Signs of recovery for the greater good

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The Independent Online
THERE are two issues that everyone is talking about this week; the other one is 'when will the recession end?'

What brought the question to the fore has been the new bout of gloom over sterling, the possibility of a rise in bank base rates and the narrowly averted rise in mortgage rates. But the ground has been prepared by the calls from the left (including Neil Kinnock) and the right (including Baroness Thatcher) for some sort of devaluation of the pound. This, they argue, would enable a cut in interest rates and so stimulate the recovery.

They might seem an odd couple, but ranged behind them are leftish economists such as Cambridge's Wynne Godley, monetarists such as Lady Thatcher's former adviser Sir Alan Walters, and pragmatists such as the new director-general of the CBI, Howard Davies. Standing against them are the Government and its advisers in both the Treasury and the Bank of England, but these are the people who have been predicting for months that the recovery would be in place by now. Had they been right, the devaluationists would have no credibility. They have, sadly, been spectacularly wrong.

So anyone arguing that the recovery is almost certainly already under way runs the risk of being thought a government stooge, a hair-shirt enthusiast for the virtues of low (even zero) inflation, or simply showing poor judgement. Yet a good case can be made that the recovery is already under way, that this will become more evident in the next few months, and that the benefits of economic growth will in the next few years be more evenly spread than those of any previous growth phase.

The case for believing that the recovery has begun starts with the evidence that most graphs with which economists monitor the level of economic activity have turned the corner in recent months. Manufacturing output, consumer goods output, manufacturing overtime, rate of change of unemployment, car and commercial vehicle sales - all now suggest that the economy turned a corner in the first half of the year.

The first quarter showed that the country was still in recession. Figures are not yet available for the second quarter, but there is an even chance that they will show a small recovery. Growth in the second half of the year may not be enough to offset the decline in the first quarter, so the year as a whole may be flat, but technically the recession will have ended.

So why do things feel so depressed? There are several answers to this. One is that they always do. The 1980-81 recession was technically over by the middle of 1981, but the economy did not feel buoyant until well into 1982. The Government was still carrying some of the unpopularity for what was perceived as its responsibility for the recession in the autumn of 1982; despite this, it went on to win the general election the following June. (The present recession, while a little longer than 1980- 81, has not been so deep.)

Another explanation is that the trough seems deeper because the boom was so great. People think back to the heady days of 1988 and compare activity then with now, rather than make fine judgements between the gloomy days of last winter and only slightly less gloomy days now.

There is a third explanation, though, which is perhaps more important than anything else. House prices are still heading down. The housing market is the one big exception to the above picture where the various graphs are signalling recovery: neither housing starts, nor house turnover have turned up at all.

There are two ways of interpreting this. One is to predict there will be no recovery: that consumers will be so fearful of their mortage debts in relation to the price they paid for their houses that they will save and save to correct their finances. The other is to say that this recovery will be different: that it will, for example, be much more akin to the slow expansion in Germany in the first half of the Eighties than the boom/bust cycle we have become accustomed to here.

Aside from the fact that the ratio of house prices to income is now reasonable by historical standards - which suggests prices are unlikely to fall much further - I prefer the second explanation. At some stage people will have built their savings sufficiently to start feeling confident of spending again. The savings ratio is back to the levels of the early Eighties; true, it is not as high as in the mid-Seventies, but then inflation was very much higher and people felt they needed to save to protect themselves from it. It may take a few months more, but at some stage savings will be deemed sufficient, and a gradual build-up of spending will take place.

But - and this is the crucial point - the recovery in spending will not be financed by people taking out part of the value of their homes when they move house. That was the motor of the late Eighties boom, and, to a lesser extent, the growth of consumption in 1983 and 1984. The housing boom distributed the rewards of economic growth in a capricious way. It rewarded people who had over- housed themselves, who had over-borrowed, who were already relatively well- off and who lived in the most prosperous parts of the country. It did not reward people who worked hard in jobs.

If the pattern of economic growth in the next four or five years follows the German model, it will be fuelled to a much greater extent by improved economic performance. The scale of the recession has tended to conceal just how well British companies have been performing in recent months. Labour productivity in manufacturing is at an all-time high, while labour costs per unit of output have not risen at all over the past year. Kleinwort Benson, the City investment bank, reckons that UK manufacturing productivity is rising by 4-5 per cent a year, against

2-3 per cent in France and Germany.

If the benefits of recovery are distributed according to increases in productivity delivered by manufacturers and the more efficient service industries, then the people who benefit will be quite different from the beneficiaries of the Eighties boom. To caricature, they will be workers in car factories, not people who have bought expensive houses. This will give the recovery a different social impact. It may even encompass a form of economic growth that will not increase differentials in wealth. And while the recovery may not feel so heady in the South-east, it may feel more just in the rest of Britain.

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