Hamish McRae: Flexibility is proving to be the key to bouncing back from recession

Economic Life: Aswe have all seen in our daily lives, shops have been innovative in creating value deals and cutting prices
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It has been an extraordinary and difficult year and it is time to take stock of the surprises, the lessons, the consequences and so on – including one surprise in the past week.

The biggest surprise of course has been the loss of output. The timing of the recession of the past year has been very much as expected: a recession in most of the developed world of between a year and 18 months, with a recovery starting from the second half of this year onwards. The surprise, indeed the shock, has been the depth. The dip in GDP this year, ranging between about 2.5 per cent and 5 per cent for the major developed economies, has turned out to be roughly double what was being predicted a year ago.

Following on from that has been the deterioration in public finances. In the UK this has been particularly savage as we all know but other countries have seen weakness too as outgoings have risen in line with rising unemployment. But much of the problem has been on the revenue side for the downturn has revealed structural weaknesses in tax-gathering that the boom years had partially concealed.

On the other hand, in much of Europe at least, unemployment has not risen as swiftly as feared. That is particularly evident in the UK, where the claimant count of unemployed actually fell – that was the surprise of this week. As you can see from the first two graphs, hours worked have plunged but the rise in unemployment was tailing off even ahead of this week's decline.

There is a puzzle here – albeit a welcome one. Just about every economic model predicted that the peak in unemployment would lag some months, maybe a year, after the upturn in output. This time it seems to be simultaneous.

We don't yet know quite why this should have happened. It may be that this is a blip and that unemployment will start to rise again next year. It may be associated with the shift to part-time employment, as many private-sector companies have shifted full-timers to part-time contracts. That would square with the employment numbers, which show this pattern. It would also square with the plunge in pay, as you can see from the middle graph. People have been prepared to accept pay freezes in response for keeping their jobs. So clearly our labour market has responded sensitively to the pressures upon it. Even now, despite the fact that it is easier to shed labour in Britain than on most of the Continent, UK unemployment is lower than in France, Germany and Italy.

If unemployment has risen less than feared, retail sales have fallen less than expected. There has been great concern about the accuracy of our retail sales figures, which in the summer showed sharp rises when other data suggested they were weak, and which last month fell when people expected them to be perking up. As you can see from the final graph, the weakness in retail sales came in the second half of last year, when the economy was only starting its decline, not this year when the economy hit bottom. If those figures are more or less right, and as I acknowledge, they are controversial, that may be the result of our retailers' ability to generate traffic even in tough times.

As we have all seen in our daily lives, shops have been innovative in creating value deals, cutting prices and bringing in £1 lines. Sadly some have not made it and a walk down any high street will show voids, where businesses have closed down. But for those that are left, one business death means more trade for those left alive. Anecdotally, I hear reports that though business is bad, it is not so bad, particularly if you are prepared to cut a deal.

So it may be that just as we have met recession with more flexible pay and employment patterns, so we have also met it with more flexible distribution patterns.

There is a further twist. Home repossessions have been much less savage than one might have expected, given the fall in house prices and the rise in unemployment. At a very rough tally, they have been running at one-third of the level of the early 1990s, the last similar crash in house prices. This is one area where government policies have been helpful, but that is at the margin. The big change has been that lenders have taken advantage of the cheap cost of funds and have seen it is very much in their self-interest to keep borrowers going if at all possible.

If those are the main surprises, what are the lessons? It is difficult to be at all confident but here are two ideas. The most obvious is that flexibility is vital. Recession is a new experience for about half the workforce, managers and managed alike, so there is not much past experience of what to do. There is, however, a folk memory of what not to do, and as a result many of the mistakes of the early 1980s and 1990s have not been repeated.

That leads to a second thought. It may be possible to bounce out quite swiftly as demand really recovers. The point is a very simple one. Recession improves the efficiency of the economy in all sorts of ways. Firms that survive emerge in better shape; those that fail are the less efficient ones and they disappear, creating room for others. But recession also destroys capacity. Now it may be that you don't need that capacity but what is gone is gone and you don't know what you need until demand recovers.

If that is right, then we can start to list some consequences of this pretty dreadful year. The most obvious is the size of the public debt burden, which will have to be tackled next year by the new government. A second and associated consequence will be weak tax revenues for some time, making tackling the deficit even more difficult.

As a side issue on that, it is very much in the self-interest of Government to get the financial services business of the UK running strongly as soon as possible, rather than beating over the head what had for many years been a huge generator of tax revenues. The danger of having too many eggs in one basket notwithstanding, it is better to have a functioning financial services export industry than a battered one.

Beyond that, I do think that emerging with a more flexible economy will prove a huge plus. That is, of course, more flexible private sector economy, and the next challenge will be to develop a more flexible public sector.

How that might be done is a story for another day, but it may be worth noting that just as the private sector has learnt from the most intense squeeze most people will have experienced in their lifetimes, it is surely plausible to think that the public sector might be able to learn, too. Something to ponder over the break?