Stuff of dreams
Friday 23 April 1993
But first, some explanation. Most economists did not expect unemployment to turn until the autumn, maybe even early next year. The reason was partly that unemployment has always been a lagging indicator, usually turning a year or more after the economy, and partly that their growth forecasts this year were for the economy to grow below productive potential - at 1.5 per cent against potential of perhaps 2.5 per cent. Besides, the last recesssion in the early 1980s saw unemployment rising for the first three years of the recovery.
In fact that experience has helped throw expectations this time. In the early 1980s there was a surge of young people hitting the job market. Now the flow is much reduced, partly because of the fall in the birth rate in the middle 1970s, partly because the proportion of students staying on for higher education has doubled over the past 10 years. Even if these falls are not sustained this summer, the fundamental demographic factors are much more favourable than they were last time round.
But demography won't account for the suddenness of the falls, after quite sharp rises. If the turn has really taken place, then there are two important conclusions: the economy is growing much faster than present forecasts suggest; and our labour market has become much more flexible than it was in the past.
On the first there is not much more that can sensibly be said. At the time of the Budget the Treasury thought that the economy was probably expanding faster than it was prepared to admit in its forecasts, and expected City analysts to be upgrading their own estimates in the months ahead. But there are dreadful problems for Britain's EC partners, in particular Germany, which the latest cut in DM rates will by no means solve. That will restrict export demand well into 1994.
One new point to be made, though, is that unusually this looks like being an investment-led recovery. In past cycles, investment has lagged the cycle, because industrialists tend to wait until their factories are running flat out before putting on new capacity. As a result the new plant frequently comes on stream just as demand is turning down, thereby exacerbating the cycle. Look at the cut in investment being made by the German companies now.
But in Britain, like the US, there is an investment boom in computers. Companies do not need new production lines. What they need is better control of the production of goods and, more importantly, services. Result: UK output of computers, information processing equipment and other similar goods is running 18 per cent up year-on-year. This sort of equipment is much quicker and easier to put in place than the production lines of old. It is used to cut costs, rather than boost production, so therefore logically would go in at an earlier stage of the cycle.
The other similarity with the US is in the speed of response of the labour market to shifts in the economy. Several things may be happening here. For a start, both economies are dominated by services. True, the difference between them and, say, Japan or Germany, is only a few percentage points of GDP - all so- called industrial economies are really service economies - but the difference may be enough to explain why they create jobs more quickly. A shop can immediately meet a rise in demand by hiring more staff; a company boosting production will take longer to organise itself.
In any case, manufacturing may also be becoming more nimble. It no longer hoards labour (except in Japan and to some extent Germany), so when demand turns it needs to recruit more quickly. Stocks are proportionately much lower than they were 10 years ago, so a rise in demand cannot be met from that source.
All this suggests that the UK labour market has become much more like the US's. It is certainly unlike Continental markets, where shedding labour is much more expensive and employing people involves large social security charges. If this is right, two or three years from now the UK could have US-levels of unemployment, instead of Continental ones, which will put a quite different perspective on EC labour legislation. Given British skill levels there will still be a structural unemployment problem, but it might look quite manageable by the standards of Continental Europe.
So we are beginning a test. If the supply-side improvements made to the economy in the 1980s are intact, then we could be set on a more easily sustainable recovery (as well as a more rapid one) than anyone dared to forecast even a few weeks ago. It is just possible, too, that rapid recovery will correct the Government's fiscal deficit much more quickly than the Budget forecasts predicted. If, on the other hand, the ferocity of the recession has really damaged the productive potential of the economy, then we will, in a couple of years, be held back by balance of payments and capacity restraints. But, meanwhile, these two falls in unemployment should make the gloom-mongers a little less shrill.
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