Here's to a prosperous, cautious and very unpredictable new year

The economic impact of a war is somewhere between negligible and a new global recession; it is impossible to be more precise about it
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The Independent Online

For most people it has been a quiet Christmas, a time for caution and reflection rather than festive excess. In many ways that is no bad thing; there are a host of reasons to be cautious.

For most people it has been a quiet Christmas, a time for caution and reflection rather than festive excess. In many ways that is no bad thing; there are a host of reasons to be cautious.

In Britain we have had a decade of rapidly rising living standards, which is fine, but that rate of increase is unlikely to continue. In any case, anyone with a sense of historical perspective will feel uncomfortable about the way this increased wealth has been shared both within this country and more generally throughout the world. And whatever view you take about the probability of a war in Iraq, and its likely outcome, it is hard to feel comfortable about a situation in which a most unstable part of the world holds 70 per cent of its oil reserves.

So there are plenty of rational reasons to be cautious. But if people are concerned about the state of the world, they are less concerned about the state of themselves, at least at an economic level.

Just before Christmas, a survey of consumer confidence done for the European Commission highlighted the contrast between what Britons thought about their own finances and what they thought about the general economic situation. Ask people whether they think that their own household finances will improve over the next year or whether it is a good time to make a major purchase and the positive answers outnumber the negatives. Ask them about the general economic situation for the next year and the negatives greatly outnumber the positives.

This figures. More people are in work in Britain than at any other time in our history. Inflation and unemployment are the lowest they have been for more than 30 years – with inflation, on the EU measure, the lowest of any large European country. Couple this with an increase in living standards of some 4 per cent a year for most of the past decade, and it would be odd were people to feel bad about their own personal finances, although the signs from the shops are that we have been cautious spenders this Christmas. Even people who have lost money on the stock market in the last three years may well have made it up on the rise in value of their homes. Household spending in the UK has risen by 36 per cent since 1994, a greater increase than in even the US. This compares with a rise of only 12 per cent in Germany, where household income has been falling for the last 18 months.

So we feel good about ourselves but worried about the future. Our worries about the future fall, I think, into two main groups: those relating to our physical security and to a conflict in the Gulf or the Middle East, and those relating to the fragility of the world economic recovery.

On the former, the margins of error are huge. It is not just the cost of an invasion of Iraq and the resources needed to stabilise the country afterwards. You also have to take into account the impact on the oil price and the possibility of an interruption to Middle East oil production.

A year from now we will know whether the bill is towards the bottom end of the scale or whether something has happened that is so alarming that it hardly bears thinking about. If we were just talking about a swift, successful invasion of Iraq, most in the developed world would hardly notice the economic cost. Normal economic growth adds more than $1,000bn (£630bn) to world output each year and the highest estimates of the cost of a war are about half that, and most are less than $100bn.

If, on the other hand, the region were to become seriously destabilised with an interruption to oil supplies, then we could easily face a new leg to the downturn. Were, for example, a large part of Saudi Arabian oil production to be knocked out for six months by an Iraqi attack, the oil price could go to $80 a barrel. That would be enough to push the US back into recession. Since the rest of the world is depending on the States to maintain export demand, most of the rest would suffer recession too.

So to be brutal, if the world economy keeps growing it can afford a war. But if a war were to kill growth by interrupting oil supplies then the costs would become very high indeed – and I mean just the economic costs, for the human costs would of course be on top of that.

I know it is unsatisfactory to say that the economic impact of a war is somewhere between negligible and causing a new global recession, but it is simply impossible to be more precise. We can make judgements about the probabilities; most people would rank the more favourable outcome as the most likely, but we cannot know.

What we do know, and this is reflected in that survey noted above, is that there is a disturbing fragility to the world economic outlook. In Britain we see less of this: we have carried on growing right through the downturn. But we have seen Gordon Brown admit to the deterioration in our public finances and we see the misery of rising unemployment in Europe, Japan and the United States. We would not be human if we didn't worry that the good times might be ending.

The most sensible response is to see this as a period of transition. The great surge in prosperity is coming to an end. In future we should continue to become richer but at a much slower pace. Call it, if you like, the shift from big bang to steady state.

We know that, left alone, an economy like ours will grow at around 2.5 per cent a year. In the future, more of that growth is going to have to be set aside for supporting our ageing population, for infrastructure and, however it is financed, for health care. There is evidence, as the IMF recently warned, that a lot of increased resources that are being funnelled though the public sector are not being spent effectively. Huge amounts, for example, are being wasted on a bodged attempt to improve services there. The efficiency of the NHS has also fallen sharply in the past five years.

Unfortunately, there is as yet no mechanism for curbing this wastage. Still, even allowing for a reasonable level of incompetence by government (and our government is not particularly bad compared with other countries), there will be something left over to increase living standards. We will be able to increase those by between 1 and 2 per cent a year. We will start to feel this cooler climate in the spring, when taxes go up – but we will not be alone.

This same shift to a slower rise in living standards is already happening on the Continent and will inevitably happen in the United States. But being in good company will not make the transition any more comfortable. By any sort of global standard, we are hugely fortunate in where we live – in a decent and reasonably competent democracy – and we are equally fortunate in when we live, in a time of prosperity and still reasonable physical security. It is good to remember these things now, for Christmas is not just about shopping; it is also about reflection.

But – a modest further thought – if you feel like hitting the sales today, do not be discouraged. The Great British Shopper has kept the economy going as a result. We need, cautiously and thoughtfully, to keep shopping. Enjoy the sales.