Mind the gap?

The financial world has become concerned over a perceived economic output gap.

The argument is over just how much of the economy has been permanently lost – for example, factories which have been bulldozed, and skills lost through long-term unemployment.

If it is perhaps 10 per cent of the economy, as believed by Goldman Sachs, there’s a big problem. Because once demand starts picking up, there won’t be enough capacity to meet it and so we’ll get price inflation. This is what happened after the recession of the early 1990s. Although growth was very subdued inflation wouldn’t go away because so much capacity had been lost.

But the gap could be much less, perhaps 5 per cent or less, as believed by the Bank of England. That’s because they think businesses have been good at being flexible – short hours, moth-balling facilities etc. So capacity would be ready and waiting to take up the slack when demand picks up.

Who’s right? No-one knows.

Although it may seem esoteric, RSL directors should keep an eye on the issue.

How have your local building & services contractors, and their sub-contractors, adapted to the downturn?

If many are closing down, there will be a squeeze on capacity and upward pressure on prices when the recovery comes. For those in the social housing sector who are trying to set five-year business plans, this could result in a significant change in costs.

However, if contractors are able to be flexible and turn out to be survivors, price competition will remain strong and this will hold down inflation – meaning RSLs will have more spare cash to play with.

The economic output gap could therefore present a major uncertainty for the sector’s business planning.