What will the recovery look like?

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By Anthony Reuben Business reporter, BBC News

As recently as October, there were genuine fears that we could be about to see a collapse of the financial system - a sort of financial Armageddon.

The government predicts there will be growth next year

Less than nine months later, there is a fresh optimism in the air and some economists suggest it could be time to start talking about having reached the bottom of the recession.

But if we are now looking forward to a recovery, what sort of recovery should we expect?

In past recessions, it has been consumer spending that has led the recovery, but personal debt was a part of what started this downturn.

Bank of England Governor Mervyn King said at the launch of his inflation report that "in the UK, our national saving rate will need to rise", and that would be difficult to reconcile with growth in consumer spending.

Nonetheless, even if there is not a big rise in spending, retailers could still boost growth by boosting their stock in the near future, according to former Monetary Policy Committee member Professor Charles Goodhart, now at the London School of Economics.

Now the City is likely to be somewhat less successful... our tradeable goods industries will be much more successful Professor Charles Goodhart, London School of Economics

"After Lehman Brothers collapsed, everyone tried to reduce their inventories as far as they could, so there was a massive inventories run-down for about six months, which made the figures for growth a great deal worse than the underlying reduction in demand."

He says that on the flip side, retailers will have to restock their shelves at some point soon, which will make the recovery look better than the growth in demand would suggest.

Nonetheless, consumer spending is unlikely to be the leading factor in the recovery. Some have suggested it could be an export-led recovery.

"I think there's a good chance that exports will play a significant role in leading the UK out of recession," says Stephen Radley, chief economist for the manufacturers' organisation EEF.

UK exporters are already benefiting from the weak pound against the euro and the dollar, which makes their products cheaper to their overseas customers.

The problem with an export-led recovery is that it means we would have to wait for other countries to have their recoveries before we can.

At the moment, about 60% of UK exports go to the European Union, and the economies of many EU countries look in just as bad condition as the UK, even if they have not had as much reliance on their financial sectors.

Only way is up

But is the UK manufacturing sector in any state to lead the UK economy's recovery?

As BBC economics editor Stephanie Flanders points out in a <a class="inlineText" href="http://www.bbc.co.uk/blogs/thereporters/stephanieflanders/2009/05/a_recovery.html">recent blog, </a> if you have stopped production altogether, as many industrial firms have done, there is nowhere to go but up.

You start to create a monster and you need to know how to stop it Paola Subacchi, Chatham House

"The worry is that some manufacturing companies won't have the capacity to take advantage of the upturn when it comes," Mr Radley says.

"Companies will have been forced by the recession to lose a significant chunk of their workforce and some of those will be highly skilled people who they've reluctantly had to let go because of the pressure they're under."

Prof Goodhart points out that the weakening of the pound is a rebalancing of the economy.

In the past, what was keeping the pound strong was the earnings from financial institutions, he argues.

"Now the City is likely to be somewhat less successful, the pound has depreciated really quite a lot and our tradeable goods industries will be much more successful in future."

A possible source of growth in the recovery could be green technology.

"I think manufacturing firms that can launch new, green products are likely to benefit," says Andrew Goodwin, senior economic adviser to the Ernst & Young Item Club.

"Though the UK has a dwindling manufacturing sector in terms of its size and share of the economy, I think it has very high quality and value-added and I think in those sorts of areas the UK has an advantage and could push forward."

'Banking has problems'

It is not just the manufacturing sector that could see an upturn in exports - the service sector could also benefit.

The UK tourist industry is expected to benefit from the weak pound encouraging visitors from overseas.

There may even be some growth from the financial services sector.

"Obviously banking has its problems and is likely to grow at a much slower rate, but I think there are other key parts of the financial services sector, which we'd expect to continue to do quite well: areas such as asset management and insurance in particular," Mr Goodwin says.

Dangerous strategy

There has also been some talk of an inflation-led recovery. The thinking is that if debt is the big problem for both the government and individuals, some controlled inflation would reduce the value of that debt.

We think growth will be much slower than it has been in the recent past Andrew Goodwin, Ernst & Young Item Club

On top of that, reasonably large, inflation-linked annual pay-rises for employees and renewed growth in house prices could make people feel good again and spark some consumer spending.

But it could be a dangerous strategy.

"You start to create a monster and you need to know how to stop it," says Paola Subacchi, head of the international economics programme at Chatham House.

"One risk when you start to play with inflation is that you create expectations and if the inflationary expectations get out of hand, then you create some undesirable inflation, which becomes more difficult to control."

Prof Goodhart says that the problem with the strategy would be the rising cost of borrowing.

"I don't think it would do you that much good because it would just raise the interest rates and therefore the cost of [the debt]," he says.

'A big mess'

So it looks as if we may be relying on exports and investment when the recovery comes, but perhaps we should not raise our hopes too high.

"We wouldn't necessarily think it's going to be a particularly exciting recovery, even in exports," Mr Radley warns.

There is a perception that there will not be a return to the sort of growth we were used to before the downturn began.

"We think growth will be much slower than it has been in the recent past," predicts Mr Goodwin.

"It's averaged over 3% over the past decade and we're looking at something nearer 2.25% going forwards."

On the other hand, the Armageddon scenario outlined in September, featuring total loss of confidence in currencies and economies has not happened and we should all be grateful for that.

"We are in a big mess but at least it's not going to get worse - we hope," concludes Ms Subacchi.