Our forecasts, like those of the Treasury published in the Autumn Statement, are based on the assumption that oil prices will fall back next year, as the crisis in the Gulf is resolved. We describe briefly below what might be the consequences, for the world economy and for Britain, if oil prices were to be $45 a barrel for the foreseeable future, as might happen as a result of a long war.

In Chapter I our main forecasts assume the continuation of existing economic policies, which we interpret as being consistent with a gradual move towards economic and monetary union. In Chapter III we consider some of the alternative policy options which might be considered if the Labour Party wins the next election.

The decision to join the exchange-rate mechanism had been expected, with increasing confidence, for several years. Nevertheless the actual announcement on 5th October came as something of a surprise. Up to that point the authorities, both the Bank of England and the Treasury, had been encouraging the view that interest rates should be kept high for the foreseeable future so as to cut back the growth of domestic demand and to curb inflation. Joining the ERM implies that interest rates must be set mainly with a view to the foreign exchange market and are no longer fully available as an instrument to control the domestic economy. The decision to join the ERM in October, and the associated 1 percentage point cut in interest rates were probably the result of a reassessment of the state of the economy—as well as being a move in the complex game of European and domestic politics.

Our last forecast, which was published in August, was moderately optimistic about prospects for the world economy, and especially for the United States. Since the summer the Yen has risen strongly, the US has begun to look like it is facing a recession, and it is now clear that the united Germany will face a very large Government budget deficit after monetary and political union. Meanwhile prospects for war in the Gulf remain high, and although EC farm ministers have managed to agree amongst themselves about cuts in agricultural subsidies it is not clear that these cuts are large enough either to prevent the GATT round stalling or stop the US erecting trade barriers in retaliation. As a result of all these factors our forecast is hedged around with rather more uncertainties than usual. Table 1 sets out our short-term forecast. We assume that oil prices will peak at $35 pb in the last quarter of 1990, and will then fall to $28 pb by the end of 1991.

Our forecasts for the domestic economy in Chapter I assume the continuation of present economic policies, and hence implicitly that the Conservatives are returned to power at the next General Election. Here we look at some of the changes in policy which might follow a Labour victory. As yet, relatively few firm commitments have been made by the Labour Party, so we cannot make any overall assessment of their plans. Instead we consider a range of options based on the general statements of objectives which have been made. The aims and priorities of a Labour Government would differ somewhat from those of the present Government; and a Labour Government would consider a wider range of options for policy change, including some that have been ruled out explicitly by government in recent years.

Macroeconomic performance in Europe was generally agreed to have been poor in the 1970s, with high inflation and low growth. The 1980s saw a significant improvement, with inflation being reduced to under 5 per cent by the end of the decade, and growth reaching some sort of peak in 1989. There were many factors contributing to this improved performance, and the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) has been given much of the credit. The ERM was supposed to have given the monetary authorities in France and Italy increased anti-inflationary credibility. Their decision to link their exchange rates to the D-Mark involved a commitment to follow German monetary policy and hence involved taking on German anti-inflationary credibility.

The happy outcome which is looked for in closer economic integration in the world is that all countries gain. This is particularly clear for a general removal of trade barriers, such as those indicated for the whole range of products by Stoeckel et al. (1990) or for individual products, such as the ending of the Multifibre Arrangement explored by Trela and Whalley (1990). Here those who have been protecting their industries gain because the losses to producers are more than offset by the gains to consumers, those who have been discriminated against in the past gain because they can increase their exports and those foreign countries which were previously benefiting from privileged access to the protected markets gain because their loss of market share is more than offset by an expansion in the market.

North American, and in particular US views of 1992 must be seen in the broad political context of transatlantic relations. The US has shown consistent support for the idea of European integration. Initially this took the form of linking Marshall aid to greater European economic cooperation, then organised by the Organisation for European Economic Cooperation (OEEC). There was also strong political support for Monnet's supranational approach to European integration as a means of helping to bring about Franco-German reconciliation and to stabilise Europe. In the early days of European integration there were strategic and political reasons for American concerns to see a stronger (Western) Europe. The possible adverse effects of economic integration for the US were seen as more than manageable, given the strength of the US economy in relation to those of the European countries. With the promise of enhanced markets for US exports and US production the creation of the EEC was seen as being trade creating rather than trade diverting.

The completion of the European Community's internal market will be achieved through the removal of a host of non-tariff barriers to trade and the mobility of factors of production and the liberalisation of the conditions for the provision of service activities inside the single market. This completion of the European Community's internal market will enhance the locational advantages of European markets.

ASEAN, the Association of South East Asian Nations, comprises the fastest growing countries of the world economy. Apart from including the only NIE (newly industrialising economy), not having encountered domestic political or social growth constraints—Singapore, with 11 per cent real growth in 1988, 9.2 per cent in 1989 and 10 per cent, first quarter 1990—it consists of recent record holder Thailand (with growth rates above 10 per cent for three years), Malaysia (growth in the 7 per cent—9 per cent range), Indonesia (recent growth 6–7 per cent), Philippines (oscillating growth due to internal instability) and Brunei (an oil-exporting sultanate). The ASEAN countries do not owe their growth to the integration of ASEAN countries into a free trade area, a customs union or a common market. Intra-group trade liberalisation and economic cooperation are still modest. These growth marvels owe their performance to exports, especially to the OECD countries. The quality and very high growth rates of exports were and still are fostered by foreign investment and imports of intermediate inputs from the target markets.

The European Community is an important trade partner for Australia and New Zealand taking 15 per cent of Australian exports and 18.5 per cent of New Zealand exports, while supplying 23.5 per cent and 18 per cent respectively of their imports. However, there has been a dramatic transformation during the 1950s, 60s and 70s away from the UK as the dominant partner (tables 1 and 2) especially in the case of New Zealand where the UK's share of exports went from 66 per cent in 1950 to 13 per cent in 1980.