Debunking the recession hype

Following the recent report of anaemic economic growth in the June quarter, many economy-watchers have gone on recession alert, primed to proclaim the ‘R’ word at the first sight of more weak data.

Some are so inclined based on objective analysis, while others would merely take delight at the political implications of a recession in an election year. Whatever their reasons, they all need to take a reality check.

The next two quarters’ national accounts will be awaited by recession watchers with breathless anticipation of the oft-parroted definition of recession being met – namely, two consecutive quarters’ decline in real GDP. Mark the likely release dates in your calendar: December 2^nd for the September quarter and March 2^nd for the December quarter. Two consecutive quarters of contraction could even be reached with the September quarter release if the June quarter figure is revised down significantly.

Anyone anticipating a recession should take a cold shower before they get too excited or depressed, as the case may be. Let’s start with the caveats on the data. The two-consecutive-quarters rule has enjoyed undeserved popularity since it was suggested some 40 years ago. It is arbitrary to the point of silliness. Two consecutive declines of 0.1% would be defined as a ‘recession’, but is this worse than a 0.9% decline followed by a 0.1% increase (not defined as a ‘recession’)? A brief decline over two quarters followed by a vigorous recovery can be less damaging to employment than a long period of sluggish growth.

The history of quarterly GDP figures is littered with aberrant declines that turned out to mean not very much at all. There is a lot of statistical ‘noise’ in the quarterly figures. If the recent June quarter was surprisingly weak, it must also be said that the preceding quarter was surprisingly strong. Half-year data are less jerky, and in the latest half year there was a rise of 1.2% (2.5% annualised) on the previous half year and 2.2% on a year earlier. Alternatively, quarterly trend data are readily available from the ABS but are rarely reported. Trend GDP rose by 0.5% (2.0% annualised) in the June quarter and 2.2% over the 12 months – hardly a boom, but not suggestive of recession either.

Recessions should only be declared on the basis of a balanced assessment of a range of data over several quarters including employment and unemployment. Often, a recession can only be confirmed long after it has started.

Australia’s modern economic history suggests that a recession is unlikely, given what is presently known. Recessions in the past have been associated with credit squeezes, wage explosions or recessions abroad, particularly in the United States. None of these conditions are present, and the first two are not at all likely to appear in the foreseeable future. A recession or severe growth slow-down abroad has a greater probability, particularly as China is now a more important part of Australia’s ‘abroad’, but is still not a likely scenario.

In modern times we have not had a recession caused solely by the bursting of a commodity price/resource investment boom. That’s not to say it couldn’t happen, particularly as the last boom was so large. However, the floating exchange rate will cushion the economic fallout, and without the other conditions mentioned above any such recession would be mild. Canada appears to have slipped into a mild recession associated with the reversal of its resources boom.

While some people will sweat on the declaration of a recession for its political ‘gotcha’ value, a broader assessment is called for. More important than whether there is a recession is the already observable fact that Australia has entered a period of sub-trend growth which is likely to continue for some time.

It is also crystal clear that real living standards are declining largely because of the decline in the terms of trade – the value of our exports in terms of the imports they can buy. The best measure of living standards – real net national disposable income per capita – has been trending down for four years, with a cumulative fall of 5% so far. However, this comes after an increase of 70% in the 18 years from 1993 – driven first by the emergence from the early 1990s recession, then by Australia’s productivity renaissance, and then by the mother of all terms of trade booms. At 3% a year it may not sound much, but it was an astonishing rate of advance for an already advanced economy.

Now we are having to give some of it back, and those eager to use the ‘R’ word have declared an ‘income recession’. However, the decline to date has been small – taking back less than two of the 18 years’ advance – and (absent a recession) living standards will eventually stop falling when our commodity export prices stop falling. The terms of trade have already fallen by 30%.

The sluggish economic growth and decline in living standards are largely dictated by external events over which we have no control. Undoubtedly the best tonic would be a brightening of the global economic outlook. However, this does not mean Australians are helpless in shaping their own economic outlook. We need to ride out the weakness in commodity prices and take the time calmly and methodically to put economic policies in place that will strengthen the foundations for sustainable growth based on a faster rate of productivity growth. Such policies would be slow acting, but even in the short term they would help restore the confidence needed for increased business investment.

Robert Carling is a Senior Fellow at the Centre for Independent Studies