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by Valentino Piana (2015)



1. Summary features
2. Typical pathways in key economic areas
3. Key events
4. Winners and losers
5. Influence on election outcomes
  6. Risks of countervailing developments  
  7. Transition to the next phase  

8. Empirical examples of economic expansion


Summary features

A healthy growth in GDP with positive development in most economic indicators. Building up and modernization of capital, including plants and buildings. Reason-based optimism in most social groups.

Typical pathways in key economic areas

Domestic business dynamics

A majority of sectors and firms enjoy profitability and turnover growth. Capacity utilization is fairly high and new investment projects to widen and differentiate production are in the pipeline, with few already undertake, more already financed, even more laid down in plans.

Especially at the beginning of expansion, positive suprises beat expectations in GDP, sales and profits.

In terms of micro-dynamics it's possible that - for at least a few sectors - a dominant design of products is taking off and locking-in the sector in a specific trajectory.

Foreign trade

If the recovery was public expenditure- and consumption- led, the fast rise of imports tend to reduce trade surpluses and even lead trade deficits, e.g. with exports growing slower than imports. Domestic expansion may attract demand-oriented FDI.

Conversely, if the recovery was export-led, in expansion you might have transmission to domestic demand (due to employment and wages), with a lagging but significan increase in imports. Trade balance should however remain positive in most cases.

Labour market

Announcements for new personel hiring multiplies, with a rise in employment. If too many people are attracted into the labour market from inactivity, the unemployment rate may temporarily have a bump but with the consolidation of expansion it turns decisively down.

Depending on unionisation and the balance of power between workers and employer, earlier or later pressures to increase wages might be prompted. If employers resist, the best skilled people might voluntarily leave the firm and get a better paid job.

Public finance

Tax revenue is on the rise (the more so if progressive taxation induce elasticity to GDP). Previous deficits (possibly built up in order to turnaround at the trough) are tamed, sometimes even reverted. Public debt-to-GDP ratio improves. If legally present, subsidies to unemployed people are less utilised, with a decreasing expenditure, possibly extending to other social chapters.

Depending on political orientation by current government, the improved public balance could be channeled into reduction of tax rates, wider exemptions from taxation, partial repayment of cumulated debt or /more or less selective and smart) new expenditures, including for public personnel.

Financial markets

Such markets have an in-built instability and non-forecasteability, since the largest profits occur by deviating from general expectations and turning out to have been right. However, general expectations for financial markets during phases of economic expansion are positive, with upward trends in stock exchange averages and relatively less dispersion around the average than in other phases. Primary emissions of shares becomes a relatively common tool to fund investment by firms active on the stock exchange. Following the motto "trend is your friend", more people invest in financial instruments.

Price level and real interest rates

Demand-driven inflation can begin before wage-driven cost inflation justifies actions from firms. However, this depends on the degree of competition in final goods markets (and retailing) as well as trade openness and cheap imports.

The central bank, if was setting lower-than-what-she-consider-normal interest rates during the recovery, may be tempted to raise to what she consider a normal interest rate. Depending on actual developments in inflation, the real interest rate may jump up quickly without an immediate and visible braking effect on investments or may remain flat (possibly leading to acceleration into a booming phase).

Key events

Singular events occurring during the expansion phase, marking it both in reality and in the media, are announcements of new infrastructure projects (both from private and public sources). If execution is fast enough, the infrastructure may also begin to be used during expansion.

Winners and losers

Income distribution become fairer, with a larger middle class, as result of some poor getting a job, a higher number of hours worked per person (so a reduction of the "working poor") and a wider number of sole entrepreneurs enjoying business success. Possibly also the public sector might produce new jobs and a slight increase in wages.

People investing in the stock-exchange on average will be significantly wealthier and may decide to begin consuming more.

If the tax system is progressive, redistribution takes place and ex-post distribution is fairer than the ex-ante one. Most people are winners, for a reason or another.

However, if inflation were to take off and some fixed income would not follow (e.g. pensioners without indexation), the rising price level might hurt them.

To demonstrate once again that policies and political orientation matter, if, by contrast with what we just described, the government is skewed towards boosting the rich and their wealth, by concentrating tax cut in such income brackets, liberalising the stock exchange, and cutting public expenditures in areas sensitive for the poor, economic expansion need not to embrace the latter, with a rising polarisation. In such case, losers are many more than in the physiological case.

Influence on election outcomes

When the economy is at the centre of voters' information and decisionmaking, elections in the expansionary phase of the business cycle tend to favour the current government, to the extent it is effective in communicating and getting attribution of the good economic news to his policies and approaches.

Governing coalitions would normally coalesce, since each component should receive something from the positive developments in public balances. However, in certain countries, there is no limit to greedness in political negotiations, so this remains not assured.

Risks of countervailing developments

Trade deficits, lax fiscal policy, and inflation are the three main risks of the phase. Conversely, if the policymaker would overreact to them, leading to a recession, many crucial opportunities would be missed, including modernisation of assets, human capital and social cohesion.

Transition to the next phase

Convenient as it is for many economic and socio-political agents, converging in their interests and actions, expansion can be long and last for many quartals.

However, acceleration into a booming phase, where the prices of several now-scarse assets (as certain real estates and skills) soar and involve quick movements in wealth, is quite normal, including because of stock exchange accelerating dynamics, as even people not used to invest in shares are attracted by the apparent predictability of upwarding trend. Raising wages (top, average and minimum wages) is key to such transition.

Conversely, negative shock from abroad and policy aimed at avoiding "over-heating" (especially if from governments adverse to wage raises) can instead lead to growth slowdown and recession.

Empirical examples of economic expansion

* Spain in 2006: GDP has been expanding by 3.8%, following several years where growth has been higher than 3% (since 1997 with the only exception of 2002 - 2.7%). For the second year, the public balance was on surplus. The trade deficits, by contrast, was deepening. Employment continued to rise and unemployment to fall. An earlier inflation acceleration was interrupted by a reduction in the inflation rate, which however continued to be higher than trade partners in Europe.

* Uruguay in 2014: a rise in GDP by 2.8%, with falling unemployment (now at 6%) and a long term decline in poverty (down to 12% of the population from 40% in 2004). Industrial diversification, with new sectors emerging, is taking place. However, risks of pollution are on the rise, especially due to paper industry.


GDP time series for most country of the world (1946-2007)

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