Much to the surprise of most commentators, the US economy has continued to grow, at least until recently, at about 4% per annum. There has not been a stock market crash. Unemployment has fallen to lower and lower levels. Inflation is still relatively quiescent. The government's finances, after years of massive deficits, are now back in healthy balance. The US economy shows every sign of benefiting from a sustained boom. As a result, policy in Britain seems to be moving more and more towards adopting the performance of the US economy as a model for the UK. This Bulletin explores whether, despite its recent achievements, the successes in the USA are sustainable, and whether, therefore, it makes sense for Britain to emulate American policies.

How have the American authorities managed to sustain a year on year rise in GDP which has enabled the US economy to grow cumulatively by an average of 4.2% per annum between 1992 and 2000, to create 24m new jobs, while leaving inflation still hovering round no more than 3.5% per annum? The key features have been a monetary policy which, under the guidance of Alan Greenspan, Chairman of the Federal Reserve Board, has avoided killing off the boom, even though it is largely financed by the rise in stock market prices; a willingness to keep the US market open to foreign competition, not least through NAFTA, which has done much to hold down prices; and determination to ride with the benefits of new technology and management practices, which appear to be much better at combining growth with low inflation than experience in the 1970s and 1980s suggested would be likely.

While there is much to commend in the US's economic performance, however, there are also a number of serious problems, which need to be put in the balance sheet on the other side. Perhaps most serious of all is the huge US balance of trade deficit, now running at an annual rate of almost $400bn per annum, or about $1,500 for every man, woman and child in the country. As an accounting identity, every extra dollar of the deficit on current account has to be matched by an extra dollar coming in on capital account from abroad to finance it. There has to be serious doubt as to whether the rest of the world is going to be able and willing to continue either buying US assets or lending the US government or its citizens money at this rate. The payments deficit mirrors a second serious weakness in the US economy which is the savings ratio, which, in the personal sector, has now turned negative. This means that much of the current consumer boom is financed by dissaving, as many US citizens spend on consumption more than they earn. The third major weakness of the US economy, especially for those concerned with equality, is the enormously skewed distribution of both wealth and income it exhibits. It is true that there has been some improvement over the last few years, but not nearly enough to make up for the impact of the years during, and surrounding, the Reagan presidency. About 20% of the population is hardly any better off now than it was in the early 1970s, while the average blue collar wage is still barely higher in real terms than it was in 1973. At the same time, the income of the top 5% of the population has risen over the last quarter of a century by more than 50% in real terms. Fourthly, reflecting the slow growth of blue collar wages, the US economy is very heavily dependent, compared to the rest of the world, on services, where productivity increases are exceptionally hard to achieve, as against manufacturing, where rising output per head is much easier to secure.

It is notoriously difficult to predict when any market will turn, but it seems very difficult to believe that a $400bn annual trade deficit is sustainable for any great further length of time. Apart from anything else, the returns required on $400bn of capital each year on their own generate a cumulative additional burden which becomes harder and harder to bear. At present, the US deficit is financeable because there are large pools of savings in the world, particularly in Japan, which are short of destinations where the returns look anything like as good as they have recently been in the USA. As the scale of the US indebtedness to the rest of the world rises, however, and the inability of the USA to repay the money it is borrowing becomes increasingly apparent, the rising risk involved in financing the deficit is likely to put pressure on the value of the dollar. The authorities will then either have to raise interest rates and tighten monetary policy substantially to try to stave off a dollar devaluation, or they will have to allow the value of the dollar to fall, perhaps a long way, to bring the US current account back in balance. The first course of action would undoubtedly bring the US boom to an end. The second might not do so directly, but the impact on the rest of the world of the disappearance of the US balance of payments deficit - or even a big reduction in its scale - could itself have a major negative impact on world trade and growth, which could, in turn, have a significant knock on effect in the USA.

If the biggest weakness of the US economy is its current account deficit - even though it is largely responsible for the prosperity of much of the rest of the world - how has this been allowed to come about? The main reason why this has occurred lies in the collapse of US manufacturing competitiveness. Like most industrialised economies, about 60% of all US foreign trade is in manufactured goods, with about 25% in services and the remainder in raw materials and re-exports. Until the early 1970s the US had a surplus in trade in manufactured goods, but since then the gap has widened dramatically, until in 1999 the deficit had reached $271bn per annum, representing 3.0% of US GDP, and 82% of the entire US trade deficit. Although what is left of US manufacturing exhibits generally high levels of productivity, this advantage is offset by the fact that the cost base in the USA, reflecting the strong dollar, is much too high to allow vast swathes of the goods which consumers want to buy to be made in the USA. This is why, for example, almost every toy sold in America shops is made in China.

Over recent years, much of the outline of US policy has been reflected in the UK. As a result, the British economy now exhibits many of the characteristics of the US economy to a greater extent than it did previously. Although on a smaller scale, there is the same deteriorating balance of payments problem, as manufacturing has been neglected in favour of services, and the cost base has been kept well above average world levels by relatively high interest rates, low corporate and personal taxation, and the resulting strong pound. As in the USA, poor manufacturing performance, and a heavy concentration on services, has tended to polarise income and wealth distribution. Britain also shows the same relatively low levels of internal investment as are found in the US economy, probably presaging slower rates of growth in the medium term than the world average in both the USA and Britain, although the US has always had a propensity for higher returns on the investment it does undertake than most of the rest of the world achieves. Low rates of taxation in Britain, and a deregulated economy, have attracted inward investment to the UK, as have rather different circumstances in the USA, but in both cases the result has been that capital flows have helped sustain the value of the currency at well above the levels justified by trading performance. In both the USA and Britain, the power and interests of those involved in financial services are now significantly greater than those engaged in most other parts of the economy, especially manufacturing.

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