Economics: British plants putting out hints of hope

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The Independent Online
IS IT for real, or is it another false dawn? Last week's indicators are, without a doubt, the most encouraging the Chancellor has had for a long time. The news was better than expected on inflation, manufacturing output and even unemployment. If the bushy-tailed optimists had not had their fur singed last year, they would be calling the bottom of the recession at last.

The latest figures show that there was a very small rise in manufacturing output in June, but the monthly numbers bounce around and are of little significance. The three-month comparison is more interesting: manufacturing is up by 0.4 per cent after a similar 0.4 per cent rise in the first quarter. The Central Statistical Office, which is nothing if not conservative, now estimates that there is an underlying trend rise in manufacturing output of 1 per cent a year.

Manufacturing represents only a quarter of the whole economy, so the recession is not over yet. But it is the most volatile part and was always expected to lead the recovery. This week's figures for gross domestic product may well show another small fall, but it will be caused by the 2 per cent drop in energy production due to maintenance work in the North Sea. The non-oil economy is the key for jobs, and it is likely to have risen for the first time since the second quarter of 1990.

Growth will have to speed up until it matches the growth of output per person before there is any rise in employment, but the number of jobs in the economy has been dropping more slowly. The average monthly rise in unemployment over the last six months was 24,400 in June, against 78,200 a year before. After three months of falling vacancies in the second quarter, they picked up again in July. Things may not be getting better yet, but at least they are getting worse more slowly.

The most impressive piece of good news, because it is the least likely to be called into question, is the collapse of inflation. I have been more optimistic about falling inflation than the consensus for some time, but the latest evidence is spectacular. Most analysts thought that it would be very hard to match last year's 0.2 per cent drop in prices in July with a similar fall this year. Therefore, the year-on-year inflation rate was likely to edge upwards even if prices remained flat. Instead, prices duly dropped by 0.4 per cent so that the annual inflation rate fell from 3.9 per cent to 3.7 per cent. Nor is this a freak: only half of the drop is due to seasonal foods. The figures mean that the Government will easily meet its 3.75 per cent inflation forecast in the fourth quarter.

The underlying trends in inflation also look good. Excluding mortgage rates, the inflation rate dropped from 4.8 per cent to 4.4 per cent. Factory gate prices slowed to 3.4 per cent in July, their lowest level in more than 20 years. Earnings growth is rapidly decelerating in line with the sharp fall in pay settlements to just over 4 per cent. The underlying rise in average earnings of 6 per cent over the year to June is lower than at any time since 1967.

Lower inflation need not of itself help growth. The gloomsters will no doubt point out that the Government cannot cut bank base rates until German interest rates come down if we are to maintain sterling within the exchange rate mechanism. So lower inflation merely raises real interest rates - interest rates after allowing for inflation - and hence the debt burden on many businesses. But that is not the end of the story, for lower inflation also raises real earnings for those in work. Even though earnings growth has been slowing down, the real rise over a year has stayed remarkably stable at around 2 per cent.

The second factor which must help output and jobs is increased competitiveness against our overseas rivals. The key sector here is manufacturing, simply because it is much easier to trade hedge-cutters than haircuts. With factory output per person rising by more than 4 per cent over the year to June, and low earnings growth, wage costs per unit of output rose by just 1.7 per cent. The equivalent German figure is running at just above 5 per cent. British manufacturers are gaining price competitiveness against their German counterparts without any devaluation of sterling.

There are, though, several caveats to any optimism. The most important remains the lack of business confidence. The latest Confederation of British Industry quarterly survey was completed in the first half of July, after the CSO figures for June manufacturing output were collected. It shows that overall business optimism fell back between April and July, and that expectations about output also declined. Most ominously, more firms thought their stocks were more than adequate. If their managers return from holiday to find costs running ahead of their anticipated sales, a new round of production cuts could occur.

The second caveat concerns sterling. The pound was weakening on Friday even though the dollar rebounded. If sterling falls much further, the Chancellor will have little option but to raise British interest rates, a move which would probably have dire effects on confidence.

The immediate trigger for renewed ERM turbulence could easily be Italy, as it was earlier this month. The apparent default on loans by Efim, the state holding company put into liquidation, raises the unpleasant spectre of a European debt crisis to match Latin America's in 1982. The financial markets' patience with Italy has already worn thin.

The third reason not to break out the champagne is debt: even if we are now crawling out of the recession, it is likely to be at such a snail's pace that many firms will hardly notice. Personal debt remains at historically high levels, and any small rise in retail sales volumes is not yet well established.

Moreover, the early stages of recovery are often the most dangerous for many companies. Their need for working capital rises, but they may still be making losses because of low levels of output. Like the Chancellor, they may be able to see land, but they are not there yet.

THE story by my colleague Chris Blackhurst on the scale of the legal costs faced by WPP during its recent restructuring will strike a chord with many people who brush with our learned friends. WPP has a particularly strong case because it is being asked to pick up a bill for which it has had no direct responsibility. Although paid by WPP, the legal costs were incurred by the banks, which have little interest in rationing their consumption of legal advice.

We would welcome other examples of soaring legal costs, since there are wider issues in the provision of legal services to business that the Office of Fair Trading should also investigate. Legal costs and delays are becoming a serious economic issue. Many business people have the impression that the whole process of settling disputes is becoming slower and more tendentious. Arbitration clauses in agreements may be one solution. But another could be a little more haste and competition in the legal system.

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