Thursday, October 27, 2016 4.49 PM / FDC
Contrary to the widely held economic doomsday opinion, there seems to be a flicker of hope at the end of the recession tunnel. This is because emerging economic indicators are pointing towards a very slow but chequered recovery.
Hitherto, there had been divergent diagnoses as to whether the economy was in a recession (fiscalists) or in stagflation (monetarists) which had led to mixed prescriptive measures.
This article seeks to shed light on both phenomena to enable investors and operators make efficient decisions. It goes further to address the informal sector and ways to integrate it into the wider economy.
In times of economic distress, it is possible for economic agents (Consumers, firms, government, and policymakers) to get misled with contradicting and inadequate analysis of the Nigeria’s economy. In order not to fall prey to all kinds of economic jargon, we must be clear in describing the present state. Nigeria is experiencing one of the worst economic growth contractions since the ‘80s. It is also plagued by other structural and transient issues such as increasing consumer prices, fiscal and external imbalances, low oil production levels, a dysfunctional foreign exchange (forex) market and so on. It is easy to morph the economy’s situation into a theoretical narrative that is not necessarily representative of the Nigerian case. This article aims to address the gaps in the theoretical explanations of the economic situation in Nigeria using global case studies.
Stagflation or Recession
A stagflation is an economic situation where consumer prices are high, economic growth is slowing and unemployment maintains a steady upward trajectory. Ian Macleod first explicitly mentioned the concept in his assessment of the UK economy.1 Strong growth and stable prices characterized post-war Britain. High in-flation in the 1960s through the 1970s plagued the UK economy. This era was known as the great inflation. The inflation rate in that period went as high as 25% (1979). It was attributed to the oil price shocks of the 70s where the price of oil spiked four times, making net importers of oil highly susceptible to economic dis-tress.
A state of stagnation is one where there is a persistent period of slowing growth often followed by high unemployment. Slowing growth does not mean negative growth. Negative growth best de-scribes a recession, where a country experiences at least two con-secutive periods of negative growth.
There are two main views that attempt to describe stagflation in a country. The UK and other net-importers of oil in the 70s saw stagflation come about as a result of a reduction in production ca-pacity attributed to a negative supply shock. Prices in the econ-omy increased because negative supply shock caused a slowdown in output due to higher production costs. Hence, output could not compensate demand.
The second channel where stagflation occurs is via macroeco-nomic policy gaps. Policy in all facets of the economy is not in sync. The government of a country might be engaging in policies that clamp down on growth spikes to target a fairly normal busi-ness cycle. However, the central bank might also simultaneously free up money supply in the economy through monetary policy. This frees up funds for goods that are unavailable.
Global Cases Studies
Stagflation in OECD – 70s and 80s2
The oil price shocks of the 70s created a wave of slowing growth and rising consumer prices, which according to John F. Helliwell was the “hallmark of OECD economic performance in the 70s and 80s”.3 Inflation was a predominant problem that affected OECD countries even before the oil price shocks. Following the hit of the first oil price shock in 1973 as a result of the Yom Kippur War, output and inflation took opposite paths. OECD policies to combat this involved different views. One school of thought believed that a downward revision of short-term growth ambitions and more efficient management was necessary to improve the situation. An-other school relied heavily on the use of expansionary fiscal policy to restore declining economic growth. Hence, a conflicting policy package consisting of fiscal stimulus measures was agreed upon in the Bonn Summit in 1978.
However, fiscal expansion worsened the inflationary trend and did little to elevate growth level. The second oil price shock hit in 1979 following the Iranian revolution. Since inflation and growth were products of a supply-side shock, policymakers were divided on what the best response should be. Utilizing monetary policy to achieve price stability became more popular in the 80s. Fiscal pol-icy transitioned into a tool for achieving medium- to long-term goals.4 As the 80s progressed, economic conditions began to re-cover as policy direction became clearer.
A recession can be described as two consecutive quarters of negative growth. It can also be described as a situation where a country’s potential gross domestic product (GDP) growth outweighs its real GDP growth for prolonged periods. In a recession, widespread con-traction in economic activity occurs; the unemployment rate spikes and inflation declines. This contraction in economic activity can be attributed to events ranging from bottlenecks in the financial system to external imbalance shocks.
History of global recessions
The United States
Since the 1980s the US has had four periods of recessions according to the National Bureau of Economic Research.
· July 1981 – November 1982
· July 1990 – March 1991
· March 2001 – November 2001
· December 2007 – June 2009
The recession of the 80s was part of the bigger picture of stagflation that plagued OECD countries following the aftermath of the oil crises of the 70s and out of sync policies that further aggravated the situation. The recession of the 1990s was a result of the economic downturn that followed the stock market crash of the late 80s.6 The Dow Jones Industrial Average fell swiftly and unexpectedly by 22.6%. The recession of the early 2000s is often criticized as not fitting the criterion for a recession – two consecutive quarters of negative growth. However, growth slowed as a result of boom and bust cycles. The global economic boom of the early to mid 90s reached the threshold for a decline and as such this ‘recession’ was predicted. The recession of the late 2000s was caused by a combination of a financial crisis and a subprime mort-gage crisis. The former has been considered the worst financial crisis since the great depression of the 20s and 30s. The decline in the value of assets and the collapse in the financial sector had the ripple effect of causing economic shock waves to the rest of the world. Confidence was badly bruised.
Brazil and Russia
Brazil and Russia are two of a few countries to be experiencing negative growth. Brazil sank further into a recession in the second quarter of 2016, falling to -0.6% from -0.4% in Q1 2016. This decline is the sixth consecutive quarter of economic decline. It is further expected that the country’s output for 2016 will maintain 2015’s contraction of 3.8%. This downturn is being attributed to reduced spending power brought on through rising unemployment, weakened consumer confidence and the political woes that plague the country. Brazil impeached President Dilma Rousseff in August following accusations of fiscal budget manipulations. Russia has been experiencing a recession for the past 19 months. A combination of low oil prices and economic sanctions – as a result of its atrocities in Ukraine - has taken a toll on the country. The economy shrunk by 0.6% in the second quarter of 2016.
Inflation in Nigeria has been on a steady upward path soaring to a high of 17.6% in August 2016. This, coupled with a negative growth rate of 2.06% and an unemployment rate of 13.3%, both for the 2nd quarter of 2016, has led some analysts to tag Nigeria’s economic situation as a stagflation. Others have argued that the economy is best described as one in a state of recession as there have been two consecutive quarters of negative growth. First quarter growth rate was -0.36% prompting multiple growth revisions by international outfits such as the International Monetary Fund (IMF) and the World Bank.8
An important point to note is that although inflation rate (Year-on -Year) rate is rising, month-on-month inflation rate is declining. The Headline rate illustrated is prone to the bias of base year effect and as such a little spike in the Consumer Price Index (CPI) could lead to exaggerated increases in the yearly inflation rate. The diagram below shows the slowing month-on-month inflation rate, which is a more representative picture of prices at present.
Therefore, labeling Nigeria’s current economic situation as stagflation does not adequately describe its reality. So far in a bid to curb the consequences of a ‘stagflation’, the CBN has been reluctant in taking a more accommodative stance with interest rates for fear of spurring inflationary pressures. An accommodative stance here would require a reduction in the benchmark interest rate to ease the cost of borrowing and generally stimulate economic activities. However, as one who believes in markets – the interaction of demand and supply for exchange is another solution path that would entail the government to provide support for the markets via limited involvement and intervention. Markets would in turn regulate themselves and transition away from this recessionary state. Whatever path policy takes, understanding the problem is important in order not to further sink the economy into a recession.
1 Gregory Mankiw (2008). Principles of macroeconomics. Pp. 464.
2 Source: OECD at 50, evolving paradigms in economic policy making. OECD Economic Outlook, No. 50 (OECD, 1991).
3 Helliwell, John. Comparative Macroeconomics of Stagflation. Journal of Economic Literature.
4 The US however was an exception, with Ronald Regan cutting taxes and freeing up funds for more spending.
5 National Bureau of Economic Research (NBER)
6 This crash started in Hong Kong before flowing down into the US.
7 Source: Ben Moshinsky (2015). Which countries are experiencing negative growth?
8 IMF revised 2016 growth rate to -1.7%. Uncertainty in the Aftermath of the U.K. Referendum (July 2016).
9 Trading economics, National Bureau of Statistics
10 FDC Think Tank, NBS