Hamish McRae: Recovery beckons. But it won't be easy

Borrowing costs mean that coming out of recession is going to be a slog
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It is time to move on. In the past few weeks three things about the world economy have become clear. The first is that some sort of recovery is in sight. The second is that the recovery will be beset with huge problems, pressures and difficulties that will last at least a decade. And the third is that when we do struggle back to solid growth the world economy will look utterly different: it won't be business as usual for the rules of engagement will have changed for ever.

Can one really say that recovery is in sight when all we have to go on is some indications that the UK economy has bottomed out, that markets have perked up, that the business community around the world has overcome some of its gloom, and that growth has continued strongly in Asia? Lots of things are still going down and will continue that way for some time yet.

Just yesterday the German Ifo Institute forecast that the economy there will continue to contract until the middle of 2010, while the OECD has said that unemployment in the developed world will go on rising until well into next year. Set against this backcloth, the talk of "green shoots" seems a bit silly – and for people whose lives have been savaged by recession, even cruel.

Nevertheless, if you stand back you can see the world economy starting to swing back towards growth. Just as a year ago it was possible to warn that 2009 would be a bad year, now it is possible to see that next year will be much better than this. We can, looking at the evidence now available, be pretty confident that the notion that we face a 1930s-style depression is wrong.

So the focus shifts. The conventional view is that the recovery will be hobbled by government debts. That is right; it will. We here in the UK have a particularly vicious squeeze in store, for our budget deficit looks like exceeding 12 per cent of GDP, quite possibly the highest among the large developed economies. But the problems will be pretty similar elsewhere. The OECD's new Pensions at a Glance paper points out that the average deficit to GDP ratio in the developed countries next year will be close to nine per cent.

While we have all seen these numbers, however, I don't think we have begun to think through the consequences. You can argue that the UK has made an error of historic proportions in allowing public finances to become so weak, and some of us have indeed been deeply critical. But what is done is done and no comfort at all to note that other countries are in pretty much the same boat. The consequences are that the governments of virtually all developed countries will be under profound financial pressure for a decade, maybe a generation. There just won't be any money. Tax revenues will be stagnant and the scope for borrowing will be very limited. Worse, this will come at a time when the demands on governments will continue to rise, not least from the ageing populations. This changes the shape of the recovery, putting a brake on growth. You can see how the demand of government to borrow money is forcing up long-term borrowing costs for everyone else. Fixed-rate mortgage rates are already on the up.

As a result, coming out of recession will be more of a slog than it otherwise would be. Money we pay in higher taxes or higher interest rates is money we can't use for a car or a holiday. Some countries will do better than others and the prospect for much of continental Europe is bleak. While deficits are lower the stock of public debt is higher.

Debts will not only change economics; they will also change politics. Governments promising more and more "investment" as our present one has, simply won't be credible because we will all know they won't have the money to finance that spending, even if it were genuine investment, which in many cases it isn't. Politicians adapt and will start to use different language to present the dilemma they face. I think you can start to catch a glimpse of this as the battle-lines for the next election start to be drawn. The longer the election is delayed the more evident it will be that both parties can only promise savage cuts in public spending.

That is here; expect similar debates to take place throughout the developed world. Indeed we may be approaching an historic turning point, the moment when public deficits – and debt – go into reverse: the moment when it is no longer perceived to be fair or right for governments to load more debt on to our children. You could say it would be a reversal of the self-indulgence of the 1960s generation, the generation that is running the show at the moment, and its replacement by a more austere and disciplined approach. At any rate, a recovery hobbled by the need to service public debt will certainly strengthen the hand of the young, who after all are the people who have to pay for it.

If this recovery changes politics within the developed world, it will also change politics globally. We still assume that the post-war model for government established in Europe and North America will dominate the world of public policy. Sure, there are different versions of the European model, and the US model is different again. But the broad boundaries of what governments should and should not do are not so far apart, and whether we incline towards the US or Swedish end of the spectrum we still see governments having broadly the same ideas of where their responsibilities should start and end.

That is going to change. As the recovery matures we will become aware that the balance of economic power has shifted. Most obviously it will have shifted towards China and India. China will be indubitably the world's second-largest economy and India will be in sight of overhauling the UK in terms of size.

That changes everything. Why should China want to follow the Western model of government when its own delivers much higher growth? How can we be confident about our own model when it has loaded so much of a burden on to generations to come? I am not saying that we will adopt the Beijing model; far from it. Phew! But when we have to confront what is, if we are honest with ourselves, a relative failure, we are going to wonder quite what we are getting wrong and how we might do things better.

h.mcrae@independent.co.uk

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