Leading Article: Now comes the hard part

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The Independent Online
THIS WEEK, it is possible to say for the first time that the recession is over and the recovery is under way. Retail spending has regained the level it reached before the recession began. Manufacturing output has risen by 2.5 per cent so far this year. Domestic air travel is taking off again. Six British companies out of 10 are now confident that the second quarter of 1993 will be better than the first.

Yet the road is unlikely to be smooth. As in the United States during recent months, Britain's economy will probably take a step back for every two it takes forwards. Although economists are fast revising upwards growth predictions of 1 or 1.5 per cent, few expect a full-scale resurgence to begin this year or next. Unemployment is unlikely to fall convincingly before 1994. Both personal and corporate debt will be high compared to levels among our Continental competitors, dragging down spending growth. Even as the British economy revives, the overseas markets on which we depend most will remain depressed.

But for all that, the risk of a lurch back into recession has greatly receded. The issue facing the Government is how to make sure that the recovery is solidly based and long- lasting. Nobody can say that Britain will never face a recession again; the economic cycle cannot be banished. Economic management could, however, avoid the kind of unsustainable boom followed by destructive bust that has characterised the last five years.

One challenge will be to prevent the trade deficit that has persisted throughout the recession from becoming a long-term constraint on economic growth. The deficit is the starkest measure that Britain consumes more than it produces; to reduce it, the country must go through a period where production outpaces consumption.

This makes the battle on the monetary front tougher. On the one hand, today's relatively low interest rates have brought a more robust recovery than seemed possible a few months ago, by reactivating the housing market and encouraging companies to invest in new capacity. On the other hand, the inflationary dragon is never slain. If Norman Lamont finds that companies are taking advantage of the new mood of confidence by passing on to customers the full extra cost of their imported inputs since devaluation, he will be tempted to raise interest rates. Yet that would only worsen the trade gap.

That is why it is mainly to fiscal policy, rather than to monetary policy, that the Chancellor should turn for an anti-inflationary weapon. Taxes need to rise and public spending to be restrained anyway, if the Government is to return the budget deficit from the present 8 per cent to a more prudent 3 per cent of gross domestic product or less. Such policies will continue a longer-term trend of rebalancing British economic management away from a mix of tight monetary and loose fiscal policy towards the lower

interest rates and higher taxes that provoke export-led, rather than consumption-led, growth.

The lesson from the damaging end of the late Eighties was that financial deregulation and a speculative housing boom are together a lethal cocktail which allows individuals to use houses as banks from which they can withdraw equity to spend on other things. This unsustainable consumption is an underlying reason for the balance of payments problem that the country faces today.

In some ways, the very madness of the Eighties boom helps to reduce the chance that it will happen again - while memories last. With their high levels of debt, consumers are shy of taking on further commitments. It will take a long period of low interest rates for individuals to reduce their debt to more comfortable levels and the problem of negative equity will overhang the housing market for several years to come. The usual risk that a relatively loose monetary policy will reignite inflation is therefore less than usual.

But there remains important work to be done if Britain is to see stable non-inflationary growth in the future. Having made house prices a leading indicator of inflationary pressures in the economy, the Government should act to correct the disproportionate influence that houses have on the economic behaviour of British citizens. Before bricks and mortar become an engine of inflation again, mortgage tax relief must be further scaled back, if not eliminated altogether. The Chancellor should stand ready to act - with higher taxes - at the first sign that house prices are growing faster than the rate of average earnings.

The opportunity to create a better-balanced and more competitive British economy has rarely been greater - thanks in part to the pain we have endured in the last three years. If that pain does not bring real long- term gain, the British people will have every right to feel they have been cheated.