Hamish McRae: A star-spangled growth rate

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The Independent Online

The US economy grew at an annual rate of 5.6 per cent in the first three months of the year.

The US economy grew at an annual rate of 5.6 per cent in the first three months of the year. OK, so it was less than the 5.8 per cent originally reported, but it is still pretty amazing. By contrast, if you believe the figures, our economy here did not grow at all, while the main continental economies only inched forward. How do the Americans manage it – and can they keep it up?

The question is vitally important for the rest of us. Whether, for example, the UK achieves the 2.5-per-cent growth the Chancellor expects will depend in large measure on the US. If we don't – and after a couple of flat quarters this is looking less likely – then the budget sums go awry. Or to take another example, Germany has just reported modest growth in the first quarter, but that was entirely thanks to the strength of exports, in particular to the US, because domestic demand fell.

A quick visit to Washington last week brought home to me the extraordinary confidence of American consumers. Retail sales are running more than 6 per cent up year-on-year, though total consumption is up a more modest 3.2 per cent. The housing market remains strong, though there are similar worries about a housing bubble as here. But there is no substitute for walking the streets, chatting to friends and popping into the shops oneself to catch the sense of comfortable growth. America is the global superpower of shopping.

US consumption has been the reliable driver of the economy for the past decade, as the left-hand graph above shows. It has been tremendously strong since the end of the early 1990s recession, running at roughly double the level of Europe. In Japan, there has been virtually no net increase in consumption in the last five years.

Changes in the leading indicator give a good feeling for subsequent changes both in industrial production and output as a whole. You can see in the next graph the extent to which the indicator has turned up, and on past experience, industrial production ought to follow.

All this is encouraging, but is it sustainable? A few months ago, the consensus on this side of the Atlantic, at least, was that it was not. Europeans fretted at the size of the US current-account deficit, seeing it as a sign that the US was spending above its means. But if foreigners want to invest enough in the US to cover that deficit, as they have done, then the deficit is more a sign of confidence in the economy than of excess consumption.

Certainly, consumers appear to be spending above their means, moving in the second half of the 1990s right outside all previous behaviour, as the graph on the right shows. That answers the first question posed above – how do Americans manage it? The answer is that they borrow. But can they keep it up?

If you look at this rationally, the answer must be no. But the adjustment could be quite a gentle one, giving the economy the chance to use the huge gains in productivity that it has carried on generating right through the downturn to soften downward pressure on consumption.

The most interesting take I have seen on this comes from the economics team at UBS. It points out that the forecasters got both the US boom and the subsequent slump wrong. They failed to predict both the downturn and the recovery. Now the consensus is getting it wrong again in predicting that growth will average more than 3 per cent over the next four or five years. That would require Americans to continue dis-saving. This, it argues, is unlikely. Even if they don't revert to the post-war norm, households will still want to pull in their horns. If they do that, it will knock a percentage point off growth, suggesting something more like 2 per cent.

There are other factors that might sustain demand. There could, for example, be a sharp fall in the dollar, which would boost exports. Or there could be greater military spending, financed by borrowing, than now seems likely. But both of these would carry costs, for the first would be likely to increase inflation and hence force a rise in short-term interest rates; and the second would push up the US national debt and long-term rates. Either way, growth will disappoint.

But that is the rational, number-crunching way of looking at things. It does not feel like that if you are in the States: the self-confidence is too overwhelming. Intellectually, it is hard to disagree with the more cautious outlook; emotionally, it feels as if the shoppers will win.

One way of squaring these two views is to say that not only will the shoppers win, but so will US commerce and industry. The other thing I noticed is the gale blowing through American business. There is a tremendous drive to use the new technologies to increase efficiency. The downturn has sent a shockwave through American companies, forcing them to think about every aspect of their business.

So what will happen will be this. Yes, there will be a pause in growth later this year. But though interest rates will rise a bit in the autumn, they will remain quite low. The American economy could not stand high rates but it does not need them. This pause, however, will not develop into the feared "double dip". Consumption will go on rising, though at a slower rate. Unemployment will start to come down, underpinning confidence in the economy.

The result will be slower growth than in the late 1990s; that was never sustainable. Consumers will rebuild their savings but sufficiently slowly to maintain decent growth. They will not panic, as the Japanese have done. Thus, the US can remain the driving force of the world economy. There are, of course, lots of risks: more terrorist attacks, a slump in the dollar, a spike in the oil price. But as long as the shoppers keep spending, US demand will pull the rest of us along. I think they will.

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