The consensus forecasting view about the economy in 2012 is gloomy – much worse than it was a year ago for 2011, which proved too optimistic. The outlook for 2012 could be too pessimistic but, from what we know right now, caution seems sensible.
Mostly, the economy operates like a series of see-saws that are not fixed to the ground. These see-saws relate, for example, exports to imports, savings, investment and consumption, and demand and supply generally. Markets work when inter-related see-saws are moving in dynamic balance. “What goes up must come down” and forward progress is possible. The economy is seldom at any point of balance for very long, but at least it’s oscillating around some ‘normal’ pattern that generates new jobs and growth.
For example, when a trade see-saw starts to look precarious (large and persistent deficits on net exports), there should be self-correcting forces (through exchange rates, cost/inflation pressures and capital flows) that start to reverse the trend. The problems in economics tend to come when the weight on one end of the see-saw is too great for the other end to react normally. This often occurs because of some policy intervention, structural inefficiency or institutional arrangement that makes the see-saw rigid: such as an inappropriate monetary system, over-regulation or some abuse of market power.
In the current downturn, several economic see-saws are stuck out of balance. As long as surplus countries fight to remain surplus countries and deficit countries are stuck with their deficits, mutual austerity only makes the lighter end more exposed. The surplus countries have to reflate domestic demand too.
Within an economy, of course, there are other sets of see-saws. For example, in the short run, a demand see-saw exists between the private and public sector. So, if the government is withdrawing demand to correct a fiscal deficit, you hope this is counter-balanced by a private sector that is taking up the strain. This is why the broad rule is “run public sector surpluses when the private economy is booming and go into deficit when the economy is not” to keep the see-saw moving. The problem comes when politicians build up discretionary deficits in the boom and have to correct them in a bust. Sound familiar?
Amongst others, then, the UK policy makers are in the situation of not wanting to start from here. In aggregate, low business and household confidence about real earnings potential is stultifying private demand. Unless this can be changed, more public sector restraint only means a see-saw stuck out of balance and shifting backwards. The Coalition has its fingers crossed that if it gets out of the way, the private sector will start to ‘crowd in’ soon. Given the vulnerability of domestic and external consumers, however, the probability of this seems low. I really hope there is an international plan brewing to put some weight behind the demand see-saws before they seize up altogether.