This chapter is in two parts. The first part contains discussion of the current situation and a short-term forecast to end-1987. The second part looks at the medium term, beginning with an analysis of probable trends in public expenditure over the next five years. The medium-term outlook for the rest of the world is discussed in chapter II.

More recent information confirms the impression which we formed in August about the course of output in the OECD area in the first half of the year. In the exceptionally severe weather experienced in parts of North America and Western Europe in the first quarter GDP was barely higher than it had been in the final quarter of 1984, and the second brought only a modest rebound. In the first half-year output increased at an annual rate of little more than 2 per cent, compared with about 3½ per cent for the previous six months. Slower growth in the US and stagnation of output in France and Germany were largely responsible.

Given the depressing effect of the gradual decline in oil production and the slow progress in manufacturing, in contrast to the faster growth of services, the importance of production industries in the economy will be lower by the end of the decade. Estimates based on volume changes alone, disregarding the future course of relative prices, indicate that ‘de-industrialisation’ appears to be continuing. This is not especially a British phenomenon and may be experienced by many industrial countries. It is more important for the UK, however, because falling oil production poses a considerable threat to the balance of payments. Manufacturing ought to play a decisive part in filling the gap and its revitalisation in the coming years is of paramount importance. In this context we are in agreement with the recent Select Committee Report which found the implications of the growing trade deficit in manufactured goods ‘most serious’ and ‘the need for change urgent’.

This article summarises research on the role of forward-looking behaviour in important sectors of a macro-econometric model. It is based on the work of a number of researchers at the National Institute over the last two years. Important changes are introduced into many central equations in the model We argue that on grounds of both the underlying theory and the plausibility of the empirical results, this work is a significant advance in explaining dynamic macro-economic behaviour.

This time last year we published in the Review an article comparing macroeconomic policy in Britain and France. That article and the present one are both based on a three-year project in which we compare events and policies in Britain with those in the other major European countries.