It is not just the consumer who is cautious about splashing out on long-term acquisitions, says David Smith. Businesses, too, appear to be waiting for the feel-good factor before making serious investments.
The most discussed economic topic this year is the absence of the feel-good factor. People are not spending on cars and durable goods in a way that past recovery patterns would indicate. And they are certainly not investing in housing anything like they did during the economic upswings of the past 25 years.
We think we know why this is. In the case of housing, the gloom is self-feeding. The more people decide not to risk extending themselves further in the way of mortgage debt, the more prices are depressed and activity stagnant. This, in turn, locks a sizeable proportion of households into negative equity and produces adverse wealth effects for the rest of us (when house prices are rising we feel emboldened enough to borrow on our rising equity). And a stagnant housing market has direct knock-on effects for other sectors - witness the rationalisation in the DIY market, for example.
Apart from housing, the other factors are also familiar enough. Job insecurity may have been exaggerated in its impact. There has been a shift towards a more flexible labour market, with a greater proportion of people on short-term contracts. This has not, however, been as sudden or dramatic as popular perception has it. Even so it is enough to make anyone feel cautious.
Most important of all is that we are still in the adjustment phase following the over-borrowing of the 1980s. After a decade in which the ratio of personal debt to annual household income rose from 60% to 120%, there is no appetite for further indebtedness, and plenty for paying off debt.
So much for the struggling feel-good factor among consumers. But, as I have argued here before, the effect of this should be to tilt the balance of the economy back towards manufacturing industry which, operating with a competitive exchange rate and more reliant on export markets anyway, can insulate itself, to a far higher degree than services, from a dull domestic market.
This remains the case, but it raises a conundrum about the economy. If the environment is so good for industry, how come investment has been so weak? For it is not just the consumer who is cautious about splashing out on big-ticket, longer-term acquisitions. The same applies to business.
It has been true that we have been in a period of growth that can be described as export-led. Economists would love to have been able to add 'and investment-led too'. Unfortunately the latter has proved elusive. Last year, after falling sharply for three successive years, business investment picked up, but only very modestly, by 2.5%, in a year when the economy grew by 4%. More than two years from the trough of the cycle, this was a muted performance. Nor has this year been much better.
The Treasury was in the vanguard of those who believed that 1995 would be the year of investment, forecasting a double-figure increase (allowing for inflation) in capital spending by business. But business has been in no mood to oblige. Investment actually fell in the first quarter of the year, and the Treasury's revised prediction, made during the summer, was for growth this year of under 5%, with the hoped-for spurt coming next year (it predicts 9.5%).
Now I am as keen on investment as the next man but there are good reasons why the investment upturn may not arrive on cue. The first is a matter of simple business-cycle economics. We are, it is generally acknowledged, past the peak for economic growth in the present cycle. This does not mean the imminence of another recession. Rather it is that, with domestic demand continuing to grow only modestly, the engine for growth, Britain's ability to sell into recovering foreign markets, is starting to sputter.
British products remain competitive, but the environment for selling them is deteriorating. This is most evident in America, where the chairman of the Federal Reserve Board, Alan Greenspan, has spoken of the possible onset of a mild recession, but it is also true in Continental Europe, where demand is, in most cases, growing at an even more subdued rate than in Britain. Japan remains mired in something close to stagnation. This leaves the strongly growing markets of the Far East, as well as the Middle East, Eastern Europe and the developing countries. But it is unrealistic to expect these to to compensate to a sufficient degree for weak growth in main markets.
As important, however, is a second broad factor, the psychology of investment. For decades, economists have been trying to get into the minds of companies for an insight into what determines investment decisions. The explanations can come down to crude battles between innovators and financial controllers within companies, or they can lead to the model 'new' company, composed of flexible semi-autonomous units, each striving to push forward its schemes.
When it comes down to it, however, businessmen are human, too. They are behaving as other consumers - risk-averse, unwilling to incur new debt, cautious about future employment prospects. And there is another parallel between personal and corporate decision-making. Just as individuals over-borrowed and over-invested in the late '80s, so the same was true for companies, as the chart shows. Businessmen are also lacking the feel-good factor necessary to prompt an investment boom.
This explanation allows, by the way, for somewhat different decision-making by manufacturers who, until now at least, have seen some of their markets grow strongly. Within a depressed investment scene, manufacturing investment rose 6.5% last year and should show stronger growth this year. But it remains to be seen how long even manufacturers can buck the trend of what they see around them.