The missing recession

Some clues may be found in research presented at a meeting of leading US economists held last week by the National Bureau of Economic Research, where academic pundits pondered the future of the US business cycle. Several research findings are of particular relevance to our current situation.

Professors Jim Stock and Mark Watson, of Harvard and Princeton, respectively, argued that the US economy has become fundamentally more stable. They find that year-to-year shifts in output growth have declined substantially. Recessions have not only become less common, they have become milder. And the latest business cycle – the longest boom on record followed by arguably the mildest recession – fits their story perfectly.

The applicability of this finding to Australia is confirmed in recent research from RBA economist Dr John Simon. Dr Simon suggests that the Australian business cycle also seems to have stabilised, and that "continued low output volatility should enhance the prospects that the business cycle will be milder than in earlier periods." Indeed, the slumps that have plagued us may be replaced by a milder form of "growth recession".

Focussing on the current downturn, prominent Stanford economist Professor Bob Hall suggested that the while the bursting of the dot-com bubble was bad news for the United States, this particular cloud had a silver lining: a large and positive productivity shock associated with ongoing innovations in information technology. Thus, output has continued to grow even as employment has declined.

Rather than simply considering economic conditions as good or bad, Hall urged analysts to consider the various shocks to the economy separately, listing the negative shocks attributable to both September 11, the wealth effects from a declining stock market, and the positive productivity shock due to advances in information technology.

The implications for Australia are immediate. Each of these shocks is affecting the Australian economy, but in each case, they are having a more subdued effect.

September 11 undermined consumer confidence on both sides of the Pacific, but it seems to have had only a minor impact in Australia. According to Tim Harcourt, Chief Economist at Austrade, much of this reflects the fact that the main "concern for Australian exporters has been the impact of the US downturn on East Asia rather than the US-Australia direct impact".

The fallout from the bursting dot-com bubble has been less important for Australia than the United States because the wealth effects are much smaller. (Information technology stocks only ever made up 15 per cent of the market capitalization of the Australian stock market; at the peak they were 45 per cent of the US market.) Furthermore, Harcourt argues that the effect on our exports "has not been as bad as expected by many analysts mainly because we are not large producers of information technology."

Yet in a provocative paper titled "Productivity Growth in the 2000s", University of California, Berkeley Professor Brad de Long argued that information technology holds the key to a rosier, more productive future. A fearless prognosticator, de Long argued that the productivity boom catalysed by improvements in information technology in the mid-1990s is likely to continue for at least the next decade or two.

His argument is simple: Moore’s Law has proved itself in each and every year since Intel co-founder, Gordon Moore famously claimed in 1965 that computing power would double every eighteen months. But while the implications of Moore’s Law for the aggregate economy were fairly small back when computers were only a small part of all spending, this is no longer the case.

With both the power of computers increasing, and the number of computers in our homes and our workplaces growing rapidly, de Long calculates that there has been "a four-billion-fold increase in the world’s automated computational power in forty years." This computing power has enabled "revolutions in data processing and data communications," that will continue for some time.

Fortunately for Australia, while we are only small producer of information technology, the key to de Long’s optimism lies in the thoughtful deployment of computers in industry, not in the production of computers themselves. On this score, Australia does pretty well, with RBA researcher Dr Simon (this time working with co-author Sharon Wardrop) finding that our "use of computer technology is amongst the highest in the world" and still growing rapidly.

All of this yields a somewhat nuanced explanation of our current situation. Current hubris appears misplaced: that we have weathered the US recession probably says more about the peculiarities of this particular slowdown than it does about the Australian economy. Yet the longer run forces shaping both the US and Australian economies show cause for real optimism. Productivity growth will be strong, and the business cycle will be somewhat milder. Surprisingly then, the dismal science finally has some good news.