The leading economies have now reached a stage where many economists and policy makers are questioning the staying power of the recovery. Following the first quarter surge of activity reported in our last Commentary, the second quarter of 1976 brought a marked slowing down in the growth of industrial production particularly in the US, and the latest indications are that this slowdown has continued into the third quarter. Much of the initial impetus out of recession stemmed from the turnaround in stockbuilding, but this adjustment of stocks would now seem to be largely completed

Carruth, Alan A.

Danson, Michael W.

Fraser of Allander Institute

Wingfield, A. A.

University of Strathclyde Institutional Repository

Strathprints Institutional RepositoryBell, David N. F. and Carruth, Alan A. and Danson, Michael W. and McGilvray, James W. and Simpson, David R. F. and Wingfield, A. A. (1976) Review of the quarter's economic trends [October 1976]. Quarterly Economic Commentary, 2 (2). pp. 1-6. ISSN 0306-7866 , This version is available at http://strathprints.strath.ac.uk/50217/Strathprints is  designed  to  allow  users  to  access  the  research  output  of  the  University  of Strathclyde. Unless otherwise explicitly stated on the manuscript, Copyright © and Moral Rights for the papers on this site are retained by the individual authors and/or other copyright owners. Please check the manuscript for details of any other licences that may have been applied. You may  not  engage  in  further  distribution  of  the  material  for  any  profitmaking  activities  or  any commercial gain. You may freely distribute both the url (http://strathprints.strath.ac.uk/) and the content of this paper for research or private study, educational, or not-for-profit purposes without prior permission or charge. Any  correspondence  concerning  this  service  should  be  sent  to  Strathprints  administrator: strathprints@strath.ac.ukTHE FRASER OF ALLANDER INSTITUTE QUARTERLY ECONOMIC COMMENTARY October 1976 The Fraser of Al lander I n s t i t u t e f o r Research on the Scot t ish Economy was establ ished i n the Un ive rs i t y of Strathclyde on 1 January 1975, as the r e s u l t of a generous donation from the Hugh Fraser Foundation. I t s p r inc ipa l func t ion i s to carry out research on the Scot t ish economy and i t s research programme includes the analys is of short- term movements in economic a c t i v i t y . The resu l t s of t h i s work are published each January, A p r i l , Ju ly and October in the I n s t i t u t e ' s Quarter ly Economic Commentary. The I n s t i t u t e also publishes a ser ies of Research Monographs to provide an ou t l e t f o r o r i g i n a l quan t i t a t i ve research on the Scot t ish economy, and a ser ies of occasional essays on economic po l i cy e n t i t l e d Speculative Papers. In co-operat ion wi th the Scot t ish Council Research I n s t i t u t e and IBM United Kingdom S c i e n t i f i c Centre the Inst i tu te is compiling a set of input-output tables for Scotland. The Inst i tu te also wishes to thank The Scotsman Publications Limited for i t s f inancial support in the appointment of a Research Fellow to work on the construction of forecasting models. Additional copies of th is Commentary, and of a l l Fraser of Allander Inst i tu te publications may be obtained from the Secretary, The Fraser of Allander Ins t i tu te , University of Strathclyde, 100 Montrose Street, GLASGOW G4 OLZ, or through leading booksellers. ISBN 0 904865 10 X QUARTERLY ECONOMIC COMMENTARY Contents 1. Review of the Quarter 's Economic Trends The World Economy 1 The United Kingdom Economy 4 2. The Scot t ish Economy Ind icators of Economic A c t i v i t y 7 Current Trends 12 Employment and Unemployment 17 Outlook f o r the Future 20 3. Summary 23 4. Special A r t i c l e The Debate on Publ ic Expenditure 25 by J W McGilvray 5. Maps, t ab l es , f igures 32 6. Publ icat ions o f the I n s t i t u t e 47 The Commentary f o r October 19 76 was compiled by: D N F Be l l A A Carruth M W Danson J W McGilvray D R F Simpson A A Wingf ie ld 1 REVIEW OF THE QUARTER'S ECONOMIC TRENDS The World Economy The leading economies have now reached a stage where many economists and policy makers are questioning the staying power of the recovery. Following the f i r s t quarter surge of ac t i v i t y reported in our last Commentary, the second quarter of 1976 brought a marked slowing down in the growth of industr ia l production par t icu lar ly in the US, and the latest indications are that this slowdown has continued into the th i rd quarter. Much of the i n i t i a l impetus out of recession stemmed from the turnaround in stockbuilding, but this adjustment of stocks would now seem to be largely completed. Forecasts for 1976 made ear l ie r in the year for the OECD countries have not been revised to any s igni f icant extent. Real GDP growth of 5~6%, 9% consumer i n f l a t i o n , and a continued worsening of their balance of payments positions due to OPEC current account surpluses expanding again are expected. However, the apparent slowdown in the growth of industr ia l production in the second and th i rd quarters is not encouraging. Price in f la t ion also appears to be accelerating due to an increased demand for raw materials and employment has not picked up in the way hoped for in some countries. On the more optimist ic side, the volume of world trade should increase by 10-12% this year, private investment has been improving in most countries, prof i ts are r i s ing , and a s igni f icant increase in capital spending is expected in 1977. Some considerable divergence of opinion has now emerged over the future prospects of the United States economy. According to one New York bank, economic advance may be tending to s t a l l rather than just slow down. An annual real GDP growth of *\\% in the second quarter of 1976 was only half that of the f i r s t quarter. Retail sales levels have been somewhat depressed, and p r o f i t levels have not improved much since the f i r s t quarter. Unemployment has been creeping up again in June and July to 7.8% , and so has consumer price i n f l a t i on . From fears of a renewed bout of in f la t ion due to f i r s t quarter experience (see the July Commentary) we have now turned f u l l c i rc le to fears of 2 s t a l l i n g i n recovery. However, the o f f i c i a l forecast for real GDP has been raised to 6J% for 1976 and i t has been suggested in the business sector that the US has room to expand faster. Clearly, this slowing down can be attr ibuted to the downturn in the stockbuilding cycle and to a lesser extent f a i r l y s t r i c t f iscal and monetary measures. Hence the future course of output w i l l be determined by other components of demand. In this l ight the re ta i l sales experience may be construed as a l i t t l e disappointing. On the other hand, another New York bank has emphasised that the cont inuing growth in incomes implies that the l u l l is only temporary as the economy changes gear into a new phase of the cycle which they feel i s l i k e l y to be more sustainable. Even so, the index of leading i nd ica to rs pointed to a further slowdown in the th ird quarter of this year , although a r e t a i l sales rise in August of 2% is encouraging. The West German economy, which has played a v i ta l role in West European recovery s t i l l displays the most promising short-term growth prospects. Expected real GDP growth is unchanged at 6%. The wage settlement norm now appears to be as low as 5|% and,given the increased productivity of the recovery,labour cost increases may be as low as 2%. Employment trends have not l ived up to expectation and the s l ight rise in the July unemployment figure was perhaps reflected in the survey of business opinion in West German industry which was rather disappointing. This may to some extent be due to an ending of investment incentives in the second quarter o f 19 76. Export prospects are s t i l l favourable, although the trade surplus is expected to be similar to last year. Some decelerat ion in ac t iv i ty is probable ref lect ing to some extent the slowdown in the US and Japan. An annual rate o f 15;:' real GNP growth was experienced in Japan in the f i r s t quar ter of t h i s year which has led to an upward revision of the real GDP forecast to 61%. However, there is some indication that domestic a c t i v i t y is slowing down and signi f icant ly the savings rat io has r i sen again. However, the norm for wage increases has fa l len considerably and i s now in the region of 9% which should help ease unit cost pressure, and continue to enhance p r o f i t a b i l i t y . Exports have continued to expand, although there is some foreign opposition to Japanese t rad ing a c t i v i t i e s . I t has been suggested that the yen is being kept undervalued, and that export dumping has been taking place. Most other i n d u s t r i a l i s e d countr ies have been making progress, although r e f l e c t i n g the slowdown in the world economy. In some, l ike the UK and I t a l y , fu ture prospects are s t i l l dependent on the ab i l i ty to keep reducing t h e i r i n f l a t i o n rates in l ine with competitors (see previous 3 issues of the Commentary) and also to make room for productive growth at the same time. The recovery in industr ia l countries is also s ign i f icant ly advanced to benefi t the non-oil developing countries, whose exports increased in the f i r s t quarter of this year, both in price and in volume. I t would now appear that world industr ia l ac t iv i ty may be slowing down, perhaps to a more sustainable pace. Clearly though the divergence of opinion must sound a note of caution on future prospects. 4 The United Kingdom Economy In our last Commentary we noted that the turnround in world trade, together with the devaluation of the pound, provided the opportunity for a strong expansion of exports. Since then the pound has dropped a further 12 cents against the dollar and in so doing has precipitated a further sterling crisis. A substantial improvement in the balance of payments position is a necessary condition for the restoration of confidence in sterling. However, recent export performance has not been encouraging. The seasonally adjusted volume index of UK exports fel 1 by 21 ' between March and August whereas the imports index rose by ?-|C over the same period. Although no doubt there are substantial lags before the full effects of a devaluation are realised, one would have expected at least a partial improvement since the exchange rate has now been falling for a period of eighteen months. A:, a shore term expedient to overcome the current difficulties the Government is probably considering some more general type of import restriction such as import deposits. Last introduced in 1968, this measure, whereby importers are required to deposit a proportion of the value of imported goods with the Government as an interest-free loan, would have the dual benefits of making imports more expensive rind reducing the rate of growth of the money supply. However, the application of such measures would depend on the reaction of our "fading partners and, in particular, on the IMF. Without its support, see cound would collapse further, so it is in a strong position to J. i elate the current course of economic policy and may insist that no restrictions ee placed on trade. rs-? rising cost of imports is likely to contribute toward an acceleration of the rate of inflation toward the end of the year. Although the longer-tene effect of the rise in minimum lending rate will be deflationary, tns immediate effect will be to increase the cost of mortgages and overdrafts - so adding to inflationary pressure in the short run. The Government is trying to prevent a sharp increase in the cost of imported food by opposing devaluation of the green pound. However, pressure from the EEC, which is currently subsidising UK food consumers at a rate of il.2m per day because no devaluation has occurred, cannot be resisted indefinitely. The combined effect of these pressures makes the Chancellor's aim of 7,' inflation by the end of 1977 seem The authorities are taking a determined stand on the growth of the money supply. Following a sharp increase in the money supply in the summer months she Bank of England raised minimum lending rate to an 5 unprecedented 15% on 7th October. Special deposits t o t a l l i n g £ 105Orn have been ca l led in to br ing money supply growth back to the Chancel lor 's 12% ta rge t . Though these measures may encourage the IMF to bel ieve tha t B r i t a i n is taking pos i t i ve e f fec ts to reduce i n f l a t i o n , i n d u s t r i a l i s t s w i l l not be heartened by the cost of funds f o r investment r i s i n g to a minimum 16%. Many f i r m s , espec ia l l y smaller ones, w i l l go bankrupt, unable to meet the higher cost o f ove rd ra f t s . The key to long-term recovery from B r i t a i n ' s economic i l l s l i e s in a substant ia l expansion of product ive investment. Although some r i se in the leve l of investment is expected to occur in the shor t - run , the real level of investment in 1976 is l i k e l y to be less than any year since 1964. That indust ry i s s t i l l unw i l l i ng to invest i s borne out by the fac t tha t advances to p r i va te industry from the c lear ing banks f e l l by £500m during August-September. The rev iva l of p r o f i t s may have enabled an expansion in the in te rna l f inanc ing of investment but , on the other hand, i t may be that f i rms are simply unwi l l i ng to invest when the average real ra te of re tu rn on c a p i t a l : a s the Department of Industry admits, has f a l l e n , from over 10% f i f t e e n years ago, to 3.9% in 1975. An immediate r i s e in investment is not l i k e l y to cause more than a marginal reduct ion in the level of unemployment, which stood a t 1.4 m i l l i o n in September. Fur ther , the recent increase in employers' National Insurance cont r ibu t ions has increased the employers' incent ive to increase u t i l i z a t i o n of the ex is t i ng labour force rather than take on add i t iona l labour. Even though unemployment a t ta ined a record post-war level i n Ju l y , 32% of a l l operat ives in manufacturing industry were working an average of 8.6 hours overtime per week. The cost to f i rms of employing add i t iona l s t a f f has increased subs tan t ia l l y as a resu l t of new l e g i s l a t i o n and increased employer cont r ibu t ions -wi th detr imental e f fec ts on employment. In our l as t issue we noted the recent f a l l in the level of real earnings. Although the unions have i m p l i c i t l y accepted the necessity f o r th i s by t h e i r acceptance of the current pay p o l i c y , i t i s not yet c lear what agreement, i f any, w i l l replace i t . I f , as we be l ieve , an increase in investment and a lowering of u n i t costs is a necessary cond i t ion f o r a long-term improvement in B r i t a i n ' s growth rate then the growth of consumption must be kept below the rate of growth of GDP to permit an expansion of investment. Whether i t i s p o l i t i c a l l y feas ib le to al low the gap between the expectations and experience of p r iva te and publ ic consumers a l i k e to continue to widen is open to doubt. Further cuts in publ ic expenditure are l i k e l y to be s tou t l y r e s i s t e d , espec ia l ly by the local a u t h o r i t i e s . 6 Industrial production in the UK has fallen marginally during 1976, standing at 100.8 in July (seasonally adjusted) against 101.0 in January. Both the Bank of England and National Institute, writing before the recent sterling crisis, expected output to grow and growth to accelerate. Obviously, prospects for such an acceleration have been reduced by the imposition of the credit squeeze. Nevertheless, we expect some recovery before the end of 1976 - real GDP growth should be approximately 3% in 1976 and will continue at that rate during the first two quarters of 1977. 

Review of the quarter's economic trends [October 1976]

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