Astonishing US figures pose fresh questions for us on limits to growth
ON labour markets and expansion
Tuesday 27 January 1998
It is important for us here, too, to try to understand because the two economies are now sufficiently close in the way they are structured that what happens in America gives an indication of what will happen here. When the long American boom ends, expect things to slow down pretty rapidly here. While it continues, we are probably OK.
The figure which stunned me was an estimate for fourth-quarter GNP in the US of 4.7 per cent annual rate. The actual number does not come out until Friday, but let's assume the estimate (from JP Morgan) is reasonably close. If it is, then the world's largest economy, after seven years of uninterrupted growth, has managed to put on a spurt which will have made it about the fastest-growing economy in the world. Maybe Ireland did a bit better, but I think it is unlikely that any of the East Asian economies will have turned out a performance like that. For the year as a whole growth is going to be close to 4 per cent.
Now add in another factor. It is widely believed that the US measure of inflation overstates the figure: the Boskin Commission reckoned that the consumer price index overstated inflation by about 1 per cent. (The reasons, which are to some extent common to inflation indices in other countries, include the failure of indices to allow for improvements in quality, and the way people shift both their product purchases and shipping habits in response to price shifts.)
If this is right, and if to some extent the GDP price deflator (the widest measure of inflation) includes some of the bias of the consumer price index, then US GDP is actually higher than the figures suggest. You see, if prices are overstated, real output growth is under-recorded. The economics team at ABN Amro Hoare Govett, which recently drew attention to this possible glitch in the figures, reckons that both the absolute level of output and the trend rate of growth in the US may well have been higher than the figures suggest.
So these pretty astonishing growth figures for the US may actually understate what has been happening. The economy may have been growing even faster than the figures show. If this is true for the US, it may also be true for the UK, though I have not seen a detailed study of the UK figures to confirm that it is. We can, however, be pretty sure that if there is any bias in the UK figures, they also will be understating GDP growth rather than overstating it.
The next question is whether this bias means that the expansion can carry on longer than was previously thought. The answer, probably, is no. Though the capacity of the economy may be greater than was previously thought, the level of activity is greater too. So rising demand meets limits of capacity at a higher level, but it still meets them - unless we are also measuring capacity wrongly. This raises perhaps the most interesting question of all: to what extent has capacity become more elastic?
The graph shows both the falling inflation rate in America, now back to the levels of the 1960s, and the conventional measure of capacity utilisation. The latter is quite high, but not grossly so. Indeed, it is way below the peaks it reached in all the previous cycles. Maybe there is some slack after all.
I cannot pretend to know how many more months or years the US economy can sustain steady non-inflationary growth. What I think we can all learn from the present US experience is that open, service-oriented economies do not hit capacity restraints in the same sudden way as closed, manufacturing- oriented ones. You can import manufactured goods if there is the demand for them, so the main indicator of shortage of capacity is on the trade account. And the lead time for increase the output of services is, in general, lower than the lead time for increasing the capacity of manufactured products.
The ultimate capacity shortage, though, is labour. Sure, a country can sometimes import labour though immigration, but this takes time. A country can sometimes outsource labour-intensive aspects of both manufacturing and services by getting the activities done abroad. A tight labour market also encourages companies to push through productivity improvements which they might otherwise hesitate about. But ultimately you get to the stage where the people simply are not available.
The question - and I think this is the absolutely crucial one in determining how long the present expansion both in the US and UK can continue - is: How tight are our labour markets?
Headline unemployment in both the US and UK is around 5 per cent. To anyone writing five years ago that would have seemed almost impossibly low; to anyone 100 years ago that would have seemed pretty normal; and to anyone 40 years ago it would have seemed terribly high. What is normality now?
Well, we won't know until we get there but I suspect it may be possible to run both the US and UK economies at unemployment rates even lower than they are at present without any great wage inflation.
Ask this question: Does the UK economy feel as though it is suffering from serious labour shortages? Yes, there are some shortages in particular areas, and these are often being filled by migrants from other EU countries, particularly in London. But most people are still pretty insecure in their jobs, and there seems little general pressure to bid up wages. So maybe the expansion can continue for a while yet.
So try to ignore the obvious questions that will arise from President Clinton's State of the Union message today, and ponder instead the state of the US economy. Can it go on growing without a surge in inflation? And if so, can we?
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