Like the US earlier this year, the UK may need a recession to get its overheated economy into better balance

Towards the end of the 20th century, there grew up in British university departments of politics a subject devoted to relative UK economic decline. No sooner had the subject become established than it became out of date. Today, the topic of discussion is not why the UK is declining, but why it seems to be doing better in the current world recession than most of its trading partners. The Organisation for Economic Co-operation and Development's latest Outlook shows UK growth declining less than that of the rest of the European Union or the US.

The proximate reason is that consumer spending is expected to rise much faster in Britain. The surprising aspect is that this is taking place against the background of a real exchange rate that appears quite as overvalued as it was in the last two recessions.

One possible explanation is that just as "irrational exuberance" has previously affected Wall Street, it now affects the UK consumer. Another is that manufacturing has declined so much as a proportion of economic activity that a slump in this sector can be combined with overall economic growth.

There is, indeed, evidence that the British economy has been overheating. Casual signs are provided by the impossibly congested streets in central London shopping districts so early before Christmas. More highbrow evidence is provided by the fact that unemployment is below the equilibrium rate estimated in the Treasury's own new guide to macro-economic policy ("Reforming Britain's Economic and Financial Policy").

In between come various tell-tale signs of repressed inflation, such as the extreme difficulty of recruiting teachers or health service personnel. It is only government control that prevents wages soaring in this sector; and in the private sector demand has been siphoned into imports. Just as the US probably needed a recession a few months ago to get its economy into better balance, so may the UK today; and despite the muted optimism of official forecasters, it will most likely get one.

These are, however, short-term issues. On a longer perspective, the UK grew at a faster rate than the Group of Seven industrial countries in almost every year from 1993 up to and including 1997. In the following three years it grew slightly more slowly. It would be silly to seek party political points here. In the earlier period, British growth reflected the economic slack that had been created during the country's unsuccessful membership of the Exchange Rate Mechanism in 1990-92. In 1998-2000 the drift into work of less qualified and experienced people as unemployment fell may have slowed productivity.

We are still discussing relatively small variations. It is no accident that the combination of more or less stable growth and low inflation coincided with the abandonment of intermediate targets such as the money supply or the exchange rate. But Anatole Kaletsky of The Times, who always emphasises these factors, overlooks the fact that the UK did not just go back to old-fashioned command management but has had since 1992 a "nominal anchor" in the shape of an inflation target that gained in credibility when the Bank of England was granted operational independence by Labour.

There is, however, more to economic performance than stability. A good overall survey of underlying trends comes from a paper given by Professor Stephen Nickell and Glenda Quintino at the British Association on September 4 ("The Recent Performance of the UK Labour Market").

They celebrate a continuing decline in unemployment "down to its lowest level for a generation without excessive inflationary pressure". They infer that equilibrium unemployment has been declining since the mid-1980s - equilibrium unemployment being the rate consistent with stable inflation and a sustainable overseas payments balance.

Prof Nickell attributes virtually all of this improvement to the lagged impact of three developments. First, the balance of power in wage bargaining has shifted as union coverage has declined and the unions have become far less adversarial.

Second, unemployment benefits declined over the same period and the benefits system became more focused on getting the unemployed back into work. Third, there was a small additional contribution from a decline in taxes on employment.

Nobody could accuse Prof Nickell (who sits on the monetary policy committee) of anti-Labour bias. Yet he remarks that "these changes were, of course, initiated long before the present government came to power in 1997". He also discusses the "significant" increase in the financial burdens on UK business of new regulations. But he believes that their ultimate effect will be in reducing real take-home pay rather than in jobless levels.

He considers that Labour's New Deal has been successful in getting young people into work. In-work benefits have had only a small impact on employment but have been worthwhile for their effects in reducing child poverty.

Alas, there is one important fly in the ointment. If you look not at unemployment but at "inactivity", that is people of working age who are not unemployed but who are not seeking jobs either, there has been no improvement at all. The overall stability in UK inactivity rates covers a dramatic fall for women and a dramatic rise for men. Among unskilled men with no qualifications the inactivity rate has soared from 3.8 per cent in 1979 to 30 per cent last year. The majority of inactive men report as sick or disabled.

Prof Nickell believes the fundamental problem is the "large body of individuals of working age, who, because of lack of skills, do not command a high enough wage in the labour market to provide a decent standard of living for themselves and their dependants". The government has concentrated on improved training for the unskilled; but Prof Nickell does not expect that this will have a large effect "in the foreseeable future". Maybe we just have to live with the problem for the time being.

Looking further ahead, I am dubious about how much the emphasis on imparting high-technology skills will help. I share Professor Paul Krugman's only half-jocular remark that in a couple of decades information technology workers will be a drag on the market and that the real job opportunities will be in personal services ranging from gardening and cooking to domestic help. What the inactive really lack are not paper credentials but streetwise skills - and a belief that service jobs are not demeaning but well worthwhile.