The Resilience of Capitalism

Paul Ormerod wrote in the Financial Times that we should not underestimate the resilience of capitalism to bounce back sharply from a deep recession, as we are experiencing today.

The fall in output in the current recession has been sharp. In the US, for example, gross domestic product fell at an annual rate of just above 6 per cent in the two most recent quarters. In Japan, GDP is down by nearly 9 per cent on its 2008 first-quarter peak. The latest UK data suggest output is nearly 6 per cent lower than a year ago, the sharpest fall since 1931.

The conventional wisdom is that the steepness of the fall means the recession will be long, and that the recovery when it happens will be anaemic.

In the UK, for example, it is argued that GDP per head would take five years to get back to pre-recession levels. The UK government projects a fall in GDP of 3.5 per cent for 2009, followed by a rise of 1.25 per cent in 2010 and a 3.5 per cent upswing in 2011. But these official forecasts have been widely criticised as too optimistic.

In the US, the consensus among forecasters is that growth at or near trend will not resume until the second half of 2010 and that the 2008 second-quarter peak level will not be regained until the first half of 2011.

As late as the autumn of 2008, economic forecasters in general were far too optimistic about 2009. Are these same forecasters now too pessimistic about recovery? The historical evidence reveals a typical pattern of recession and recovery that suggests this may be so. Very few recessions last longer than two years. And most recoveries, once they start, are strong.

Since the late 19th century, there have been 255 recessions in western economies. Of these, 164 have lasted just one year and only 32 have lasted for more than two years. In other words, two-thirds of recessions last a single year, and only one in eight lasts more than two years.

The pattern of duration is virtually identical regardless of the size of the initial shock. Even when the initial fall in output has been more than 6 per cent, 70 per cent of recessions have lasted just one year. Even in the 11 examples where the initial fall in GDP was more than 8 per cent in a year, eight recessions only lasted that single year. This does not of course guarantee that the current recessions in western economies will be short-lived, but, equally, the speed of the fall does not imply they will be long.

An analysis of recessions since the second world war shows that those lasting one year or less typically end more abruptly. The average growth rate in the year after such a recession was 3.5 per cent, and in the subsequent year 3.8 per cent. This is compatible with the view that short recessions are essentially inventory cycles. Once inventories are reduced to satisfactory levels, normal production levels resume, and fixed capital investment expenditures postponed during the recession are carried out.

The 4.8 per cent GDP growth rate projected by the UK government from 2009 to 2011 has been criticised as too optimistic. It is in fact rather modest in this wider context.

Recovery was rapid even after the Great Depression. The nature of the economic catastrophe that started in 1929 varied enormously across countries, both in size and duration. The UK escaped relatively lightly with a 6 per cent fall in output spread over two years. In Japan, Denmark and Norway the recession lasted only a single year. But in Germany, Austria, Canada and the US, the cumulative fall in output was between 25 and 30 per cent, with the recession lasting four years in the latter three countries and three in Germany.

However, once the recovery began – in different calendar years in different countries – the average rate of growth was strong. GDP growth in the first year after the Great Depression averaged 4.7 per cent, followed by 4.6 per cent in the second and third years.