It feels bad now, but it looked good then

A flurry of economic indicators in the last few days have confirmed that the economy has shifted gear. The main trends are beginning to look oddly reminiscent of an earlier era, suggests Paul Wallace
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The Independent Online
With fireworks, poppies and parades, Britain commemorated the end of the war last week. But 50 years on, the British economy is starting to resemble the economy that emerged after the war in some remarkable respects.

The 1950s delivered an enviable mix of low inflation, interest rates, unemployment and mild economic cycles. The mid-1990s are also turning out to be a period of low inflation and interest rates. The big difference is in unemployment, which at more than 2 million remains wretchedly high. The jury is still out on whether we are on course for a more stable economy after the boom-and-bust cycle of the past 15 years.

As recently as this spring, boom and bust seemed alive and well. A resurgence in inflation was expected as the economy continued to expand strongly, following the 4 per cent growth chalked up in 1994. This was seen as sure to precipitate an unwelcome rise in interest rates.

Three months on, most economic forecasters have revised their expectations. They are responding to the accumulating evidence that the economy has changed down a gear to a lower rate of both growth and inflation. Like confetti on a summer wedding, a flurry of figures in the past few days have put the seal on this new perception of where the economy is heading.

Official figures this week showed that the economy grew by 0.5 per cent in the second quarter of the year compared with the first quarter - equivalent to an annual rate of 2 per cent, below the underlying rate of growth of 2.5 per cent.

This followed inflation and employment figures released last week, which painted a more encouraging picture on inflation but a more discouraging one on unemployment. The inflation rate had been expected to rise to 3.7 per cent. Instead it stayed put at 3.5 per cent, helped by the biggest July drop in clothing and footwear prices this century. This raised hopes that retailers would be able to continue absorbing the cost pressures from manufacturers hit by last year's rise in commodity prices and the 5 per cent decline in sterling in the first half of the year.

In the long run, labour costs are the principal motor of inflation. So the prospects for inflation also took a distinct turn for the better when the latest figures showed how subdued pay pressures in the economy have continued to be. Earnings had been thought to be rising at 3.75 per cent and there was some concern they might accelerate still higher before too long. Instead, the latest figures for both May and June showed they had fallen back to 3.5 per cent.

The downside to the rosier picture on inflation was the fact that unemployment rose in July for the first time in two years. This raised the fear that the decline in the jobless total might now have come to a halt, suggesting that unemployment would fall no lower than 2.3 million in the current recovery, even higher than the previous low point of 1.6 million achieved after the boom of the 1980s.

Small wonder that Andrew Smith, Labour's Treasury spokesman, seized upon the figures, saying that they "exploded the complacency of Conservative claims that the economy was healthy". Party rhetoric? Yes, but there was more to it than that.

After the most protracted recession since the war, there was a lot of ground to be made up once recovery got under way in spring 1992. That implied the economy should grow well above its "trend" rate of growth - generally estimated at 2.5 per cent - for some years. So it is undoubtedly a disappointment that after only two years of above-trend growth, the economy has again dipped below its underlying rate of expansion.

Worse still, there is a distinct danger that there could be a further relapse in the next few months. Firms built up extra stocks in the second quarter of the year and are expected to run these down, which could trigger a further slowing in growth. This is not just alarmist talk: the Bank of England warned at the beginning of August that the main danger to the outlook for economic activity was a downturn due to destocking.

Yet as so often, a glass that is half-empty for one drinker looks half- full to another. Provided that growth picks up next year - as most forecasters expect - the economy could be on course for a more sustained expansion. Together with the more promising outlook for inflation, this would obviate the need for yet another damaging stamp on the brakes as the economy careered out of control once again.

Certainly the view in the City now is that Kenneth Clarke has won his battle with Eddie George over the Governor of the Bank's call for higher interest rates. If interest rates have peaked at their present level of 6.75 per cent, then that represents under half of their last peak - 15 per cent - at the beginning of the 1990s.

To a generation acclimatised to double-digit inflation and interest rates, the present conjuncture looks and feels quite alien. Yet to the post-war generation, it would have seemed normal.

After a temporary surge in inflation caused by rearmament for the Korean War, inflation in the rest of the 1950s fell back to average about 3 per cent. The expectation, established by the depression of the interwar years, was that prices did not rise year-in, year-out. And indeed in 1959 prices hardly rose at all.

Interest rates, which had been held at 2 per cent since 1939, did move up in the 1950s. But the peak of 7 per cent in the autumn of 1957 and spring of 1958 seems laughably low compared with the 17 per cent peak they reached in Mrs Thatcher's first year of office.

Growth rates, too, were much more stable than in recent years. Indeed in only one year, 1958, did the economy produce less than in the preceding year.

If the economy is returning to the 1950s' mix of low inflation, interest rates and more stable growth, this isn't necessarily a bad thing. A new era of low inflation and interest rates should help to prevent the wild swings in activity that have so debilitated the economy in the past 15 years. The gains made in the booms have been more than compensated for by the losses made in the busts.

Yet in 1959, Harold MacMillan was able to convince the electorate that they had never had it so good. In the 1990s, voters are determined to feel bad, no matter how hard ministers coax them to feel good.

One reason is that consumer expenditure is no more than trundling along after the wild excesses of the 1980s, when shopping became a way of life. What is more, quite a bit of whatever spare cash people want to part with is going on a flutter on the National Lottery.

A more fundamental problem underlying the stubborn persistence of the feel-bad factor is the harsh labour market of the 1990s. Unemployment averaged not much more than 300,000 in the 1950s. The Tory government panicked when it reached 2 per cent. By contrast, today's labour market is stamped with endemic insecurity; with redundancy notices a way of life and temporary, contract jobs growing all the time.

Yet from another perspective the contrast in unemployment between the two decades can be seen as a similarity. The low rate of unemployment in the 1950s owed much to the wage restraint born of a belief that inflation was a temporary phenomenon. Many of the difficulties afflicting the recovery, such as disappointing levels of investment, arise from a reluctance to believe that inflation can do other than rise relentlessly. Andrew Britton, director of the National Institute, points out that this leads to companies setting unnecessarily high rates of return for investment.

Britain in the 1950s was a closed economy by contrast with Britain in the 1990s. Economic policy makers had more leeway for action than a modern chancellor, who must always look over his shoulder at the financial markets. But as we move into the unfamiliar territory of a low-inflation recovery, the immediate past of the 1970s and 1980s may offer less guidance than the more distant post-war period. If sustainable growth means slow forward, it may also mean back to the Fifties.