It is always comforting to economy-watchers when something you think intuitively ought to be happening has in fact started to do so. We are just starting to get two pieces of evidence which suggest the recovery may be able to carry on longer without hitting capacity restraints and pushing up inflation. The evidence is, to be fair, pretty thin, but if it is right it is hugely encouraging. The longer the recovery can be sustained, the more manageable potential worries like the size of the public sector deficit become.
The first bit of evidence concerns investment, the second wages. Let's start with investment. In previous economic businesses have tended to invest at the wrong time: they would wait until the factories were running at full tilt or they needed more office space, then start planning. The result was usually that the factory would be ready just in time for the next downturn and the office blocks would sit empty for the next five years.
In the present cycle, however, they seem to have wised up: instead of increasing their investment at the wrong time they have not increased it at all. Result: pessimistic predictions that the economy will run into capacity constraints, inflation will start to rise and so on.
There has, however, been an optimist's response to this, which is to say that the nature of investment in a predominately service economy is quite different from a predominantly manufacturing one. Investment in service industries, which one exception, is largely in intangibles, things which are difficult to pick up in the formal investment figures, like staff training, development of human capital, new work practices which may make more use of existing equipment, and so on. Even in manufacturing, investment now is qualitatively very different from investment 20 years ago. Things are smaller (power stations are a good example) and the lead times are much shorter.
The exception is IT. Services are IT hungry. Look at one of the great boom areas in services, the growth of over-the-telephone insurance and banking. These are easy to set up in that the technology is available off-the-peg and the know-how is established. But the electronic kit is expensive. So you would expect service industry investment to be rising, even if manufacturing investment was not.
That does now seem to be happening. Some work by the economic team at Kleinwort Benson shows the extent to which service industry investment has picked up in the last year. On the left-hand graph can be seen the familiar tale of depressed manufacturing and construction investment right through the recovery, and a surge in investment by the privatised public utilities (much of which probably represented a catch-up after years of under-investment). For the first part of the recovery, service industry investment was stagnant, but since the trough at the beginning of 1993 it has been climbing steadily. Compared with manufacturing, where investment has been rather weak, it has shot up, as the right-hand graph shows.
The Kleinwort team believes we are on the verge of an investment boom, which I suppose on past performance is a bit of a sell signal: as soon as the investment boom is truly under way you can be sure the next recession is not far behind. But whether we are or not, it seems a reasonable proposition that investment in the service side of the economy will not be a serious constraint. And, of course, the service side is the motor of growth.
The other encouraging factor is pay. The issue here is at what level of unemployment do labour shortages become serious and wage rates accordingly soar. Last week, Alan Greenspan noted that the sense of insecurity in the US was helping to hold down pay rises, but at some stage tightness in the labour market will impact on pay. JP Morgan is forecasting that US unemployment, at present 5.4 per cent, will fall to 4.8 per cent this summer.
We surely have some of the same forces at work here. The economics team at HSBC markets have looked at expectations for wages growth each year for the past four years and point out that every year pay has turned out lower than forecast. This year, they believe, will be no exception. They argue that, while conventional indicators suggest that wages ought to rise faster, there are several reasons why they probably will not.
These include: the fact that wages are already growing at 4.25 per cent in the year to December, which is delivering a decent real wage increase; headline inflation turning out at 2.75 per cent, well below the consensus; pressure on exporters from higher sterling which will encourage them to hold down wages; and determination by the new government to hold down pay in its first year. Their conclusion: pay this year rising at 4.25 per cent, the same as last year.
The evidence for this second encouraging thought is thin. But it feels right. Insecurity, for all its unpleasantness, does carry economic benefits. Indeed, the only justification for it is if it really enables the country to run at a much lower level of unemployment than would otherwise be the case. Looking ahead, a change of government may increase the sense of insecurity, rather than diminish it, though do not expect that to be in the New Labour manifesto.
It is important to remember just how wrong people have been in reading this recovery. Most economists thought the devaluation of sterling would result in rapid inflation. It didn't. Most expected a long lag between the first signs of growth and the first falls in unemployment. There wasn't. Most expected the current account deficit to widen as the recovery got under way. It narrowed.
And now most expect the recovery soon to hit constraints in capacity and in the labour market. Maybe they will be wrong yet again.Reuse content