Wednesday, August 09, 2006

Different Countries' Position in the Business Cycle

One of the most important distinctions when it comes to discussing growth differentials between different countries is differences in structural growth and cyclical growth. Structural growth is the long-term sustainable growth rate while cyclical growth is growth or contraction related to business cycle fluctuations. The distinctions are not always as razor sharp as one can imagine, as some growth spurts can be temporary but not really cyclical in the traditional sense, such as the higher growth usually enjoyed by initially poor countries, a "catch-up" effect occurs which will ebate as the income gap closes. But nevertheless, the distinction is very real and very meaningful for understanding economic trends.

When comparing growth rates between countries to evaluate differences in the effect of various microeconomic policies (taxes, regulation etc. ) it is for this reason important to take into account the different positions different countries have in the business cycle.

We can now for example see how Sweden have higher growth than not only most of Western Europe, but also compared to the U.S. and (probably) Japan. Swedish socialists can and do claim this is vindication of the superiority of the Swedish model, yet there is good reason to believe, based on the higher money supply growth and the discretionary rate cut measures in 2004-05 and the fact that growth in the preceding years was below that of most other advanced countries that this is wholly a cyclical upswing, not a structural one.

As this distinction have unfortunately gone lost in the Swedish economic debate, and for that matter the economic debate in many other countries as well, this bodes ill for free market advocates in the short-term.

Just how long the current strong cyclical upswing in Sweden will last is as always in economics uncertain, but I only expect a moderate slowdown (which is to say, a repeat of the 5.5% number or anything close to or above it is highly unlikely, but 4% or at least close to 4% looks likely). Meanwhile, a cyclical downturn looks imminent in America, as the imbalances created by Alan Greenspan starts to unfold.

So, with the cyclical upswing likely to continue for a while in Sweden while a cyclical downturn in America is on the way, and with America being perceived in Sweden by both most socialists and most free market advocates as a symbol of capitalism and with most free market advocates clueless on business cycle theory, this means that socialists will likely get the upper hand in the economic debate for the coming year.

In a few years, the roles will likely be reversed as the imbalances created by the Riksbank starts to unfold and as America, provided the Fed and the Washington politicians don't mess things up too much during the coming recession starts to recover. But as I've argued in two previous posts ( here and here ), unless free market advocates starts learning Austrian business cycle theory, they're gonna be toast in the public debate for the coming year or so.

What about other countries then? In what stage of the business cycle are they? Most of continental Europe are roughly in the same stage of the business cycle as Sweden, only their cyclical component aren't fully as big as the ECB, while having pursued a too inflationary monetary policy haven't been fully as bad as the Swedish Riksbank.

Britain on its hand appeared to be at the same stage as America (i.e. on the verge of a recession), but have now seen its economy re-accelerate as it benefits from the cyclical upswing in the rest of Europe. This is fairly similar to Australia who a year ago seemed ready to fall into a recession, but who saw its economy re-accelerate as it benefited from higher commodity prices.

China is at a later stage of the cyclical boom than Europe, and will arguably see its economy slow down significantly soon as a result of the downtrun in its most important export market America and various tightening measures in America. But as China's structural growth rate is so extremely high, growth will even during the cyclical downturn be very high by Western standards.

Japan is in some sense in the most admirable cyclical stage. It have gone through a more than decade long stagnation during which households and companies have slowly but steadily liquidated the malinvestments and payed off most of their debts. Japan can therefore enjoy a long period of cyclical upswing before they risk developing significant imbalances. But Japan will of course suffer if its two biggest export markets, China and America, enters a cyclical downturn. And Japan's structural growth rate is steadily falling because of the accelarating decline in its working age population.


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