A squeeze not a recession

The following comment by me appeared in this week’s Fund Strategy.

Many will no doubt see the latest gloomy data from the eurozone and Japan as confirmation that the world economy is heading for a deep recession. Such a view is based on a superficial reading of global developments.

GDP figures for the second quarter show output falling by 0.2% in the eurozone and 0.6% in Japan. In addition, global fund managers say that the credit crunch is spreading from America to the rest of the world.

It is certainly possible, although not certain, that many developed countries will see a technical recession in the coming year (defined as two consecutive quarters of falling output). However, given the strength and size of the developing economies it is hard to see the whole global economy suffering such a fate. In July the International Monetary Fund forecast that emerging and developing economies would grow by 6.9% this year and 6.7% in 2009.

What looks likely is a protracted period of slow growth in the developed world punctuated by financial volatility. Developing country growth is likely to slow but to remain positive.

It is also important to remember that numbers only tell part of the story. This downturn is different from most previous ones in that it is a consumption-led slowdown. It is centred on problems on the consumption side of the economy and the financial markets rather than the industrial sector. Instead of the violent shake-out that has characterised many previous cycles, a less intensive but more prolonged squeeze looks likely.

The outlook is far from rosy, but it is not comparable to recessions such as that of the mid-1970s or early 1980s, let alone the Great Depression of the 1930s. Although the contraction will not be as great, it is likely that the recovery will be muted. Previous shake-outs often played the role of restructuring the economy with a new round of expansion after the weakest firms and sectors were shaken out – what one economist famously called “creative destruction”. This time around, no such recovery is likely as no fundamental restructuring has occurred.

The other big difference is the relative importance of the developing world. In relation to the global economy, the past provides little guide to the present or the future.