Hamish McRae: Does Britain's new-found prosperity offer lessons for other countries?

'100 years ago Argentina was the second or third richest country in the world'
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The Independent Online


That's Christmas over, now it's time to hit the sales. But what about countries that are not doing so well? The boom in the run-up to the festive season has brought home to people the extent of Britain's recent economic success.Not only do we have a higher GDP per head now than, for example, France or Germany, but we spend a higher proportion of our income.

You have to aim off a little because we are at the top of a boom and the strong pound flatters the UK comparison with Europe. But next year Britain again looks like growing faster than most of Europe, even at the current exchange rate, so in relative terms we are still gaining ground.

This is an astounding contrast to the end of the 1970s, when Britain was the sick man of Europe. A famous editorial, in April 1975 in The Wall Street Journal, encapsulated the mood of despair. It was headed "Goodbye Great Britain". It advised investors to get out of sterling and lamented the country's seemingly inexorable economic decline. Its judgement was understandable. Inflation was higher than 20 per cent, the projected budget deficit was nearly 9 per cent of GDP, public spending as measured at that time took nearly 60 per cent of GDP. The current account was in widening deficit and the country was running out of money to pay for its essential imports.

Next year, 1976, came the crisis. Britain was forced to accept an austerity programme of public spending cuts and IMF scrutiny of its policies as a condition for a bail-out loan. In short, the economic situation in Britain then was nearly as bad as that of Argentina today.

But we turned it round. On the back of the austerity programme of the then Chancellor, Denis Healey, the market and labour reforms of the governments of Margaret Thatcher and John Major, and the prudence of Gordon Brown, the country has become an economic success. Mistakes were made, of course, but the job was done.

So the question is: what can countries that are now failing – dramatically in the case of Argentina, but to some extent also in the case of previous leaders like Japan and Germany – learn from our experience? There seem to me to be three main lessons, the first political, the other two economic – assuming that the basic physical, legal and social infrastructure of a developed country is in place.

The political lesson is that you have to have an appreciation that you cannot go on as before. That occurred in Britain in 1976. Political change did not happen for another three years but the sense of public humiliation from the IMF bail-out led to a profound change in attitudes in the civil service (particularly the Treasury), the City and in business. So when the reforms were challenged, as inevitably they would be, there was enough self-confidence to sustain the political support needed to keep them going.

This is obviously an immediate issue for Argentina, because it may slip back into the failed policies of excessive inflation and economic controls that characterised its economic management for the best part of a century. It is hard to appreciate that 100 years ago Argentina was the second or third richest country in the world.

But the need for acceptance of failure and determination to change is also evident in Japan, where despite the rhetoric reforms have been timid. It may even be that Germany's relative decline will continue unless there is a similar acceptance of the need to change the model there. Though its situation is not yet as serious as that of Japan, Germany has gone into recession with more than 8 per cent of its workforce already unemployed. Plunging tax receipts threaten to push its budget deficit above the EU ceiling of 3 per cent of GDP.

The second lesson is the need to get macro-economic policies right, even if this means, in the short term, cuts in public spending and high interest rates. Getting UK public spending down to an affordable level took five years from 1976. Not until the 1981 Budget did Britain get its budget deficit under control. This Budget was much criticised at the time, but with hindsight it laid the base for the economic turnaround of the 1980s. At the same time, the country carried on the monetary targets established in the 1970s, which gradually brought UK inflation down to the levels of other developed countries.

As it turned out, the UK forgot these lessons in the late 1980s, relaxed policies by too much and created the Lawson boom of the late 1980s. Recession followed, which Britain escaped only after sterling left the European Exchange Rate Mechanism in 1992.

The clear message to Argentina and Japan is that they both need to devalue now to escape from recession, and to couple that with much greater fiscal discipline. We can expect them both to devalue: Argentina immediately, Japan gradually over the coming months. Getting their budget deficits under control will take longer. The option of a devaluation is, however, no longer available to Germany now that it is part of the eurozone. Expect the relatively poor economic performance there to continue for several years as a result.

And the third lesson is that a country in economic trouble has to go through the laborious, detailed slog of clearing away the mass of legislation and other restrictive practices that inhibit growth. Different countries have different problems, so there is no magic wand that can be waved to fix things.

In Britain, a large part of the problem was an outdated trade union structure. To fix that required a decade of legislative reform and several bruising national strikes. But now Britain has lower unemployment than the United States or Japan and half that of the rest of the EU: the benefit does eventually come through. Similarly, British taxation took more than a decade to sort out, but now gives the UK a significant competitive advantage over most of Europe.

The structural problems of the present economic laggards vary from country to country. The feature they have in common is that detailed and unpopular legislative changes have to be made to fix them. But if you don't fix them, you gradually get poorer – in relative terms, like Germany, or worse, in absolute terms, like Argentina and now Japan.

Of course Britain made many mistakes. There was no road map: our policy-makers had to create as they went along. Other countries have the advantage that they can learn from our reforms.

Or they can make the choice not to reform. It is a tough process and people get hurt. But don't cry for me, Argentina – or for Japan or Germany – if you find yourself slipping further down the wealth league. And sooner or later your shoppers will notice.

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