Econiomy: We're leaner, but not necessarily fitter

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This will be the worst peace-time year for the economy since 1921, according to the National Institute for Economic and Social Research. Even in 1931, at the height of the Great Depression, the British economy shrank by less than the 4.75 per cent Alistair Darling says the UK will have lost by New Year's Day 2010.

Still, perhaps more importantly for the Chancellor, there seems every chance that the economy will, at last, return to growth by the end of the year, as Mr Darling has doggedly insisted since the spring.

In the short term, the prospects remain relatively poor. The scale of the economic downturn this year has forced the Chancellor to revise his growth forecast for 2009 from 3.5 per cent to 4.75 per cent. Overall, the economy will have shrunk by six per cent, and output levels are unlikely to return to pre-crisis levels anytime before 2011.

In international terms, and despite recent upgrades of past GDP data, the UK is still the only economy in the G20 to still be in recession. Few economists would rule out a relapse next year.

The Treasury's forecast of growth next year in the one per cent to 1.5 per cent range is broadly in line with the Bank of England and other independent forecasters' views, The 3.5 per cent bounceback in 2011 is, if anything, slightly lower than the Bank of England's latest central estimate of four per cent,

However, the economy that comes out of this recession will be rather different to the one that went into it. The Treasury says around five per cent of the economy's productive capacity has been permanently wiped out as a result of the financial crisis, just as if it had been destroyed in a war-time bombing raid. In other words, about £1 in every £20 generated during the boom has simply disappeared forever. Sharply lower investment will almost certainly reduce the economy's long-term growth rate, as will the emigration of many east European workers.

The Treasury also says that the economy's large margin of spare capacity now – estimated by independent economists at around five to six per cent of GDP – will not be eliminated before the middle of the next decade.

Despite pleas from ministers and the Bank of England for a fundamental rebalancing of the economy in the longer term – away from consumption, finance and property and towards manufacturing, investment and exports – there is little sign of that transformation happening soon. Indeed although the current crisis had its genesis in the financial sector, it is the manufacturing and construction industries that have borne the brunt of the pain.

An already diminished British industrial base has been denuded still further, with manufacturing accounting for only about 12 per cent of GDP, against 30 per cent at the start of the 1980s. The UK is leaner after this downturn; whether it emerges fitter is much more doubtful.