Join our community of smart investors

Back to dreary normal

The economy is returning to normal. Latest figures show that since November real GDP has risen 3.5 per cent and the number of employees by 429,000. Yes, both are still well below pre-pandemic levels, but we’re getting there.

Which isn’t as good as you might think. Before the pandemic, the economy was stagnant. Labour productivity, for example grew only 0.3 per cent per year in the 10 years to 2020, compared with 2.2 per cent in the 30 years before the financial crisis. That’s why real wages were flat.

Yes, the economy is recovering well now. But we must not confuse short-lived expansions for the trend. Before 2020, trend growth was weak. Why should the pandemic have changed this fact?

It might have made things worse. It has left many companies with huge debts: the Bank of England estimates that small and medium-sized enterprises (those with under £25m in turnover) have seen their bank debt rise 25.5 per cent in the past 12 months. That will limit any expansion plans they had. And the pandemic might have a scarring effect: it could permanently reduce optimism and the willingness to invest and innovate.

It’s not just SMEs that have been left with a debt overhang, though. So too has the government. And it plans to tighten its belt. The OBR foresees cyclically-adjusted borrowing falling from 6.9 per cent of GDP this year to nothing by 2024. This retrenchment will hold back demand growth.

So, what offsets these drags? We can disregard the government’s talk of building back better. Economists such as Dietz Vollrath, Peter Robertson and John Landon-Lane have shown that national economic policies actually have little impact upon longer-term growth.

Instead, there are other reasons for optimism. One is that as the IMF recently pointed out the pandemic has accelerated progress towards a digital economy, such as working from home, which could raise productivity.

Another is that if companies’ debt overhang forces enough of them out of business, it’ll raise the profits of their surviving rivals thus enabling them to invest – all the more so as they’ll be able to get cheap empty premises and equipment vacated by the dying companies. This lays the foundations for faster growth.

This is an old-fashioned view, associated with economists such as Hayek and Schumpeter. It fell into disrepute in the 1930s, when the depression then proved not to be self-correcting. But it was a decent description of earlier recessions. And the previous two US recessions, in 2001 and 2008, did indeed greatly restore profitability, if only temporarily. Recessions can have what the MIT’s Ricardo Caballero has called a “cleansing” effect.

You might object here that the companies hardest hit by this downturn aren’t lame ducks – the best restaurants and hotels have had to close as much as the worst ones – and so killing them off won’t help raise productivity. True. But firm closure is only part of the story: there’s evidence from the US that companies that start up in hard times are unusually efficient – a fact that can raise productivity growth.

Perhaps, then, the new normal will be better than the old. Given how powerful the pre-pandemic forces for stagnation were, however, these are slender hopes rather than expectations.