How do we know if we're in a global recession?

Since the start of this year, stock markets around the world have fallen as panicked investors have begun believing that the world is slipping into economic malaise.

This fear has also driven down prices of commodities like oil and copper and impelled some central banks, like Japan’s, to make dramatic efforts to boost growth. The concerns are being magnified by memories of the worldwide recession of 2008 and 2009, when many countries experienced widespread joblessness, business bankruptcies and homelessness.

While national and international leaders cannot prevent worldwide economic downturns, a coordinated response among them can mitigate some of the impact. But it’s hard to rally government resources to this cause without the ability to determine whether we are actually in a recession or not.

So how do we know when the world is in a recession and such a response is needed?

What is a recession?

To answer this question, first we need to understand what it means to actually be in a recession.

The generally accepted – and rather broad – definition of recession is a period of time when economic activity declines. While most people agree with this, there is controversy over how to translate it into practice.

Currently, three methods are used to determine when the world is in a recession.

1) Threshold definition

One way of defining a recession is when world output falls below a certain benchmark or threshold. For example, if global gross domestic product grows less than 2.5 percent or 3 percent a year, that means the world is in a recession.

It’s a yardstick the International Monetary Fund has used in the past and some in the media still employ.

Why 2.5 percent or 3 percent? Doesn’t a recession suggest an actual decline in GDP? The thinking is that since the world’s population is growing rapidly, each person’s slice of the global economic pie shrinks unless the overall pie expands by the same pace. If the world’s population is growing at 2 percent a year, as it was during the 1990s, world GDP has to increase at least 2 percent to keep up.

Many people, including current economists at the IMF (see box 1.1 here), feel the threshold definition is problematic because if the world is growing at 3 percent then total production doubles roughly every quarter-century. Doubling output in such a short period of time, even if population increases, does not match the general definition’s spirit of declining economic activity.

Nevertheless, the world is currently nowhere close to being in a recession by this definition, since the IMF estimates that world GDP will grow by 3.4 percent in 2016 and 3.6 percent in 2017, compared with population growth of barely more than 1 percent.

2) GDP definition

A second definition of recession is when GDP falls two quarters in a row. This definition is widely known, often quoted in the press and more closely matches the idea of declining activity since GDP is currently the best measure of what countries and the world produce.

The best way to calculate the world’s actual GDP is to simply add together the quarterly GDP figures provided by every country. Unfortunately, this simple method has a number of problems.

First, some countries provide only yearly data, like the Solomon Islands, while others in the midst of civil war or strife, such as Syria, Yemen and Libya, cannot provide any information.

None of these countries is a major economic power, of course, so their data woudn’t make a huge difference to the end result. But if the world is on the knife edge of being or not being in a recession, knowing what is happening economically in small countries or in war-torn areas could be the determining factor in deciding if the world overall is expanding or contracting.

Second, some very large countries like the U.S. and India revise their GDP figures very frequently. U.S. GDP figures are revised a minimum of three times and then are periodically revised roughly every five years as better data become available. It is hard to determine if the world is in a recession if a key country’s data are constantly being modified.

It is doubtful the world is currently in a recession based on the two consecutive quarters of negative GDP growth definition. While the U.S.‘ most recent figure of 0.7 percent growth in the fourth quarter of 2015 was lower than expected, it was not negative. OECD tables that track quarterly growth among the largest countries show a few negative numbers in places like Brazil and Greece, but the vast majority of the world’s economies have positive values.

3) Committee of experts

The third method of determining if the world is in a recession is to ask a nonpartisan panel of wise men and women. Both Europe and the U.S. use this method to determine – officially – if either is in a recession.

In Europe, nine people associated with the Centre for Economic Policy Research, or CEPR, make the determination. In the U.S., an eight-person committee at the National Bureau of Economic Research, or NBER, carries out the same task.

Both committees comprise academics who look at a wide variety of economic data. When the committee concludes (by consensus) that the economy is declining, it declares a recession; when it decides the economy has resumed expanding, it declares the end of the recession.

The primary problem with wise advisers is that by design there is no consistent methodology. Each recession is treated as a unique experience that is assessed using a wide variety of data.

The other problem is that the process is historical. Until the committee makes its declaration – usually not until long after a recession has begun – no one is really sure of the state of the world. Finally, it is much harder to do this for the world than for a country because there is a wider variety of data to consider.

Is the world in a recession based on the opinion of the experts? This is impossible to know since neither CEPR or the NBER makes statements ahead of any pronouncement.

A new alternative definition

I believe it is time for a new definition to be added to the list: a recession is when the growth of GDP per capita is negative for at least half a year.

This is a modification of the threshold and GDP definitions and simply means that a recession is whenever the average person’s piece of the world’s economic pie shrinks for a sustained period of time.

Currently, GDP per capita has been growing about 1 percent per year, after shrinking a dramatic 6 percent during the 2008-09 economic downturn.

I prefer this new definition because it is useful not only when population is rising but also useful in places like Japan and Eastern Europe where population is or will be falling.

While not all GDP and population data can be trusted completely, it is important to handle both rising and falling populations. Classifying a country that experiences a 1 percent decline in GDP when population falls by 3 percent as “in a recession” does not make sense for the reasons explained above.

What can be done?

There are numerous international treaties and organizations designed to coordinate world trade, defense and global health.

However, presently there is no organization that has the mandate to define, determine or coordinate a response to an international recession. The lack of a responsible organization is a huge problem since global recessions affect all of us.

Whatever definition is chosen, it needs to be simple enough to be widely understood, be easy to make accurate forecasts and handle countries that have declining populations as well as rising ones.

I don’t believe the world is presently in a recession, based on my preferred method. Nevertheless, sooner or later the world will experience another economic downturn. When this happens we cannot hope that an individual country changing its economic policies will cure a global problem.

Instead, today we need an international organization to define and declare global recessions and marshal a global response to return the world to prosperity.