Mixed signals on economic recovery

Dennis Morrison, Contributor

As we moved from 2008 to 2009, the investor class and indeed the majority of the population in the United States (US) and other western economies looked aghast at the plunging global financial markets fearing the near downfall of modern capitalism. A year later, as we enter 2010 and most of these economies are emerging from recession, the threat level has fallen but there are conflicting views as to the strength and sustainabi-lity of the recovery. The signals are mixed at best.

On the more pessimistic side, some leading economists including one of the most celebrated from Britain, Professor Charles Goodhart, have expressed serious concern that contraction of lending in the US and Europe in recent months which is the steepest since the 1930s raises the risk of a slide back to recession. Federal Reserve Chairman Ben Bernanke has also spoken of the "considerable headwinds" that the US economy faces and of a protracted period of elevated unemployment possibly running in double digits to the end of 2011.

There are, too, some warning signs that China's bigger-than-expected growth in 2009 that provided some momentum globally could falter as the brake is applied to its breakneck expansion of credit in order to avoid a Japan-type asset bubble of the late-1980s. Evidence from the US housing sector for October 2009 is also worrying as it showed that the rate of increase of home purchases was slackening suggesting that the government's efforts to stimulate the market may be losing their effectiveness. This and the higher-than-projected unemployment rate have fed calls for another round of stimulus spending.

More optimistic observers assert, however, that the US economy like a rubber ball thrown against a pavement usually bounces back with a force that is typically roughly approximate to that with which it fell. Thus according to this view, a strong rebound is likely notwithstanding impediments such as the indebtedness of US consumers or the steep loss of wealth arising from the meltdown in the financial sector.

optimism

A second pillar of optimism according to James Grant, the proprietor of Grant's Interest Rate Observer, a newsletter popular among Wall Street's elite, is drawn from the sayings of the late British economist Arthur C. Pigou: The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. Put simply, people go into shock in a crisis but get over it even though a mood of pessimism persists after economic circumstances have begun to change for the better.

The optimists also are projecting that with the world's leading economies expected to be back in growth mode again in the first quarter of 2010 and China's economic engine gathering speed and supporting the wider world economy, the recovery could exceed the forecasts of the International Monetary Fund and World Bank which anticipate tepid growth. They point as well to the moderation being shown by Organisation of Petroleum Exporting Countries which in December refused to tighten production quotas signalling that it wanted to maintain oil prices in the US$70-US$80 per-barrel range out of concern about upsetting recovery in world economic growth.

On balance, the recovery of the global economy is likely to be on firmer footing at least in early 2010 as financial markets continue to stabilise and as central banks and governments remain committed to keep monetary and fiscal stimulatory policies in place. For Jamaica, our main challenges are rooted in the fiscal and debt problems and how measures to deal with these will affect inflation, production, employment and household purchasing power. That is not to say we will not continue to be hurt by weak demand for our exports and the downturn in remittances arising from high unemployment in source countries (US, Canada and United Kingdom) of these remittances.

tax measures

The reality is that the recent tax measures which are aimed at increasing revenues to help bring down the fiscal deficit will inevitably lead to contraction of domestic consumption as the purchasing power of households is squeezed. This, in turn, will lead to lower production. Likewise, expected curtailment of government expenditure will reduce incomes compounding the contractionary effect of increased taxes on local production. Without compensating increased production for the export market, the result will be further decline in output. In other words, we are likely to experience negative growth in 2010.

This scenario, though painful, is not unusual in situations where governments must act to correct fiscal deficits. The pain of such adjustments is, however, usually moderated where private investment can be boosted especially in export sectors. Or where increased investment activity in infrastructure development can be stimulated through private-sector participation, including privatisation of state entities. Our difficulty is that weak international economic conditions are weighing against large-scale private-sector investment in the short term, especially in tourism which has been the driver in recent years.

But this could change by late 2010 or in 2011 as the travel industry recovers. Efforts can also be concentrated on the development of attractions and other linkages related to agriculture which generate employment while not needing large capital outlays.

The other major area of buoyancy up to 2008 was the mining sector which could provide investment activity within a similar time frame. In this case, investment related to energy diversification is critical as the long-term viability of the sector depends on such investment which should be tied to replacement generation capacity for the national grid. Ultimately, to ease the pain of fiscal adjustment and to lessen the contraction of the economy will require Herculean efforts to mobilise private investment in 2010 and 2011.

Dennis Morrison is an economist. Feedback may be sent to columns@gleanerjm.com.