Hamish McRae: Growth, not government, is the way to fix the UK's economic mess

Economic view
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So what is really happening to our economy? This ought not to be a political issue, but I fear it has, perhaps inevitably, become so. It ought not to be political for two reasons.

One is that what is happening here is really determined by the pace of the global recovery. The other is that while governments can have some influence on economic performance in the medium term, it is ridiculous to cite a month's retail sales or inflation figures, or a three-month GDP estimate, as supporting or undermining the government of the day. In any case, the figures may turn out to be wrong, for most economic data is subject to revision. For example, my own guess is that those first quarter GDP figures that came out on Friday and showed only 0.2 per cent growth, will probably be revised upwards in the coming months.

So let's try to stand back from the politics a bit and focus on what is happening in the world – we will come back to politics later. As it happens, a fair bit of international economic news has come out in the past few days, news that gives us much more of a feel for the likely profile of the global recovery.

The first came from the International Monetary Fund. You may recall the stories about IMF calling for a tax on banking, but what I feel was more significant was the solid upgrading of the growth forecasts by the IMF staff. Last year, the economists there were revising down their forecasts, having seriously underestimated the scale of the recession (yes, I know, they were in good company). Now they are busy revising them up. Their estimate for global growth this year is 4.2 per cent, up from 3.9 per cent on the previous reckoning. You might think that 0.3 percentage points is not a lot but we are talking the whole globe. Also, we are one-third through the year so this up-grade is in response to real data.

But not all parts of the world are being upgraded. The US is up and is now expected to grow at 3.1 per cent, while unsurprisingly the emerging countries, taken as a whole, are up too. But German and Italian growth prospects have deteriorated, with growth expected at 1.2 per cent and 0.8 per cent respectively. The UK's prospects are seen as much the same: growth at 1.3 per cent this year. I suppose you would say that this is better than no growth but it is not a powerful recovery. The long-term growth potential of the economy is around 2.5 per cent, so it does not begin to make up the ground that has been lost.

But the most striking thing of all, is the way the emerging nations are continuing to outpace the developed world. The main graph shows the pattern since 1970. The gap that started to widen around 2000 had remained as wide as ever during the downswing. So while both parts of the world experienced a sharp V-shaped dip, only the developed world actually went into recession; the rest of the world still showed decent growth. But – and this surely is the other message that emerges from the graph – at least there is a reasonable prospect of adequate growth in the developed states for the next four or five years. Those lines through to 2015 are projections rather than forecasts but they seem reasonable enough to me.

Other data last week? A couple of things stood out. One was the German IFO survey, which tracks the country's business opinion. This index shot up, which suggests that notwithstanding those IMF numbers, the German recovery has become quite solid. This echoes strong indications in business surveys elsewhere, including the US. All this suggests that the business community now feels the recovery is broadening and if it is right, that is encouraging for the rest of us.

The other was strong US new house sales, which to be sure were the result of a tax break now ending, but with other OK numbers suggest that the US economy grew by about 0.8 per cent, or a 3 per cent annual rate, in the first quarter. We get the actual growth figures this coming Friday.

Now come back to the Britain and have a look at that graph on the right. It is taken from the new GDP numbers and shows the profile of the recession. There are at least three points to be noted. One is that on the evidence so far there is no V-shaped recovery at all. Next, what an astounding comparison there is between what happened to manufacturing (and other production industries) and what happened to service industries. Service output has now climbed back to the level of end-2006, whereas manufacturing is still some 12 per cent down. And third, given this divergent performance, are these ideas that it will be possible to shift output away from such dependence on services really credible? Surely not.

This leads to a further point, the individual components of growth this first quarter are surprising. Government output added nothing – it was flat, having either been flat or falling for the previous five quarters. Construction was down on the previous quarter. Hotels and restaurants were down too. Manufacturing was up, but as we have seen, from a low base. So what was the largest contributor to growth? Business and financial services. So we have a recovery led by the reviled financial sector, while the Government has not been a net contributor to growth for the past 18 months. If you are as surprised as I was to see that, have a look on the Office for National Statistics website.

This does have some political implications. I happen to think it unfair to beat the Government over the head for the relatively muted recovery so far. The figures probably understate what has been happening and even if they are proved to be right, growth is better the stagnation. On the other hand, it is fair to criticise the Government for claiming that it is supporting the recovery when the ONS is producing data that shows that Government output has been falling.

This is paradoxically good news for the rest of us, post the election. We all know that there will be a more serious fiscal squeeze than any of us have experienced in our lifetimes. So the government cannot contribute to growth; quite the reverse. But the upturn has begun without any increase in government output. So actually the self-healing mechanisms of the private sector are already at work, albeit in lack-lustre form. As long as the next government does not do anything stupid there is no reason why they should not continue to keep pulling the economy along, all the more so as global demand picks up pace. We have a fiscal problem and a serious one. But we may not have such a serious growth problem.

The biggest economic issue is not the detail of the next government's policies, whatever its colour. It is whether the IMF is right in projecting that swift V-shaped recovery for both the emerging and developed world. Growth does not of itself fix problems but it makes it much easier to tackle them.

A balanced parliament might just help balance the books – in the end

The sharp increase in the possibility of a balanced parliament (a nicer expression, surely, than a "hung" one) has raised the prospect that a minority or coalition government might not have the authority to bring in needed spending cuts and tax rises. Might the result be chaos à la Grecque?

This has been a fear in financial markets during the past weeks, but as the chances have increased of such an outcome so the concerns seem to have become less marked. This may partly be because the more investors become accustomed to the notion, the less they fear it. But I think it is more that the scale of what has to be done is so massive that the reality will dictate the outcome. There will be no alternative and the electorate is utterly unprepared for what will happen. It is worse than that. None of the three major parties have explained what will happen. The question then becomes, if, under these circumstances, the next government will be able to push through fiscal consolidation on its own, or call in the IMF to give some external validation. Actually, the chances of a minority government needing to call in the IMF would be greater than a majority one. So the chances of orderly progress back to a balanced budget might be greater, though so too would be the danger of a big bump on the way.

The sad truth is that, from an economic perspective, the leaders' TV debates are irrelevant. They do not change economics. I suppose what worries me most is not the next two or three years – we can see in outline what has to happen. No, the problem will be the long years stretching on from that as the squeeze goes on and on. The National Institute has just produced a new assessment of this Government's economic record. This has not been a total disaster, some productivity gains have been sustained. But one of its conclusions is: "Labour has not run the economy in a sustainable way. Net saving has been much too low.... Labour has not addressed the question of how to pay for an ageing population."

Might a coalition government be better able to think long-term?