Hamish McRae: Global Overview

A hopeful end to the year everything went wrong
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For most countries, 2001 was, on the economic front, the year when everything went wrong. But for one country, Britain, it was a year when quite a lot of things (though not all) went more or less right.

For a start, at the beginning of 2001 hardly a single well-known economic forecaster predicted a recession. At the beginning of the year the consensus forecast for US growth was nearly 3 per cent. We don't have full figures yet, but growth will probably be less than 1 per cent, with nearly all the ground made up in the first half of the year lost in the second. For Germany and France, the hope was for 3 per cent and 3.25 per cent respectively; the outcomes will be about 0.7 per cent and 2 per cent. For Japan, hopes of growth of 2 per cent look absurd; the country will be lucky to do better than -0.25 per cent. But Britain, expected to grow by some 2.5 per cent, looks like growing by close to 2 per cent.

What went wrong? For the United States, the dominant feature was the collapse of demand in the hi-tech sectors. Most commentators expected that if the economy slowed, the Federal Reserve would cut rates and the economy would revive. They were right about the Fed, for successive cuts have brought the Fed Funds rate down to only 1.75 per cent. They were wrong about the effect. It is now evident that the US was in recession even before the blows of 11 September. Rate cuts did help maintain consumer demand but the hangover from the dot.com boom was so pervasive that companies carried on cutting investment and shedding labour. By the end of the year, consumers were losing confidence too, with worrying implications for 2002.

Japan, inevitably, was caught in the backwash. Quite aside from the ongoing weakness of the country's financial system, its exporters were known to be heavily dependent on the East Asian market and several of the fast-growing countries were themselves dependent on exporting to the US. But the scale of the collapse has stunned even the pessimists. The country has been in recession since the second quarter and the latest figures for industrial production show it down some 18 per cent on a year earlier.

The European disappointment was less expected. Most people, including the German government and the European Central Bank, thought that Europe would be relatively well insulated from the hi-tech downturn. Technology was a less important part of the economy and the eurozone did not seem very dependent on exports to the US. The fact that the euro remained weak ought to have supported demand for exports. But for reasons that are still not fully evident, the Eurozone is probably now in recession and its largest member – Germany – almost certainly is.

Part of the blame can be put down to the reluctance of the European Central Bank to cut rates as swiftly as the Fed or the Bank of England, but not all.

Amidst all this mayhem, Britain has seemed the safe port in the storm. Or rather it has for much of the country, for some parts have had a rough ride. The overall economic growth at about 2 per cent for most of the year conceals a service sector that has been doing pretty well and a manufacturing one that has been having a miserable time. London and the South East, where services dominate, has cracked on. But as you move northwards, the prosperity has become more spotty, with some parts still doing well (for example, Leeds and Edinburgh) and others finding it tougher (such as Liverpool and Glasgow). The great test for economic policy is how to reconcile the needs of such different sectors: how to ease policy enough to help the North and manufacturing without easing it too much for the rest of the country. Retail sales, up some 6 per cent a year, are rising at nearly the same rate as during the late 1980s boom.

But unbalanced growth is better than no growth. Among the Group of Seven countries, the world's seven largest economies, only the UK – and, at a slower pace, France – ended the year still growing. The world goes into 2002 in the first synchronised recession since the dark days of the 1970s.

With hindsight, it is now clear that the attacks of 11 September hit the world economy at the worst possible time. Both the US and Japan were sliding into recession and the damage to key industries such as travel and tourism, coupled with the more general blow to confidence, made the slide steeper.

The financial markets have struggled to make sense of this largely unpredicted recession – "largely" because the possibility was at least being discussed in these pages more than a year ago. The bear market in shares started in most countries in the middle of 2000, showing the markets were more prescient than the economists. Since the end of September, share prices have started to recover, suggesting in their incoherent way, that the world economy might revive some time in 2002.

By contrast to share prices, the price of government bonds did very well until recently, reflecting the desire of investors to hunt for safety. In the last month or so they have weakened, which may suggest concern about the move of most of those governments that were in surplus back into deficit – and those that were still in deficit, which includes most of the Eurozone, into even deeper deficit.

This concern about the economic vigour of the eurozone continued to undermine the euro, which of course stops being a synthetic currency on 31 December and becomes real one.

If 2000 ended with fears, more than justified fears as it turned out, 2001 ends with hopes. These include, most obviously, hopes for renewed growth in the year, with most forecasters expecting a resumption in the US by the middle of the year. They also include hopes for the smooth introduction of the euro and the avoidance of catastrophe in Japan. They should also, on any sensible set of values, include the hope that the benefits of some of the resumed growth in the rich world should spread to the poorer parts of the world, too.