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Vitamin FTSE: pundits have been asking for months whether the UK economy will necessarily catch cold because the US has sneezed. David Ross predicts that it will in fact fare better in 2002 than its eurozone neighbours. (Economics).

The true extent of the divide between the truth and the panic about whether the UK would inevitably plunge into recession along with several other world economies in late 2001 and early 2002 can be clearly shown by taking a closer look at some of the macroeconomic variables. In the third quarter of 2001, for example, the UK economy expanded by 0.5 per cent, whereas the euro area managed growth of just 0.1 per cent. Without strong consumer expenditure growth in France, this eurozone figure would have been negative.

According to data from the National Bureau of Economic Research, the US has been in recession since last March. This has put an end to the longest expansion of the country's economy on record. Revised figures show that gross domestic product (GDP) in the US shrank at an annual rate of 1.1 per cent in the third quarter of 2001. While the omens may not be bright, however, it is not inevitable that history will repeat itself and the UK will catch flu just because America has sneezed.

It is true that economic growth in the UK slowed last year in comparison with 2000. It is also true that it is likely to slow further this year. A provisional estimate for 2001 is for growth of 2.2 per cent, down from 2.9 per cent in 2000. The manufacturing sector, suffering from the continued strength of sterling, is in its deepest recession for a decade, but the services sector continues to expand. The UK's performance last year compares favourably with estimated growth in the US (1 per cent), Germany (0.7 per cent), France (2 per cent) and with Japan, which is already in recession (-0.6 per cent).

In his pre-budget statement at the end of November, Chancellor Gordon Brown predicted growth of between 2 and 2.5 per cent this year and even faster growth next year. His forecast surprised many City analysts who think it is a little optimistic. Brown had been expected to revise his March 2001 budget forecast downward by at least another 0.5 per cent. In addition, experts at the OECD and on the Economist panel of forecasters are more pessimistic: both forecast growth of 1.7 per cent this year. Even this lower forecast, however, compares favourably with forecasts for the other major economies.

The Economist panel predicts that the US economy will grow by just 0.6 per cent, Germany by 0.7 per cent and France by 1.2 per cent. There may also be areas of negative growth in some of the larger European economies, particularly in Germany, before the corner is turned.

Growth in the UK during 2001 was sufficient to bring unemployment down to its lowest level since 1975--down to fewer than 950,000 according to the claimant count, or to 1.5 million according to the wider International Labour Organisation definition. In addition, employment remains close to a record high and the participation rate (those making themselves available for work) has also remained at almost record levels.

By the end of the year, however, unemployment started to rise, as redundancies in manufacturing began to offset job creation in the services sector. A tight labour market in the UK in the past has usually meant rising inflation and higher earnings growth, which is then curtailed by higher taxes and higher interest rates--the classic boom and bust scenario. This has not happened in the current economic cycle, which may explain why it is not inevitable that the UK will repeat its experience of recession in the early 1980s and early 1990s in the 2000s.

Partly because of the UK's relatively better economic performance, interest rates, at 4 per cent, are higher than in the US (2 per cent) and in the eurozone (3.25 per cent). Nevertheless, rates fell to a 37-year low during 2001, and they may fall further still in the short term if it appears that business and consumer confidence needs a boost, although they will probably rise towards the end of the year. Companies with more interest payable than interest receivable will have benefited from the lower cost of finance during 2001 and will continue to benefit this year.

The seven cuts in interest rates last year helped to keep inflation, which is estimated to have averaged 2 per cent, under control. The measure of inflation, RPIX, which excludes mortgage interest rates, remained comfortably under the government's 2.5 per cent target. Neither measure of inflation is expected to rise this year, so this is unlikely to threaten to throw the government's economic policy off the rails.

The only cloud on the horizon results from the deteriorating state of public finances. In the March 2001 budget, the chancellor predicted a small surplus in the current financial year. This has now turned into a deficit, while the deficit forecast for the 2002-03 financial year has grown by 10 billion [pounds sterling]. Although the UK does not have to comply with the 3 per cent budget deficit ceiling under the EU's Growth and Stability Pact, it has plenty of scope for fiscal manoeuvrability to ensure that the economy does not slide into recession.

This year may not turn out to be a great one for the UK economy, but it is likely to be better for the UK than for many other countries. This relatively good news should not be sneered at--after all, it is not long since people were accusing the UK of being the sick man of Europe.

David Ross is an independent economics consultant. He can be contacted at
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Author:Ross, David
Publication:Financial Management (UK)
Date:Jan 1, 2002
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