Vince Farrugia | Sunday, 29 March 2009

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Recession: How soon are we out of it?

One striking feature of the recession that is now hitting practically all economies is the speed of the follow-through from the banking crisis, that in September sent financial centres in an unpredicted downward spin, to the real economy.
Normally financial events take a lot longer to affect growth, and longer still to hit employment. This time, however, in most industrialised countries the effect has been instantaneous. The smaller economies like Malta, which did not suffer from the financial crisis in any dramatic way, suffered soon after as the impact on employment and earnings in the major economies, on whose markets the smaller economies depend, rocked them to an unsustainable degree.
The near meltdown of the banking system hit credit hard – particularly trade credit – and walloped confidence all over the world. This time round it was not just the USA, Japan or Great Britain, but all major economies. Business behaviour changed immediately as the trade credit crisis hit major businesses hard and in real time.
The impact on businesses such as manufacturing, major industries and service providers that together employ millions was much more rapid than the impact on consumer behaviour. The impact on consumer behaviour came soon after. As the consumer credit crunch hit hard, people lost their jobs and their homes and everything around began to bear the impact of the crisis. Here in Malta we only read about it and for most people it was something that affected others.
When I literally screamed on Budget Day that we were not bold enough and that we were not realising how deep this recession was going to be, some promptly criticized me for being too negative. Unlike many people, however, I have lived through previous recessions holding important posts with great macro-economic management importance and I know perfectly well that the question of a world recession rebounding in little Malta was one of a few months before orders for exporters and hoteliers drop dramatically.
I also had the experience of how to defend our entrepreneurs. Most of our firms are essentially strong but not so resilient. These include exporters, tourism operators, Freeport, service providers and the others that depend on them as the leaders that bring the orders from abroad, as well as all others that supply them to help them deliver to an overseas clientele. The weakness of most of our firms is their weak capital structure. They are incapable of withstanding an extended period of low activity and unless financially relieved by big brother, the State, they simply would not be able to survive a long recession in world markets. I urged government strongly to act on an enterprise-by-enterprise basis, helping firms not only to live through the recession but to compete even in a deflationary market were prices for manufactured goods and for hotel beds were being dumped.
This is now happening. Not as much as I would like, as an economist and as Director General of GRTU, but enough not to let the recession swallow us. We must keep our seatbelts fasted as the economic tremor is still wild.
What many out there believed, up to November, that this time round, given the world experience of handling recession, it would be a mild recession. I think some brainboxes in Malta also thought so. They would not have predicted in November that the Maltese economy would in 2009 grow by 2.5% and advised the Minister of Finance to include this as a basis for his Budget 2009 predictions. But we all now know the prospects of a mild recession turned into the reality of a deep one.
How deep and how long? The International Monitory Fund is very pessimistic on the economic growth prospects of many major economies. Next month IMF will give us a proper update for all major individual European economies. This will help us assess the impact on the European Union economies and on smaller economies like Malta, and could help us define better the time scales for revival.
In the meantime we can get some ideas from historical evidence. Paul Ormerod, the leading economic historian of Valterra Consulting, last week published a paper that analysed all recessions hitting advanced economies since 1871. A total of 255 recessions were registered between 1871 and 2007. Each recession has been defined as an episode in which gross domestic product falls from one year to the next.
It is interesting that Paul Ormerod says that most recessions end quickly. 64% of recessions suffered only a single-year GDP fall. Next most common, 23% were two-year recessions. Three-year recessions are rare but they happened 20 times, just under 8%. Four-year recessions occurred only six times: 2% of all recessions. There was one example each of a six- and seven-year recession.
Recessions are generally self-correcting as they are usually cyclical. If firms feel the world is in a good economic state and consumer confidence is high, they over-produce and they over-order raw materials and some manufactured goods and services (these are the kind of orders on which Maltese firms live, or on which the Maltese economy depends). When recession hits, they are forced to cut back, supply demand out of stocks (inventories). Production cutbacks drive the economy into recession, and only when stocks are so low that firms start producing again do we come out of it.
There is an element of all that in the current global recession, though as many leading economists point out, it is essentially the product of two big shocks suffered by major economies: the credit crunch and last year’s oil and commodity price surge.
The good news is that the recent G20 gathering of Finance Ministers and Central Bankers resolved on a commitment by Central Banks to explore further ways of boosting their economies by unconventional measures. This is really a commitment to boost the money supply by extraordinary measures. Most Central Bankers are normally terrified of this as such measures lead to an immediate surge in inflation and this could be counter productive.
Most leading economies are in a deflationary spiral, that is, prices are falling and inflation is negative (Malta is one of the very few countries where inflation keeps rising!) so implementing what the economists call quantitative easing – printing of money – is an unprecedented action that will push economies without danger of immediate inflation.
In America, the Federal Reserves Board-approved monetary interventions will move America’s deficit to 12% of GDP. The economy is receiving boosts of unprecedented size and form. President Obama now predicts that by borrowing trillions (millions of millions) to fund his government’s economic stimulus package, the American’s economy will soon be growing at an annual rate of about 4%. America is facing the challenge. They are showing that they are not afraid to shoulder their responsibility to lift the world out of recession sooner than later. This resolves for sure and will bear results. We will be out of recession sooner than many predicted.
Here in Malta we need to hold tight. Government needs to intervene more. The Central Banks need to be more courageous. MFSA needs to hold the banks tighter to manage the availability of credit to enterprise better. Tightness of credit and a squeeze on accessibility of funds to business will lengthen our recession. The Opposition in Parliament needs to grow up and stop simply criticising. They must join forces with Government and with the business community to help the nation sail through a very difficult period.
If we act together, and smartly, little Malta will also be out of it in a shorter period than the professors of doom are predicting.

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