Hamish McRae: What we can learn from the early 1980s

Economic Studies
Click to follow

The economy last year turned out better than most people expected, with a fall in unemployment and growth of around 1.8 per cent – not wonderful, and with real worries about inflation, but compared with the previous two years, not bad at all. So what can we sensibly say about this year?

If those two years have taught us anything, it is to be profoundly sceptical of economic forecasts. But I think it is possible to sketch an outline of what might happen and then be prepared to change your ideas as new information, or new shocks, come along.

Start here in the UK because we do have a template of sorts: the recession of the early 1980s. The British economy is almost exactly on the same trend line as it was then. Output fell a little further this time, but now is a tiny bit above the 1980s path. Actually, if you make an allowance for North Sea oil and gas output, which then was growing fast, and offset to some extent the 1980s recession, this downturn is slightly less deep than that one. But for practical purposes, they are near enough the same.

If we continue to follow the 1980s path, the UK economy will have another year of growth of around 2 per cent, maybe a bit more, but will not regain the previous peak output until the second half of 2012. So there will be growth but no sense of prosperity, for we will as a country be generating less wealth than we were in early 2008. And there is a further known headwind: the impact of higher taxation and spending cuts, both of which have only just begun to take effect. Most, maybe all, of the fruits of the growth will go in cutting public borrowing, not in increasing living standards. It has to be done, but it will not be a bundle of fun.

So that is the outline. What might change it? The trouble is that most of the obvious imponderables are negative and there is only one I can spot that would be really positive.

The most obvious imponderable is how the economy will respond to fiscal tightening. How badly will the rise in VAT hit consumption? Will the private sector be able to offset the job losses in the public sector? Will tax revenues hold up as higher rates bite? We cannot know the answer to any of these, for the evidence from the past is too mixed. The early 1980s saw a sharp tightening of policy, for which the then chancellor, Sir Geoffrey Howe, was much criticised, but growth did continue. On the other hand Japan's experience in increasing tax rates in the 1990s was much less successful.

My own main concern is less about the impact on growth and more about tax: might these higher tax rates fail to bring in the extra revenues they are supposed to do? We will have to wait and see.

The other set of imponderables concerns monetary policy. Interest rates will start to rise this year, for it is very hard to see any set of circumstances where this will not happen. The question then is how fast the rise in rates will become. There will be headlines when the first rise in the Bank of England base rate comes through, maybe even in the spring, but in practical terms, the odd quarter or half percentage matters little.

But if rates need to rise swiftly, perhaps because of even higher-than-expected inflation, then that will matter a lot. The housing market in particular does not need much of a rise in rates to be pushed backwards. Expect, too, a rise in longer-term rates worldwide, as lenders demand a higher premium for lending to what are seen as risky governments.

That leads to questions about the rest of the world. The big shock in Europe last year was the way rescues had to be organised for Greece and Ireland, and the euro itself came under suspicion. That game is not over by any means and more rescues seem inevitable. Southern Europe will have a tough year.

There are other potential external shocks, nearly all negative: a pause in the US recovery; further rises in energy and commodity prices, driven by demand from China and India; the sovereign debt crisis spreading beyond the eurozone. There is, however, one big possible positive, not a game-changer for the UK but something that would be a huge help, and that is faster-than-expected growth in Asia.

Look at British exporters and they are massively optimistic; ditto German industry; ditto any company in the luxury trades. This optimism is driven by demand from the new rich of the world, from Russia and the Middle East to parts of Latin America and India and China. UK output will not reach its past peak until next year but global output is already way ahead. The world economy is doing just fine, hence the pressure on resources, the oil price and so on. So the question is to what extent the export-orientated chunk of the UK economy, and this includes service exporters as well as manufactured goods exporters, will continue to benefit from this global growth. It is a bright light in an otherwise rather too dull world.

A rosy outlook for emerging economies

And if you want to look beyond this coming year? Goldman Sachs made such a splash with its work on the Brics, giving the world a new acronym to pull together the four largest emerging economies of Brazil, Russia, India and China, that it is good to see another bank having a stab at a similar exercise. HSBC has just produced a report, "The World in 2050", which also analyses the rate at which the emerging economies are likely to overhaul the developed ones.

The big picture is much the same as that of Goldman, in that the emerging world economies will collectively be larger than the present developed world, that 19 of the 30 largest economies will be in the former category, and that the pecking order then will be China, the US, India, Japan. But after that will come Germany and the UK, both somewhat higher than on the Goldman model, while Brazil and Mexico will be somewhat lower.

Well, 2050 is a long way off, so of course these are not hard predictions. But they do ram home the big message that the influence of the West, for want of a better word, will inevitably diminish, while that of the East will inevitably rise. The times they are a-changin'.