United Kingdom - Developments in Individual OECD Countries

OECD Economic Outlook, June, 1994

Economic recovery strengthened in the course of 1993, and by the first quarter of 1994 real GDP was 2.6 per cent up on a year earlier. Private consumption, led by consumer durables, remained buoyant during the second half of 1993 and the household savings ratio fell further. Business investment has begun to pick up and, given rising levels of capacity utilisation and improved corporate financial positions, should continue to expand. Employment growth resumed in early 1993 and unemployment started falling, both developments occurring earlier than in past cycles. By end-1993, wage settlements and average earnings growth had dropped to 25-30 year lows, though earnings growth has, not surprisingly, picked up a little in the early months of 1994. Inflation in the retail price index excluding mortgage payments fell during 1993, despite the sharp drop in sterling's effective rate in late 1992, and in April 1994 reached its lowest rate since 1967. Sustained output growth, low inflation, modestly declining unemployment and a small current account deficit are projected for the coming two years.

Recent developments

The profile of current economic recovery has so far been strongly influenced by adjustment of household balance-sheet TABULAR DATA OMITTED positions. Given extremely high indebtedness at the outset of recession -- the highest since the Great Depression -- the significant falls in interest rates since late 1990 substantially reduced debt-service payments. Gross interest payments declined from a 1990 peak of around 15 per cent of household disposable income to some 8 per cent by mid-1993. Led by buoyant demand for new cars and household durables, private consumption picked up strongly, reaching an annual rate of 4 per cent in the second half of 1993, and consumer borrowing rose again. The growth in retail sales strengthened in the three months to March 1994, and continuing strong new car sales and housing starts suggest that the impact of higher taxation on households may be reflected more in lower savings.

Business investment had until recently been the missing ingredient in this recovery. Although investment was cut back sharply, it has remained higher as a proportion of GDP during this economic cycle than in the 1980s, reflecting stronger trend profitability and on-going investment by the newly privatised firms and the energy sector. Business investment started to contribute to recovery during the course of 1993, and investment intentions are now responding to improved cash-flow and balance sheet positions, and to rising capacity utilisation. Public investment in transport and social infrastructure was a TABULAR DATA OMITTED major source of strength in 1992 and 1993, though it will be scaled back in the coming years.

A notable feature of the current business cycle is that the drop in unemployment occurred at a much earlier stage in the recovery -- several years earlier compared with the cycle in the early 1980s. Unemployment started to fall in January 1993, and registered unemployment was down by some 280 thousand by April 1994. To some extent, this can be attributed to modest real wage outcomes and more flexible employment practices, a dividend of structural policies pursued so far. Real wages had increased throughout the 1990-92 recession (due in part to strong disinflation in goods markets), but were flat in 1993.

To date, job creation has been more than accounted for by growth in (largely voluntary) part-time employment. Full-time job equivalents have barely changed. To some extent, this pattern reflects the continuing downsizing and cost-cutting in manufacturing and construction, where full-time male jobs dominate, and is one reason why long-term unemployment has hit adult males hard. By contrast, steady service sector output growth has boosted part-time work (typically by females), notably in the retailing and hotel and catering sectors. In the event, the modest pick-up in employment indicates that underlying labour market conditions are firming slowly, albeit from an uneven base, and that hiring decisions have quickened.

The economy has been on a strong disinflationary path due to the large output gap and keen competition, especially in the retail sector. Inflation and inflation expectations fell markedly during the past year. By April 1994, the 12-month rate of increase in the retail price index excluding mortgage payment (RPIX) was down to 2.3 per cent ("headline" retail price inflation was 2.6 per cent) and might have been even lower without higher indirect taxes. The growth in economy-wide average earnings picked up to 4 per cent in the 12 months to March, as the economy strengthened. This outcome partly reflected the confluence of weak commodity and oil prices and an unanticipated fall in total unit labour costs due to labour shakeout in late 1992, despite steadily rising output. These factors absorbed the initial price level effects of sterling depreciation.

Disinflationary pressures ensured that sterling's large nominal depreciation resulted in a big improvement in international competitiveness. It appears that UK export performance in manufactures improved in 1993. Real net exports made a large contribution to the recovery in the first half of 1993, which was subsequently reversed in the second half of the year. Given uncertainty concerning the measurement of intra-EC trade, however, recent trade prices and volume data should be treated with caution. The current account deficit deteriorated very little, as the "J-curve" effects typically associated with depreciation were surprisingly absent according to the most recent trade data.