Hamish McRae: For economies in the so-called advanced world the challenge is to adapt and thrive

Plus: Congress must cook up a deal to delay fiscal crunch

What if there is no growth? There are two debates that have become conflated. One is the disappointingly slow recovery from the last recession, not just in the UK but throughout the developed world. The other is whether the great machine, which has been humming ever since the industrial revolution and has propelled the present developed world towards an ever-higher standard of living, is somehow slowing down.

There has been a deal of anguish about the first issue, especially here in Britain, and that will continue. But the other debate seems to me infinitely more interesting and important. After all, if growth recovers across the developed world, unless a country does something seriously stupid, it will be pulled along. The UK might have slightly slower growth than the rest of the pack, as we did in the 1960s and 1970s; or we may have slightly faster, as we did in the 1980s and 1990s – indeed through to 2007. But the differences will be marginal and eventually growth will recover.

If, on the other hand, there were to be a general and persistent slowdown across the developed world then one core assumption – that we will generate greater wealth and use that to improve the human condition – will come into question.

It is a complicated debate so let's try to sort out the different strands. For a start, there is a confusion between GDP and GDP per head. Obviously countries' economies can grow yet living standards remain stagnant if the GDP per head does not rise. So whenever you hear of a country's economy growing you have to factor in population growth. This cuts both ways. A country with a rapidly growing population needs to grow faster just to stay in the same place. A country with a stable population – Japan at the moment – does not have the same imperative, though it has other pressures, such as looking after its elderly population and servicing its national debt.

This leads into one of the two biggest issues affecting long-term growth: age structure and productivity growth. A word about each.

A population's changing age structure has a deep influence on growth performance, with a key factor being the size of the working population relative to the total. Other things being equal, a country with a rising working population relative to the number of young and old people will tend to grow faster than one with a declining working population. You can see some projections for the main developed countries' total working populations in the main graph. One obvious conclusion is that the US will have a better chance of retaining its growth model over the next half century than Italy or Japan. It will also be easier for the US to pay off its debts.

Countries can, to some extent, cope with ageing populations by keeping more people working longer. That is one of the most interesting phenomena of the UK's slow recovery, for more than half of the rise in employment since the recession has been of people over the age of 65. You can see that in the right-hand graph, with particular growth among the elderly being in self-employment and part-time working.

So countries can, to a degree, counter potentially adverse demographic trends by adapting to them. But I don't think we can get away from the fact that, for the past couple of hundred years, virtually all developed nations have had rising populations and that this has been associated not only with growth in GDP (of course) but also with growth in GDP per head. Now many developed countries –though not the UK – face the prospect of declining populations. That does mean that it will be impossible to increase living standards; just that it will be harder to do so.

The extent to which it will be harder will depend on the ability of societies to keep increasing productivity, output per person. It has proved relatively easy to increase productivity in manufacturing but much harder to do so in service industries. As a rule of thumb, you get an increase of about 3 per cent a year in productivity in manufacturing, as companies find ways of doing more with fewer people. In the Sixties, British Motor Corporation employed more than 20,000 people in Cowley. Now the BMW-owned Mini plant produces more cars with fewer than 5,000.

Productivity is increasing in service industries, but they are harder to automate. A consultation with a doctor, a university tutorial, a restaurant meal – all require human interaction. We are learning how to produce acceptable quality with fewer resources and in some industries that has led to big increases in productivity. Airlines manage their capacity much more efficiently now than they did 20 years ago, thanks to online booking and other innovations. The shift of retailing to online is, I suppose, the most recent example of this.

Can we go on doing it? It is easy to see the world as a whole increasing productivity by less-developed countries adopting technology invented in more advanced ones. But that does not help increase living standards in the present developed world – quite aside from other massively important issues such as the environmental consequences of China and India seeking to achieve the living standards of the West. That is a whole extra subject.

For us – those of us in the so-called advanced world – there are, I think, three challenges. One is to use the new technologies to improve productivity in service industries, including especially the public sector.

A second will be to rethink how we make not just service industries, but our societies more efficient. For example, less crime would release resources not just from the police and courts but from insurance companies and all the other services needed to cope with the effects of crime – quite aside from the social and human benefits.

And third, a more efficient society requires different skills and behaviour if it is not to include greater inequality. We have a world of declining inequality between countries but increasing inequality within them. A lot to be done.

Congress must cook up a deal to delay fiscal crunch

The boom in US share prices and the steady growth in employment have continued, notwithstanding that negative number for final-quarter growth.

There were big upward revisions for job growth in both November and December and employment rose through January, too. Over the three months to the end of last month, 600,000 jobs were created. That cannot be a shrinking economy.

But the US faces a huge problem, as the focus shifts back to the stalled budget plans. The Centre for Economic and Business Research put it starkly: "Towards the end of this month Congress will have to complete another round of negotiations surrounding spending cuts, tax rises and the US debt ceiling. If a deal is not struck, the resultant tax rises and spending cuts have the potential to push the US deep into recession and cause large rises in unemployment."

So are employers and traders betting on a positive outcome for these talks? And if so, will Congress deliver?

My own reading is that the real crunch in fiscal policy is some way off. All Congress has to do is cook up some deal that is deemed good enough, as, paradoxically, it cannot fix the deficit in this set of talks.

What is needed is an overhaul of the whole tax structure, reducing nominal rates and closing loopholes – a two-term, if not a two-decade job. All the President can hope to do is to nudge the public towards requiring legislators to be realistic about closing the deficit, notwithstanding the present ability to finance it. Got to be done; can't be done quickly.

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