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.

PROMOTED VIDEO
News
video
Life and Style
tech
Sport
Jodie Stimpson crosses the finishing line to win gold in the women's triathlon
Commonwealth games
Arts and Entertainment
While many films were released, few managed to match the success of James Bond blockbuster 'Skyfall'
film
News
John Barrowman kisses his male “bride” at a mock Gretna Green during the Commonwealth Games opening ceremony
peopleBarrowman's opening ceremony message to Commonwealth countries where he would be sent to prison for being gay
Arts and Entertainment
Jamie Dornan stars as Christian Grey in the Fifty Shades of Grey movie
filmFirst look at Jamie Dornan in Fifty Shades of Grey trailor
Life and Style
Phillips Idowu, Stella McCartney and Jessica Ennis
fashionMcCartney to continue designing Team GB Olympics kit until 2016
News
ebookA unique anthology of reporting and analysis of a crucial period of history
Sport
Shinji Kagawa and Reece James celebrate after the latter scores in Manchester United's 7-0 victory over LA Galaxy
football
Sport
Farah returns to the track with something to prove
Commonwealth games
Voices
voicesGood for Lana Del Rey for helping kill that myth, writes Grace Dent
Life and Style
fashion Designs are part of feminist art project by a British student
Arts and Entertainment
The Tour de France peloton rides over a bridge on the Grinton Moor, Yorkshire, earlier this month
film
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

Junior Research Analyst - Recruitment Resourcer

£18000 - £20000 per annum + OTE £25K: SThree: SThree Group has been well estab...

Senior Analyst - Financial Modelling

competitive: Progressive Recruitment: This really is a fantastic chance to joi...

Associate CXL Consultant

£40000 - £60000 per annum + BONUS + BENEFITS: Harrington Starr: CXL, Triple Po...

Business Anaylst

£60000 - £75000 per annum + BONUS + BENEFITS: Harrington Starr: Business Anal...

Day In a Page

Screwing your way to the top? Good for Lana Del Rey for helping kill that myth

Screwing your way to the top?

Good for Lana Del Rey for helping kill that myth, says Grace Dent
Will the young Britons fighting in Syria be allowed to return home and resume their lives?

Will Britons fighting in Syria be able to resume their lives?

Tony Blair's Terrorism Act 2006 has made it an offence to take part in military action abroad with a "political, ideological, religious or racial motive"
Beyoncé poses as Rosie the Riveter, the wartime poster girl who became a feminist pin-up

Beyoncé poses as Rosie the Riveter

The wartime poster girl became the ultimate American symbol of female empowerment
The quest to find the perfect pair of earphones: Are custom, 3D printed earbuds the solution?

The quest to find the perfect pair of earphones

Earphones don't fit properly, offer mediocre audio quality and can even be painful. So the quest to design the perfect pair is music to Seth Stevenson's ears
US Army's shooting star: Lt-Col Steven Cole is the man Hollywood calls when it wants to borrow a tank or check a military uniform

Meet the US Army's shooting star

Lt-Col Steven Cole is the man Hollywood calls when it wants to borrow a tank or check a military uniform
Climate change threatens to make the antarctic fur seal extinct

Take a good look while you can

How climate change could wipe out this seal
Should emergency hospital weddings be made easier for the terminally ill?

Farewell, my lovely

Should emergency hospital weddings be made easier?
Man Booker Prize 2014 longlist: Crowdfunded novel nominated for first time

Crowdfunded novel nominated for Booker Prize

Paul Kingsnorth's 'The Wake' is in contention for the prestigious award
Vladimir Putin employs a full-time food taster to ensure his meals aren't poisoned

Vladimir Putin employs a full-time food taster

John Walsh salutes those brave souls who have, throughout history, put their knives on the line
Tour de France effect brings Hollywood blockbusters to Yorkshire

Tour de France effect brings Hollywood blockbusters to Yorkshire

A $25m thriller starring Sam Worthington to be made in God's Own Country
Will The Minerva Project - the first 'elite' American university to be launched in a century - change the face of higher learning?

Will The Minerva Project change the face of higher learning?

The university has no lecture halls, no debating societies, no sports teams and no fraternities. Instead, the 33 students who have made the cut at Minerva, will travel the world and change the face of higher learning
The 10 best pedicure products

Feet treat: 10 best pedicure products

Bags packed and all prepped for holidays, but feet in a state? Get them flip-flop-ready with our pick of the items for a DIY treatment
Commonwealth Games 2014: Great Scots! Planes and pipers welcome in Glasgow's Games

Commonwealth Games 2014

Great Scots! Planes and pipers welcome in Glasgow's Games
Jack Pitt-Brooke: Manchester City and Patrick Vieira make the right stand on racism

Jack Pitt-Brooke

Manchester City and Patrick Vieira make the right stand on racism
How Terry Newton tragedy made iron men seek help to tackle their psychological demons

How Newton tragedy made iron men seek help to tackle their psychological demons

Over a hundred rugby league players have contacted clinic to deal with mental challenges of game