Bush dealt a strong economic hand but at an awkward time

The administration should avoid being distracted by short-term bad news

It is a fascinating inheritance. The new administration, of which we will learn much more today, comes in towards the end of a boom, maybe at the end of one. But it is also a time when the US economy has outpaced the rest of the developed world both in growth and in technical and entrepreneurial competence.

It is a fascinating inheritance. The new administration, of which we will learn much more today, comes in towards the end of a boom, maybe at the end of one. But it is also a time when the US economy has outpaced the rest of the developed world both in growth and in technical and entrepreneurial competence.

In economist lingo, it is in a potentially precarious macro-economic position but has undoubted micro-economic strengths. How the tension between these two forces is resolved will determine the economic success or failure of the administration.

The outline of the macro story is well known but the outcome is unknowable. The forces that normally end booms are not particularly evident: there has been no surge in inflation and the US has been able to fund its current account deficit without any pressure on the dollar. But the extent to which the economy is depending on strong consumer demand financed on tick and strong investment financed by market borrowing has become alarming. At some stage US households will have to rebuild their savings and at some stage US companies will be finding it difficult to fund their investment. Both are vulnerable to any sharp slowdown in the economy and the markets are steadily downgrading forecasts.

You can see that in the graph, which captures this change in mood. It shows the changes in the consensus forecasts for growth in 2001 for the three main economic zones, over the past year. Those for Europe have stayed pretty much the same, as have those for Japan (though at a much lower level). But the US has been downgraded sharply. In one sense forecasters are only reflecting the current change in performance. In the third quarter US growth fell below that of the eurozone for the first time since the early 1990s.

But that was bound to happen at some stage. It would be astounding were the US not to grow more slowly than the eurozone at some stage. I think there are a number of reasons to expect it to grow faster than the eurozone over the next 20 years. More of these in a moment. But if it were to grow faster every single year, well, Europe's politicians might as well pack up and sub-contract economic management to the US. The issue now is whether there is a cyclical recession coming and if so, will the US make a swift recovery.

If there is not much point in banging on further about the "R" word. If it happens, the Bush administration will have to cope with it. But it is worth reflecting on the possible pace of recovery because that has all to do with the flexibility and vitality of the US economy.

It is too early to judge maturely the reasons for the sudden spurt of growth of the US during the second half of the 1980s but you can note down some exceptional features of the economy. It has zones of excellence in the new technologies unequalled anywhere in the world: love it or hate it, no other country would have the combination of human skills, entrepreneurial zeal and cash to back good ideas that created Microsoft. It has also the resource of innovative consumers, which have driven the new technologies forward by providing a ready market.

But the success story is not just in new technology. Old Economy companies have been particularly adept at employing technology to boost productivity. It is hard to be sure because we have not yet gone through the full economic cycle. But there really does seem to be a productivity effect that is not just associated with high levels of capacity use, and which must have something to do with the enormous investment in information and communications technology by US companies.

In so far as we know anything about the new administration's policies, we can be confident that it will be business-friendly. You can over-emphasise the significance of politicians on the economy. Vice-president Gore did not, after all, invent the internet. But the combination of tax cuts, assuming the new president can get them through, and lighter regulation ought to give yet another impetus to American growth. So we should perhaps be looking at ways in which a flexible economy will respond to what will inevitably be tougher times.

It has two important things going for it in the longer term. The first is demography: the US becomes by far the youngest of the G7 countries in terms of the proportion of people aged over 65. It is getting older but more slowly than the rest of us. Part of the reason for this is slightly higher birth rates than in Western Europe or Japan but part is immigration. The US and Canada are the only G7 countries still accepting large numbers of immigrant workers. That leads to the second bull point. These workers bring innovation and skills with them. Add in the fact that the US is the destination of choice for economic migrants and you can see how the growing pool of skills is likely to drive the economy forward over the next decade.

My guess - it can be nothing more - is that there will be a difficult 18 months as the US makes the macro-economic adjustment to slower growth. But the micro-economic strengths noted here are going to enable it to make a quick bounce back, probably quicker than the less flexible European nations and far quicker than Japan. You could say that the administration has been dealt a strong hand of cards but at an awkward time. The important thing for it will be to avoid being distracted by short-term bad news and to focus on bolstering long-term advantages.

Is that something that politicians can do? Only to a modest extent. It can set a mood and mood matters. But if things go badly Americans will not be pleased. The country has had such an extraordinary run of economic prosperity that many people can hardly remember tougher times. For that lack of perspective the administration can do zilch.