures aimed at moderating
the down turn that persists. Effective action to try
and reverse it would have to wait till the new President
takes over. But to buoy expectations and prop up confidence,
Obama has begun to declare intent. Immediately after
the November job loss figures were announced, he promised
to “create millions of jobs by making the single largest
new investment in our national infrastructure since
the creation of the federal highway system in the 1950s.”
But even if that package is implemented fast and works,
this would be a recession that lasts longer than many
of its predecessors, and can reach levels where it would
have to be termed a Depression.
All that said, we must realise that this is not just
an American problem. The recently released preliminary
edition of the OECD’s Economic Outlook for end-2008
shows that GDP in the Euro area declined in both the
second and third quarters and is likely to fall also
in the fourth, and that economic activity in Japan which
fell in the second quarter of 2008, is set to fall in
the last quarter as well. In the event, GDP growth in
the OECD area which fell from 3.1 per cent in 2006 to
2.6 per cent in 2007 and 1.4 per cent in 2008 is projected
to fall to -0.4 per cent in 2009, and the unemployment
rate which rose from 5.6 per cent to 5.9 per cent between
2007 and 2008 is expected to climb to 6.9 per cent in
2009 and 7.2 per cent in 2010.
Other projections share this pessimism. Chapter 1 of
the UN’s World Economic Situation and Prospects 2009,
released in advance at the Doha Financing for Development
conference, estimates that the rate of growth of world
output which fell from 4.0 per cent in 2006 to 3.8 per
cent in 2007 and 2.5 per cent in 2008 is projected to
fall to -0.5 per cent in 2009 as per its baseline scenario
and as much as -1.5 per cent in its pessimistic scenario.
There is much pessimism on how long this recession would
last as well. According to the OECD, for most countries
"a recovery to at least the trend growth rate is
not expected before the second half of 2010 implying
that the downturn is likely to be the most severe since
the early 1980s, leading to a sharp rise in unemployment.”
Moreover, even this assessment is based on the assumptions
that the crisis in financial markets would be resolved
soon and that there would be no negative feedback loops
both between the real sector and the financial sector
(which would exacerbate the financial crisis) and within
the real sector (which would intensify the crisis in
the real economy), before the positive effects of intervention
by governments materialise in full. Such assumptions
are indeed tenuous, increasing the lack of certainty
about a recovery. Thus, job losses in the US are increasing
the number of housing foreclosures. Around 7 per cent
of mortgage loans were reported to be in arrears in
the third quarter, and another 3 per cent at some stage
of the foreclosure process. According to the Mortgage
Bankers’ Association, about 2.2 million homes will have
entered foreclosure proceedings by the end of this year.
This would intensify the financial crisis as well as
dampen consumer spending, and could worsen the downward
spiral.
Such pessimism is also warranted by the evidence that
arguments predicated on a decoupling of growth in emerging
markets, especially China and India, from growth in
the developed industrial countries were unfounded. Direct
dependence on developed country markets and indirect
dependence on the developed countries via the liquidity
injected by capital inflows that sustained a consumption
and housing investment boom were important for growth
in these and other emerging markets. A recession in
the OECD area implies that external markets would shrink
sharply and the financial crisis in the developed countries
has resulted in an exodus of capital from many emerging
market with attendant liquidity and demand problems.
Not surprisingly growth in the emerging markets is slipping
at a rapid pace, and thus far only China has managed
to announce a large package amounting to close to $500
billion to combat these effects. If growth in the other
emerging markets falls even further, as it is expected
to, and the Chinese stimulus package does not deliver
adequate results, the negative feedback on a global
scale would be greater and the global recession would
be steeper.
In sum, we are yet not in a position to ignore the similarities
with the 1930s that have haunted the world ever since
the financial crisis triggered by the sub-prime crisis
began to unfold. Not surprisingly, demands for a coordinated
fiscal stimulus have intensified. But as yet we have
only scattered responses from individual countries that
are very varied in terms of their scale and scope.
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