Capacity constraints are often a harbinger of inflation. But does this mean 'capacity utilisation' statistics are worth paying attention to, asks Gerard Le Page?
If we organise the multitudinous statistics, indicators and figures available for the UK economy into a league of usefulness, inflation and unemployment head the Premiership, the last election's opinion polls face outright relegation and 'capacity utilisation' (CU) belongs halfway down the first division. CU can be a useful, even predictive measure - but equally it is prone to ambiguity, and is best taken with a decent-sized pinch of salt.
The concept itself is hardly difficult.
Say a factory has 100 machines, of which 30 lie idle - the CU is 70% - that's all there is to it in the US and most of Europe. In this country things are a little different.
The most widely respected measure of CU is a quarterly figure released by the CBI.
This derives from a survey of their members, which asks the question, 'Are you working below a satisfactory rate of operation?'. In the recession of the early 1980s, for example, over 80% of respondents replied that, yes, this was indeed the case. Some years later, at the height of the Thatcherite boom, this was true of less than one-third.
CU does have several rather important inbuilt failings. The first, truly fundamental flaw is that it is a measure of manufacturing and manufacturing alone. Now, back in the 1950s, when Britain actually made things, this was doubtless a good idea. Nowadays manufacturing accounts for less than a quarter of GDP and so CU can be rather misleading. As Professor Charles Bean of the LSE points out: 'In the early '80s, CU tended to overstate the downturn, as the recession hit manufacturing particularly hard.'
So why not measure CU across other sectors, such as services which command a beefier chunk of Britain's balance sheet? Such series do exist, but they carry little weight - for one very obvious reason. Ask the boss of a frozen chip factory how many fries per hour it can produce and he or she will have the answer; now try the same with a firm of solicitors.
Capacity limits in much of the service sector are nebulous things. A better indication of impending bottlenecks is the availability of skilled labour.
A second important failing is that the measure is ultimately subjective - it is based on the perceptions of senior members of the CBI's constituent companies. A third, more unfounded, criticism that CU does attract is that even within manufacturing its meaning is ambiguous. The argument is as follows: CU in the frozen lasagne industry has fallen by 15% - what does that tell us? Is it that demand for chill-cook Italian cuisine is way down and factories have cut their output accordingly? Or is it that the demand for freezer-to-oven pasta products is about to boom and that factories have invested in new equipment. (In point of fact, with a swing as large as 15%, it will almost always be the first scenario: even a significant upswing in investment is unlikely to result in a couple of per cent increase in capacity.)
So is CU any use at all? Yes it is. For one thing it can be a good leading indicator of inflation; particularly in the '80s it proved itself to be an accurate prophet of inflationary times. By the beginning of 1995, the figures suggested that, with CU near that of the Lawson Boom, rampant inflation lay just round the corner. On this occasion, however, economy-wide capacity constraints were not evident. Whereas in the '80s all sectors were suffering from constraints, by early 1995 it was only manufacturing which had performed strongly. The inflationary pressures from manufacturing were swamped by excess capacity in the service sector.
CU does have another advantage: whereas most figures are a long time coming it is quick off the mark, arriving only a month after the fact. If the CU data clearly heralds trouble, evasive action by policy-makers can be taken quickly.
In the US, where everything must have a value, CU is treated as a heavyweight economic statistic - here less so. As Paul Droop, the ITEM club's chief economist, puts it: 'A lot of people think it's rubbish.' Such critics may be a little harsh. It has its uses - but if you're going to look at one economic statistic this week, this shouldn't be the one.