Outlook for 1998

• • Sharp slowdown to 1.5 per cent growth in the first half; a one in four chance of a recession

• • Inflation to fall to 2.4 per cent by end-year despite average earnings growth of almost 5 per cent

• • Unemployment rate to fall below 5 per cent

• • Pound to fall to 2.80DM by end-year

• • Interest rates to peak at 7.5 per cent this spring coming down to 7.25 per cent this autumn

• • House prices to rise by 9 per cent.

• • Fiscal position improving but no case for policy loosening

Outlook till end 2000

• • Interest rates to fall to 5.25 per cent

• • Pound to fall to 2.60DM

Outlook for 1998

• • Asian fall-out on Western economies limited, provided no further setbacks

• • World trade to grow by 5.75 per cent and OECD output by 2.6 per cent

• • Japan the main loser with growth almost halved to 1.4 per cent because of Asia effect; a one in five chance of recession

• • US and EU to grow by 2.6 per cent

• • Recovery of smaller Asian economies quicker than anticipated: S.Korea to grow by 2 per cent

• • Fed to hold fire but short rates to rise by half a per cent in core EU

• • Dollar to peak in first quarter but subsequent decline modest

• • OECD inflation to decline, but no threat of deflation

By almost any criteria 1997 turned out to be a very good year for the British economy. As in the preceding three years, real growth was faster than the rate of consumer price inflation. Unemployment fell very sharply, by almost half a million on the claimant count definition, and around 350,000 mostly full-time jobs were created over the course of the year. The balance of payments showed a surplus on current account of an estimated £4 billion and the fiscal position strengthened significantly. Among the demand components, consumers' expenditure rose by about 4 per cent, largely as a consequence of fast income growth. The windfall payments received by the personal sector on the conversion of some building societies into banks appear to have been mainly saved rather than spent, thereby adding to wealth. Personal sector wealth also benefited from increases in house prices of about 10 per cent and a rise in equity prices of around 20 per cent.

There has been a substantial improvement in the financial position of the public sector over the past year. The PSBR is expected to fall from 3 per cent of GDP in 1996/97 to about 1¼ per cent of GDP in the current fiscal year. The restrictive policy promised over a number of years, together with the effects of the economic cycle, is now having the desired effect. Further action by the new government to raise the tax burden has also improved the outlook for the public finances. Public borrowing is expected to continue to fall and the public sector balance sheet should begin to improve from the start of this year.

Global economic conditions improved markedly last year. Within the OECD, output growth is estimated to have risen to 3 per cent, the best outturn since 1989. Growth was particularly buoyant in North America, reflecting strong domestic demand, with the NAFTA economies forecast to have grown by 4 per cent. Economic prospects also improved in Europe, with growth picking up in both Germany and France. However this has yet to produce any significant declines in unemployment in those countries, suggesting that a considerable degree of slack still remains in their labour markets. In contrast, the unemployment rate in the United States has fallen under 5 per cent for the first time since the early 1970s. Growth has slowed, although not yet collapsed, in Japan with domestic demand having proved unexpectedly weak in the aftermath of moves to tighten fiscal policy. We expect to see some slowdown in global growth this year, largely as a result of the impact of recent developments in Asia, with the growth in OECD GDP projected to moderate to 2.6 per cent, some 0.4 percentage points lower than we would otherwise have predicted.

The turmoil in East Asia over the last six months has led to major realignments of many currencies in the region, whilst domestic equity and property markets have collapsed. Though each of the directly affected economies had some unique problems, all shared the key factors behind the collapse, an over-rapid growth in domestic investment, declining external competitiveness and inefficient and loosely regulated financial institutions.

This article analyses the implications of switching from unfunded to funded pension systems. It is plausible that in the long run and on average people would be better off if pensions were funded. But in the transition from an unfunded to a funded scheme funds need to be accumulated and that requires national saving to be higher. While deficit financing can, under certain circumstances, help spread the burden of the transition across generations the scale of extra debt that might be needed in many European countries is problematic in the context of Monetary Union. Ultimately, it is likely to prove hard to make significant headway towards greater funding of pensions in Europe without some people being worse off. The task is harder the more generous are existing state pensions, the more rapid is the ageing of the population and the more constrained is the government in using deficit financing. Given all this the UK is in a relatively good position (vis a vis rest of Europe) to complete a transition which, arguably, began almost twenty years ago. Things are much tougher on the Continent.

But there are more than transitional issues. Unfunded pension schemes can help people insure against shocks that affect particular generations and because such schemes often involve intra-generational redistribution (because linkage between contributions made and pensions subsequently received is often quite low), as well as inter-generational transfers, they can help compensate for missing insurance markets. A key question for those who advocate a complete move to funded schemes is how the redistributive and insurance roles that are played, to varying extents, by state-run, unfunded pension schemes could be achieved by other means.

The ‘Stability Pact’ agreed at the Dublin Summit in December 1996 and concluded at the Amsterdam European Council in June 1997 prescribes sanctions for countries that breach the Maastricht deficit ceiling in stage three of European Monetary Union. This paper explores the central provisions and possible motivations of the Stability Pact as an incentive device for fiscal discipline and as a partial substitute for policy coordination and a common 'stability culture’.

Research and development in the German economy is internationalising: recently there has been an increase in outward DFI by German companies relative to the inward DFI of foreign-owned companies in Germany. By examining the long term trends in patents granted in the USA to the world's largest firms between 1969 and 1995, it emerges that Germany is now catching-up with a world-wide trend to internationalise technological activaty, and has done this on the basis of its core technological strengths developed historically at a national and corporate level. The research and innovation infrastructure of the economy remains strong, and German companies are locating abroad in the industries which are the most science-based, which are supportive of domestically-based core technologies and in which they hold the strongest competitive position relative to other European firms. German-owned companies retain their dominance of German-located R & D in five key industries—electronics, chemicals, pharmaceuticals, metals and motor vehicles—and they have developed technological specialisms clearly focused on the core technologies of these industries, at home and now also abroad.