Better than the rest: Do Tory claims stand up?

`Since the UK is still trailing at least 20 per cent behind our continental neighbours in terms of income per head, the fact that our productivity is catching up a little is not in itself a triumph'
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The best economy in Europe? The most favourable economic prospects for a generation? These are the key Conservative claims that we will hear repeated remorselessly between now and polling day. And in making these assertions, the Government is moving with the current tide of opinion in the chattering classes, and indeed in the financial classes, in this country and elsewhere. Anyone who has spent time talking to global investors about the relative performance of the major economies will be aware that there is now a strong bias towards believing that the Anglo-Saxon economies, especially the UK and the US, have prepared themselves better for the economic challenges of the next decade than either continental Europe or Japan.

This represents quite a change in conventional wisdom. Up to the end of the 1980s, Germany and Japan were generally regarded as the success stories of the post-war era, while the Anglo-Saxon economies were seen as inflation-prone areas subject to chronically low productivity growth. It took some time to shake off this image, but the relatively strong recovery in GDP in the English speaking world in the past four years has certainly done the trick. The UK and the US are now usually described as more flexible economies (especially in their labour markets) than others in the developed world. They are viewed as attractive to inward investment, likely to produce superior returns to capital, and are held up as examples of how the injection of a free market culture can transform economic performance.

Meanwhile, Japan and the Continent (notably Germany and France) are described as over-regulated systems which are unresponsive to market forces. As a result, they are accused of producing excessively high labour costs, rocketing unemployment and low returns to investment. The clinching argument, critics claim, is that these over-protected systems will not be able to survive in the coming decades, since footloose capital will simply migrate to those parts of the world which provide the highest returns. Finally, as an important addendum, most global investors outside Europe, though not inside, view the European Monetary Union (EMU) project as deeply flawed, and an example of how governments on the Continent seek to impose market-constraining solutions on their economies, often without the obvious support of their electorates. There are few powerful international financiers who have a good word to say about EMU.

The Toyota car company went some way to puncturing these beliefs last week when it suggested it would prefer to invest in the highly regulated markets of the Continent rather than in the UK's haven of free enterprise if we stay out of the single currency. Toyota, at least, does not seem convinced of the overwhelming advantages of our particular brand of the free market system. But theirs seems to be a minority view, given that Britain continues to attract about half of all Japanese investment in the European Union. Furthermore, it is no longer fashionable to extol the "stakeholder" economies like Germany and Japan, instead it is thought appropriate to lecture them on how to become more like us.

Given the performance of the major economies in the past several years, this shift in perception is not exactly surprising. The tumbling rates of unemployment in the US and the UK have not so far triggered any significant rise in inflation, while the Japanese and continental Europeans have suffered from an apparently endless recession. But the key question is whether these differences in performance really are structural, or whether they are simply reflecting the fact that the Anglo-Saxon nations are more advanced in their cyclical economic recoveries than the rest of the world.

The correct answer to this question is that "it is too early to say", since we should never attempt to draw definitive conclusions about long- term national performance until we can be sure that we are examining at least one full economic cycle. By the same token, it is also too early to say whether Manchester United or Southampton will prove to be the most successful football team of the 1990s. But sadly the evidence so far indicates that Southampton have rather a lot of catching up to do. So what does the evidence so far tell us about national economic performance?

The table compares the performance of the UK economy against our three main competitor blocks in four sub-periods since 1960. Examining this table, several important conclusions become apparent. The first is that the growth rate of GDP has fallen sharply in all areas, and on an almost continuous basis, since the first oil shock of 1974. The UK has not managed to buck this trend. Over the whole of the current economic cycle, from 1989 to (say) 1998, the growth rate will be roughly half that of the golden years from 1960 to 1973, and will actually be less than it was during the doom-laden years from 1973 to 1979. This is not good.

The second point to note, which is more surprising, is that the UK and the US have really performed no better in the present economic cycle than Japan and continental Europe. Given the degree of gloom that has descended on these latter economies, it really is remarkable that their growth rate has been in the region of 1.5-2 per cent per annum, which is little different from that mustered by the supposedly miracle economies in the English-speaking world. Once the whole of this cycle is over, it is perfectly conceivable that Japan and Germany will once again have out- performed their rivals.

Third, the UK has nothing to crow about on the inflation front. Despite the almost universal belief that this is no longer a problem, the inflation rate during the current cycle has been only fractionally below 4 per cent, which is substantially higher than the rates recorded by any of the competitor economies shown in the table. Given this higher inflation rate, the "nominal income split" between inflation and real output growth in the UK has remained substantially worse than it has been elsewhere in the world.

So where is the silver lining? Encouragingly, productivity growth has been higher in the UK during the current cycle than in any of the other blocks shown in the table, and - crucially - the UK and the US have managed to improve their unemployment performances, thus reversing a 30-year uptrend. Meanwhile, Japan and continental Europe have conspicuously failed in this regard. So at least this aspect of the conventional wisdom seems to have been vindicated.

Where does all this leave us on the great debate? Clearly, there have been aspects of Britain's economic performance which have dramatically improved relative to the rest of the world in the last few years, but it is not yet clear whether even these gains can be sustained for an entire cycle. Since the UK is still trailing at least 20 per cent behind our continental neighbours in terms of income per head, the fact that our productivity is catching up a little is not in itself a triumph. And to suggest that we have more to teach the Germans than we have to learn from them is as hubristic in the economic arena as it is on the football field.