Economic View: Can Britain keep its house in order as the foundations start to creak under worldwide property prices?

With a slowdown on the way, and a housing bubble threatening to exacerbate the damage to growth, we need to raise our game on productivity

To go or not to go, that is the question Gordon Brown is apparently deciding on this weekend. The economic argument appears clear-cut: the state of the economy is bound to worsen over the next 18 months. But whether that in itself translates into a case for going to the country next month is a much more complex question, precisely because electors do expect there will be an economic slowdown and will factor that into their judgement.

There is, however, a real debate as to how serious the forthcoming slowdown is likely to be, with the former head of the Federal Reserve, Alan Greenspan (who is an adviser to the Prime Minister), suggesting a significant possibility of a recession, at least in the US. That, as it happens, is not a bad starting point, since what happens here will in large measure be determined by what happens elsewhere in the world. We have already seen that at a micro-economic level, with the US sub-prime fallout hitting banks in Europe, including Northern Rock. Expect it to happen more and more at a macro-level too.

The issue in the US, which may become an issue here next year, is the extent to which cuts in interest rates can give a sustained lift to the economy. Interest-rate disarmament has begun and further falls are expected, whereas here most commentators are pencilling in the first cut in rates early next year. You can see why reductions in the cost of borrowing have star-ted in the US: there has been a collapse in the property market, with new house prices down around 10 per cent year on year. I saw one story that some developers had cut prices by 50 per cent. Maybe they were too high in the first place, but this does raise the point that there has been a global housing bubble.

The significance of global housing to global demand was discussed by Goldman Sachs in a new paper last week. We tend to think of housing bubbles in domestic terms; that prices have been falling in Ireland, Spain and the US for several months is an interesting but academic sideshow, unless of course you have just bought a house in Florida. Individual housing markets are individual markets and will remain so. The danger, though, is that they could have a co-ordinated impact on world economic demand if most of them started falling at the same time.

As you can see in the left-hand chart, there has been a boom, and maybe a bubble, in house prices in all major markets apart from Germany and Japan. The UK has experienced a particularly vigorous version of the phenomenon. That does not necessarily mean we face a correspondingly vicious version of the correction – let's call it that – but it does mean we're exposed. Goldman's point, though, was wider: that global house prices present a risk to global growth, and threaten to undermine its general view that demand in the rest of the world will offset a fall in demand from the US.

How big a risk? The latest Goldman forecasts for the G7 economies are shown in the right-hand chart. The figures for 2007 are still forecasts but will be pretty accurate; the figures for 2008 are its best guess. Goldman expects UK growth to slow from 3 per cent to less than 2 per cent next year, which is a lot sharper than the slowdown predicted elsewhere: the consensus is for 2.4 per cent growth next year. Too gloomy? I don't think so; I would expect the other forecasters to come below 2 per cent in the next few months.

If that is right, you then have to ask what damage growth at less than 2 per cent would do to employment, government finances and so on. Employment has remained buoyant, at least in the private sector, and could probably ride through a period of slower growth. But there would be an immediate impact on government revenues, and this year the fiscal deficit is already running higher than forecast.

More worrying still is that, in contrast to the late 1990s, there is now no leeway in public finances to offset any slackening of demand by boosting spending. The official Maastricht definition of the budget deficit last year puts it at 2.5 per cent of GDP, which is at least below the 3 per cent level branded as "excessive". But not by much and, according to the government's own "golden rule", current spending is close to the limit. The rule is that borrowing should only be for investment, not to fund current spending. Public finances are not terrible, but they are tight.

A wider perspective on the performance of the British economy and its prospects came last week from the OECD. Its report on the UK hit the headlines because it suggested that there might be a need for interest rate cuts – a view echoed by the Ernst & Young Item Club. The OECD made the point that 10 years ago the UK had the lowest GDP per head among the G7 countries, and now it is third highest.

Even accepting that this was in fair measure the result of policies in place before the Labour Government took over, it would be perfectly reasonable for the Prime Minister to claim credit for this. More troubling is evidence, also in the report, that the UK stopped closing the productivity gap with the US about 10 years ago too. Indeed we have been losing ground on that measure since 2000. The OECD has come up with a number of policies to boost productivity, including changing planning regulations and investing in transport infrastructure; any government of any hue should take note.

The key point here is that whatever happens to global demand during the coming downturn, the better the UK productivity performance, the better able the country will be to cope with the next, and less agreeable, part of the economic cycle. I don't know whether that constitutes a case for calling an election. What we as voters should recognise, and all political parties acknowledge, is that while the UK economy has made a lot of progress, it is still extremely uneven both in sectors and in geography. The best are great; a lot pretty mediocre. The economy as a whole has benefited greatly from globalisation, as the OECD points out, but there is still a huge amount to be done.