Hamish McRae: Here's hoping that Britain's economy has the capacity to keep boosting output for some time to come

Economic View: Not only is headline unemployment coming down but vacancy rates are rising

How much spare capacity is there in the economy? Or put another way, how swiftly can the economy grow without overheating?

It is a debate that is currently absorbing the Bank of England's Monetary Policy Committee (MPC), for the obvious reason that the closer we are to full capacity the sooner interest rates will have to be raised.

There are, as we see in the MPC minutes, a range of views. But there is a wider point here about the pace, nature and sustainability of the present expansion, for our economy now is structurally quite different from what it was a decade ago. Indeed it may be that we have an asset-price problem rather than a capacity problem.

The best place to start is to look at the puzzle over the size of the economy now. Employment (including self-employment) has boomed. Consumption has been strong. Yet GDP as officially measured is still a bit short of its previous peak, at least if you include the falling output of North Sea oil. The standard response to this is to say there must have been a decline in productivity, and to wonder whether as output rises productivity will pick up. But suppose GDP is wrong, not just a bit wrong but completely wrong.

There was a really interesting paper a couple of weeks ago, picked up by my colleague Russell Lynch in the London Evening Standard, from Morgan Stanley and written by its economic consultant, Charles Goodhart. The main thrust of his argument was about the rise in self-employment (an issue which is tackled today by Ben Chu on page 58), but almost as an aside he noted that there may have been a rapid increase in the size of the cash economy, which might have risen from around 12 per cent of the official economy in 2007 to 16-17 per cent now. We are under-counting the economy by 4-5 per cent, and that is just as likely to be an underestimate as an overestimate.

There are various bits of corroborating evidence, of which the one I find most convincing is the surge in the amount of cash in the economy relative to GDP since VAT went up to 20 per cent. You can see this in the first graph.

The amount of cash had been gradually falling through the 1980s as credit cards replaced folding money. But the recent increase is quite remarkable – and puzzling. Did you know that there is roughly £2,000 in cash floating about for every man, women and child in the country? Of course there is some in shop tills and bank cash machines, so it is not all in our wallets and purses, but that is still a huge amount. So much for the cashless society.

If this is roughly right – and I would trust Mr Goodhart's judgement – a lot is explained. There is still a big shortfall as to where GDP would have been had growth continued as before, and this is still a relatively disappointing recovery. But the higher GDP figure would square more with the employment numbers, consumption, hours worked and so on. Productivity growth has been poor, but not dreadful.

You can catch a slightly different element of the answer to "why is consumption so strong?" from the second graph, which comes from Coutts and shows the squeeze on wages, but also how total real disposable income has performed much better than wages. It shows there has been much less of an earnings squeeze than a wage squeeze. There are a number of reasons for this, including the fact that more people have gone out to work.

Now let's turn to the question about the amount of spare capacity. There is little doubt that the labour market is tightening. Not only is headline unemployment coming down but vacancy rates are rising and are now above their long-term average. You would expect wage rates to start climbing pretty soon, but this improvement has been running for some months and there has been zero movement in pay. So it may be that the combination of being able to attract workers from the rest of Europe and our very flexible labour market will be able to adjust to meet the additional demand.

That is the key. Our labour market is quite different from what it was 10 years ago: many more part-timers, many more self-employed, many more people with two jobs, many more workers beyond the normal retirement age. So it may be that companies will figure out ways of increasing output without adding disproportionately to their fixed costs.

The principal tool they have available is technology, which has made matching labour to demand much easier. Service industries are learning all the time to use their capacity more efficiently. The prime example is the way airline seats are priced so that they generate some revenue even in slack times.

While we all know about the zero-hours contracts, a lesser-known example is the way service industries fine-tune their demand for labour, using technology to predict more accurately how many shifts they need to add at any particular time.

A further flexibility in the labour market is the growth of teleworking, for anyone at home has as good a kit, maybe better, than he or she would have in the office.

We think of investment as something that companies do, but individuals who have put in super-fast broadband have in fact invested in productive equipment. As demand picks up, expect to see a host of innovative ways to increase output without adding to costs.

All this may seem wishful thinking and in a way it is. Since this is the first strong expansion to occur for the best part of a decade, we simply don't know how the economy will respond to it.

Anecdotal evidence would suggest that quite a lot of people who are doing some work at the moment feel they are somewhat under-employed, but if that is right then it should be easy to boost output for quite a long time.

Instinctively I feel that is right, but let's hope so – and watch the evidence very closely.

News
Russell Brand was in typically combative form during his promotional interview with Newsnight's Evan Davis
peopleReports that Brand could stand for Mayor on an 'anti-politics' ticket
News
The clocks go forward an hour at 1am on Sunday 30 March
news
Arts and Entertainment
The Doctor finds himself in a forest version of London in Doctor Who episode 'In the Forest of the Night'
TVReview: Is the Doctor ever going stop frowning? Apparently not.
News
Voluminous silk drawers were worn by Queen Victoria
newsThe silk underwear is part of a growing trade in celebrity smalls
PROMOTED VIDEO
Sport
footballMatch report: Real fight back to ruin Argentinian's debut
News
Candidates with surnames that start with an A have an electoral advantage
newsVoters are biased towards names with letters near start of alphabet
Arts and Entertainment
Isis with Lord Grantham (Hugh Bonneville)
TV
Arts and Entertainment
Jay James
TVReview: Performances were stale and cheesier than a chunk of Blue Stilton left out for a month
News
ebooksAn unforgettable anthology of contemporary reportage
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Compensation and Benefits Manager - Brentwood - Circa £60,000

£60000 per annum: Ashdown Group: Compensation and Benefits Manager - Compensat...

Data Analyst/Planning and Performance – Surrey – Up to £35k

£30000 - £35000 Per Annum plus excellent benefits: Clearwater People Solutions...

IT Systems Business Analyst - Watford - £28k + bonus + benefits

£24000 - £28000 per annum + bonus & benefits: Ashdown Group: IT Business Syste...

Markit EDM (CADIS) Developer

£50000 - £90000 per annum + benefits: Ampersand Consulting LLP: Markit EDM (CA...

Day In a Page

Wilko Johnson, now the bad news: musician splits with manager after police investigate assault claims

Wilko Johnson, now the bad news

Former Dr Feelgood splits with manager after police investigate assault claims
Mark Udall: The Democrat Senator with a fight on his hands ahead of the US midterm elections

Mark Udall: The Democrat Senator with a fight on his hands

The Senator for Colorado is for gay rights, for abortion rights – and in the Republicans’ sights as they threaten to take control of the Senate next month
New discoveries show more contact between far-flung prehistoric humans than had been thought

New discoveries show more contact between far-flung prehistoric humans than had been thought

Evidence found of contact between Easter Islanders and South America
Cerys Matthews reveals how her uncle taped 150 interviews for a biography of Dylan Thomas

Cerys Matthews on Dylan Thomas

The singer reveals how her uncle taped 150 interviews for a biography of the famous Welsh poet
DIY is not fun and we've finally realised this as a nation

Homebase closures: 'DIY is not fun'

Homebase has announced the closure of one in four of its stores. Nick Harding, who never did know his awl from his elbow, is glad to see the back of DIY
The Battle of the Five Armies: Air New Zealand releases new Hobbit-inspired in-flight video

Air New Zealand's wizard in-flight video

The airline has released a new Hobbit-inspired clip dubbed "The most epic safety video ever made"
Pumpkin spice is the flavour of the month - but can you stomach the sweetness?

Pumpkin spice is the flavour of the month

The combination of cinnamon, clove, nutmeg (and no actual pumpkin), now flavours everything from lattes to cream cheese in the US
11 best sonic skincare brushes

11 best sonic skincare brushes

Forget the flannel - take skincare to the next level by using your favourite cleanser with a sonic facial brush
Paul Scholes column: I'm not worried about Manchester United's defence - Chelsea test can be the making of Phil Jones and Marcos Rojo

Paul Scholes column

I'm not worried about Manchester United's defence - Chelsea test can be the making of Jones and Rojo
Frank Warren: Boxing has its problems but in all my time I've never seen a crooked fight

Frank Warren: Boxing has its problems but in all my time I've never seen a crooked fight

While other sports are stalked by corruption, we are an easy target for the critics
Jamie Roberts exclusive interview: 'I'm a man of my word – I'll stay in Paris'

Jamie Roberts: 'I'm a man of my word – I'll stay in Paris'

Wales centre says he’s not coming home but is looking to establish himself at Racing Métro
How could three tourists have been battered within an inch of their lives by a burglar in a plush London hotel?

A crime that reveals London's dark heart

How could three tourists have been battered within an inch of their lives by a burglar in a plush London hotel?
Meet 'Porridge' and 'Vampire': Chinese state TV is offering advice for citizens picking a Western moniker

Lost in translation: Western monikers

Chinese state TV is offering advice for citizens picking a Western moniker. Simon Usborne, who met a 'Porridge' and a 'Vampire' while in China, can see the problem
Handy hacks that make life easier: New book reveals how to rid your inbox of spam, protect your passwords and amplify your iPhone

Handy hacks that make life easier

New book reveals how to rid your email inbox of spam, protect your passwords and amplify your iPhone with a loo-roll
KidZania lets children try their hands at being a firefighter, doctor or factory worker for the day

KidZania: It's a small world

The new 'educational entertainment experience' in London's Shepherd's Bush will allow children to try out the jobs that are usually undertaken by adults, including firefighter, doctor or factory worker