Anatomy of slumps
"Whatever the caveats, Dow's study is one of the seminal books of the last few decades and needs to be studied by anyone who presumes to pronounce on economic policy."
At a time of widespread distrust of economic research, the last and posthumous work of Christopher Dow (Major Recessions, Britain and the World,1920-1995, Oxford University Press, £55)stands as a landmark of what can still be done.
Dow was assistant secretary general, in charge of economics,at the Organisation for Economic Co-operation and Development and then an executive director of the Bank of England.
After he retired from the Bank in 1981 he continued to work intensively as an applied economist, not only looking at numbers but asking fundamental questions about what they meant and how the economy worked. He just managed to finish his last work before he died at the age of 82.
If there is such a thing as an economic saint, he was it.
Dow's last work should be a model, even to those who disagree with it, of how such research should be conducted and explained. He is rigorous and makes use of econometrics where applicable. But instead of throwing at us a few equations (even when such equations are valid they usually account for only a limited proportion of the variations analysed), his own work is, in the vogue phrase, completely "transparent".
It is also brought to life with lots of comprehensible charts and tables.
Since capitalism has been exposed to boom and bust for centuries, the fundamental question is how much they matter. Dow defines a major recession - of which there have been five in the UK since 1920 - as one in which output does not merely fall behind trend but drops absolutely. Such recessions do matter because they displace the trend itself (see chart).
Economies do have a natural tendency to revert to a trend rate of growth but they climb from a lower starting point and the lost output is not recovered except through fortunate accidents or unusually successful policy.
As a result of the last three recessions Dow believes that British output was, by 1993, some 25 per cent below the level suggested by the previous trend. But he does not regard this shortfall as a scandalous policy failure and - unlike some undergraduate Keynesians - he does not think that the shortfall can be made up by an enormous boost to demand.
Cautious as ever, he believes that the possibilities of re-expansion are limited by two factors. First, the "natural rate of unemployment" (a concept he reluctantly accepts) may itself have risen; second, there is the concept of speed limits. If the underlying trend growth rate is, say, just less than 3 per cent per annum, an attempt to grow after the end of a recession by more than a half or 1 per cent above this rate could run into bottlenecks. This could have an inflationary effect even if the "natural rate" has not yet been reached.
The author will surprise some readers by his finding that the UK recessions of 1973-75, 1979-82, and 1989-93, in each of which output fell by a cumulative average of 10 per cent, were just as severe as the inter-war recessions of 1920-21 and 1929-32. An important chart shows that even if the inter-war recessions were no worse in terms of lost output, they had a much more severe effect on unemployment.
He also suggests that there were no severe recessions in the period 1860-1920, although there may have been a couple early in the 19th century. One possible conclusion is that the economy did not do too badly in the Victorian and Edwardian periods when no one tried to steer it. Alternatively, Dow's concept of a "severe recession" leaves out some of the forces that operate in sustained periods of stagnation or high unemployment.
Dow finds that severe recessions have had varying causes. The 1929-32 experience is traced to the decline in exports, itself a consequence of the US-initiated world depression.
The 1979-82 recession, at the start of the Thatcher term of office, is ascribed to a mixture of an export setback (itself reflecting a combination of world recession and the overshooting of sterling), the contractionary fiscal policy adopted by the new government and a superimposed "decline in business confidence".
The last recession of 1989-93 is,somewhat surprisingly, ascribed to declining business confidence alone.
Dow concludes that such recessions cannot be forecast. His policy inference is that preventive action should be restricted to not provoking them - for example by a big fiscal clampdown at a time of depressed business conditions.
Moreover, he argues it is just as important to avoid excessive booms: they inevitably provoke corrective action which can push the economy over the brink. For unlike many of those who would regard themselves as in his camp, Dow does not think that ever-rising inflation can be tolerated.
Once a major recession has developed, he can only suggest fairly conventional, but cautious, fiscal and monetary stimulation. He refers to the limits imposed by the amount of available capacity or the possible atrophy of labour force skills and so on.
These limits are inherently difficult to measure. Surely the way to impose speed limits is to monitor the movement of nominal demand, a concept he too quickly casts aside.
The author asks why growth did not get out of hand and generate runaway inflation in the golden age up to 1973. He suggests as one reason the Bretton Wood system of fixed exchange rates.
But if that system acted as a proxy for a monetary rule - until the inflationary financing of the Vietnam war - then the distance between Dow and the moderate monetarists is less than either side would like to think.
A volume of this scope inevitably provokes further questions. Dow rightly dismisses theories that attempt to explain severe recessions by excessively high real wages. The collapse of the American banking system at the beginning of the 1930s and the oil shock of the early 1970s hit the world economy through their effect on demand.
But "high real wages" surely contribute to long-term problems, such as the recent persistence of high unemployment in continental Europe in both boom and slump. Moreover, it is not just wages that matter but all the costs of employing an hour's labour, including the now notorious social overheads and restrictions on working time, dismissal procedures and so on.
Finally, if each big downward shock ratchets world or national output lower, how has the human race managed to achieve such rapid economic growth in the last few centuries? Did Dow really believe that if Sir Robert Walpole (the 18th century politician commonly regarded as the first British Prime Minister) and his successors had run an active monetary and fiscal policy, UK real national income would have been a multiple of its present level? The author guards his flank, however, by describing the loss of output in a severe recession as "semi-permanent", thus suggesting that there is more to investigate.
Whatever the caveats, Dow's study is one of the seminal books of the last few decades and needs to be studied by anyone who presumes to pronounce on economic policy.