Raising the speed limit on the road to growth

My litmus test is the number of references to competition rather than competitiveness

My litmus test is the number of references to competition rather than competitiveness

AN ECONOMIC analyst from Mars (yes, they get everywhere) would have some difficulty in detecting any great break-point in the past eight years of the British economy. This is irritating to both Opposition and Government, which would like to see 1997 as a watershed. In truth, however, growth has continued, virtually uninterrupted, since 1992. Inflation, falling below 3 per cent in 1993, has moved very little since. And unemployment, which began falling that year, has just gone on down, to levels unseen since the 1970s.

Is the pattern now changing? Certainly, there has been an about-turn on public spending, resulting in a big boost. Meanwhile, however, the economy seems to be slowing. Last month's upward blip in the claimant count suggests it may take a little longer than ministers hoped to drop below that politically important one million mark. Good news on the inflation front: wage rises have subsided since earlier this year, and expectations of the next move in interest rates are swinging from up to down. This is something of a triumph for the Monetary Policy Committee, which came in for quite brisk criticism for failing to raise rates in the summer.

How close we had come to capacity is debatable. The National Institute, for example, argues that there is still more slack in the labour market than the statistics suggest. But we cannot forever grow "above trend"; which is putting the spotlight on the Chancellor's favourite subject. What is our trend rate of growth? And how can it be raised?

The rate of growth in productive potential depends on two things: whether the workforce is growing, and what is happening to its productivity. Since (give or take a bit of migration) Britain's potential workforce appears in the birth statistics 16 years in advance, it should be easy enough to forecast. Actually, it is not that easy to tell what will happen to the "economic activity" rate - the proportion of the population looking to work (ie, in a job or registered as unemployed), as opposed to staying in education, at home to look after the children, or opting for early retirement.

There are some clear long-term trends. The proportion of women going out to work is still rising- mostly sharply, right now, amongst the over-50s. But the boundary between the active and inactive varies with the state of the economy. It is no accident that in the North-east, where the unemployment rate is higher than down south, the overall economic activity rate is relatively low.

Still, since Britain's activity rate is already very high, by international standards, it is fair enough to base forecasts of potential on growth in the working-age population as a whole. According to the Treasury, this has been accelerating slightly, to 0.5 per cent a year. As in all developed countries, however, the impact of this on our output potential is (or should be) dwarfed by what is happening to productivity.

In a report published on pre- Budget day, the Chancellor set out his "ambition" to drive Britain's productivity growth rate above its competitors'. No small ambition, given that the US has been enjoying a technology-based spurt in productivity, up 2.5 per cent a year since 1996. Embarrassingly for the Chancellor, Britain's productivity has meanwhile slowed down. A fixation with the election break-point has led his advisers into a trap of their own making: the publication of figures showing that labour productivity rose 2.1 per cent a year between 1990 and the first half of 1997, subsequently dropping to 1.6 per cent.

There is a silver lining. In 1990-97, employment fell. The slowdown in productivity since then has been balanced by an increase in the number of jobs. Had this not happened, the Chancellor's report argues, the productivity decline would have been very slight. That sounds rather like saying that if I hadn't gone shopping, there would be more money in my bank account. However, the Treasury is forecasting a return to something more like pre-1997, with very little growth in employment and a rebound in productivity. And it has raised its estimate of the trend rate of output growth from 2 ¹/ ₄ per cent to 2 ¹/ ₂ per cent a year, starting - you guessed it - in 1997.

Timing aside, this is perfectly reasonable. Our growth potential clearly did accelerate in the 1990s, although the Treasury doggedly refused to accept this at the time. A quarter-point may seem hardly worth arguing about, but at £2 ¹/ ₂bn (in today's money) extra each a year, it amounts to nearly £40bn of extra output over five years. Most importantly, a change in the estimate of the trend should raise policy-makers' sights. Actually, the Treasury is cautiously continuing to make Budget forecasts on the basis that our productive potential grows by only 2 ¹/ ₄ per cent. Meanwhile, however, the speed limit could be raised for monetary policy - ie, interest rates could be lower. Nowadays, that is a judgement for the Monetary Policy Committee to make, not the Treasury. But there are signs in the latest Inflation Report that the MPC takes the same view. It notes that productivity has already been recovering. Others, too, are expecting a spurt: the National Institute is forecasting a 3 per cent rise next year.

Most analysis suggests that Britain's improved performance in the 1990s had more to do with its labour market than with a US-style leap into the New Economy. It is not merely that waning trade union power increased flexibility, or that work incentives have been increased: there has been a step-change in the "quality" of labour (ie, its qualifications and skills). Since the mid-1980s, this has, according to the Organisation for Economic Co-operation and Development, been more marked in Britain than the US, France or Germany. Good news in itself, this raises hopes of more to come from technology and innovation.

What, however, is that to do with Government? Well, a stable macroeconomic climate is, as the Chancellor says, "necessary but not sufficient". A good education system is even more necessary. The public sector can help by putting its own house in order. But business productivity will be generated by business decisions; and mostly, the best thing government can do is to get out of the way.

Well-meaning political "ambitions" can be dangerous. It is a short step from ownership of the problem to over-confidence in your ability to provide the solution. My test of the good sense of such reports is the number of references to "competition" as opposed to "competitiveness"(which is usually code for intervention). Alarm bells ring with the sections of this report demonstrating the huge gap between the most and least productive businesses. Is this a signal for government to rush in with quack solutions, rather than leaving it to competitive product markets (and stock markets) to spread "best practice"?

Thankfully, it seems not. There is a certain touching faith that any government remedy for market failure must be better than the disease. But this goes hand in hand with faith in the virtues of competition, which gives coherence and discipline to the report. A little political gloss is, perhaps, a small price to pay for a public commitment to that basic belief.

Sarah Hogg is chairman of Frontier Economics