It is easy to convince oneself by glancing at business surveys that, beneath the picture of strong global activity and exceptionally low inflation, there lurks a serious potential threat from inadequate plant capacity. Capacity utilisation is already above normal mid-cycle readings in several economies, including the US, Britain and Canada. More surprisingly, utilisation is close to mid-cycle levels in France and Germany, two economies where the recovery in activity has only just started.
The "every silver lining has a cloud" school of economic thought is beginning to work itself into something of a lather about this, as it would appear to imply new investment has been woefully inadequate to meet demand in the developed economies in recent years. Furthermore, it might indicate that central banks have been a little late to scotch a build-up of so- far-hidden infation pressures as the recovery in global activity mounts.
But is there really anything unusual going on? In particular, is capacity utilisation in the developed economies rising at a surprising rate, given other estimates of economic slack, such as unemployment and the gap between actual and trend output? I have been examining these questions for each of the biggest economies with Philippe Gudin de Vallerin, my colleague at Goldman Sachs. For most economies, we have concluded that there is nothing untoward happening.
The methodology is straightforward. For each economy, we estimate an output gap by subtracting the actual level of output from its trend. Then we compare this output gap with the deviation of capacity utilisation from its trend, after adjusting the capacity figures to ensure that the amplitude of their cyclical fluctuations is the same as the output cycle. If there is an unusual difference between the two series, we would be able to conclude that there is less spare plant capacit than normal, given the present stage of the output cycle. If not, then not.
The first graph shows the results of this procedure for the group of developed economies as a whole. The close correspondence between the output cycle and the capacity cycle is immediately apparent. On average, the 1991-93 recession was not as sharp or as deep as the oil-induced recessions of the early 1980s or the mid- 1970s. In fact, it was closer in depth to the recessions of the 1950s and 1960s, when relatively little spare capacity (of the order of 2 per cent of GDP) was created during the downturn.
More importantly, the recovery in global activity since the first half of 1993 has been at a sedate pace and, as the graph shows, global GDP should remain below trend throughout 1995. But what about capacity utilisation? It has indeed risen more rapidly than the output gap has shrunk in the past 18-24 months, which on the surface might indicate that an abnormal shortage of plant capacity is developing, even thVp)ZXion is s6u++1z.zBWW.Kon further inspection it turns out that the extent of the recent rise in utilisation is not unusual at all. In the early stages of an economic recovery, it is typical for utilisation to grow more rapidly than output. This has happened in every global recovery since 1970, and the recent deviation between the two series is very similar to what happened at the same stage of the last recovery in 1983-85.
It is a matter of conjecture why this pattern tends to develop. Perhaps companies become too pessimistic when they frame their replies to business surveys during the darkest days of recessions, and this may distort downwards the capacity series, which are predominantly derived from surveys. …