Is this the start of something good?

Britain's economic prospects are looking quite impressive - just as long as we don't blow it

The British economy is "impressive" but there is little room for tax cuts. That was the verdict this week from the OECD - the economic monitoring organisation for the club of rich nations. In its quarterly report yesterday the Bank of England was fussing about inflation, yet house prices are plunging and threaten to plunge further. Unemployment is falling, but most people are frightened of losing their jobs. Retail sales are pretty stagnant, while exports are at an all-time record. The car manufacturers are crossing their fingers about the N-reg car sales - yet the airports are jammed with holidaymakers.

To this cacophony of conflicting economic indicators is added the disinformation of the politicians. Yesterday we had Michael Heseltine, Deputy Prime Minister, greeting the highgrowth rate, prospects for rising living standards, improved competitivenessand record export levels: "This is the dream target," he said. But John Prescott, deputy prime minister in waiting, said that the Bank of England report "highlights that low investment and the lack of capacity in manufacturing ... are once more threatening to derail the recovery at this early stage".

Confused? If you are not, you haven't been paying attention. Yet there are things which can sensibly be said, the first being that we are at a very interesting point. The confusion - aside from the political statistics- abuse - arises partly because the figures are at best a snapshot of the recent past, and partly because, as a result of structural change in the economy, the things we are accustomed to measuring may themselves have become less important.

The OECD report is a good starting point. Every six months the OECD does a forecast of the world economy, but it also has a rolling programme of detailed two- to three-yearly reports on its member countries. This new report is one such and its judgement deserves attention. On the macro-economic side, it confirms that we have decent growth with low inflation and a current account balance, but it warns that we have to be quite careful if we are to transform this recovery into a "soft landing", combining somewhat slower growth with low inflation and a current account balance. We are on track for that, but we need to be alert.

On the micro-economic side, it acknowledges the progress made with the labour market reforms of the 1980s, which have cut the "natural" rate of unemployment - the rate which does not lead to inflationary pressures. But we need to improve education and training to attack skill shortages if we are to progress further.

That is all good solid stuff. The problem with this sort of analysis is that it is static. It is a sharply defined picture of the recent past rather than a (necessarily) fuzzy vision of the future.

The Bank of England's Inflation Report, on the other hand, does try to look forward, but it does so with the narrow aim of projecting the path of inflation. It looks at one particular variable with a telephoto lens - and a slightly wobbly camera, because it has proved almost invariably to be too gloomy about inflationary prospects.

Still, it does look forward, which is helpful, for the lags in monetary policy are very long. If you want to influence inflation in 18 months' time you have to start moving now. That is the core of its case for higher interest rates at this stage of the cycle. The Bank also, in trying to project inflation, looks at the dynamics of the economy: which bits are still growing strongly and which bits have turned down; which industries are running into capacity constraints and which still have slack.

This is fascinating because it confirms anecdotal evidence. For example, there has been a manufacturing downturn in the last few months, with output still growing, but more slowly than last year. Services output, however, has continued growing without a break and some services, such as transport and communications, have been sizzling upwards. Thus GDP is up 10 per cent since the beginning of 1992, but transport and communications are up nearly 18 per cent. As for slack, our factories seem overall to be running close to full capacity, but while chemicals are at full tilt there is plenty of slack in motor manufacturing.

The Bank even has an explanation for the conundrum of the labour market: more jobs yet more insecurity: it is because of our job insecurity that unemployment is able to come down without adding to inflationary pressures. The OECD came to the same conclusion: "labour market reform" is a nice way of saying that people are too insecure to be able to ask for much more money.

Taken together the two reports also throw some light on the fact that quite rapid growth does not make us feel much richer: because it is exports rather than home sales that have been climbing fastest, and because the Government is cutting its deficit, our disposable income has not been rising as fast as the growth of the economy. We are working harder, but not able to spend all the additional fruits of our labour. The very fact that the expansion is sustainable accounts for the fact that it does not feel too good.

So the dispassionate reader of these reports can catch some explanation of the apparent inconsistencies of our economic situation. But not all. I think there are three big unanswered questions.

The first is what does capacity mean in a service economy? We know that manufacturing or other industrial plants have physical limits to the amount that they can produce and that investment has to be added early in the economic cycle if demand later in the cycle is to be met. We have been pretty dreadful at that in the past, which is what underlies the concerns of people such as Mr Prescott.

But in services it ought to be possible to add capacity much more quickly. It does not take long to write more software, trade more financial derivatives or even open a new rave club. Maybe our whole economy has become much more nimble, and more capable of sustained growth than it was even in the last economic cycle.

The second question is where does the flat (or falling) housing market fit in? We have recent experience of the impact of a housing boom: it increases demand in an unsustainable way. But we cannot remember what it is like to have stable house prices. Will the effect be to increase other forms of saving and if so, what effects will that have on the economy? Will lower turnover of homes lead to more stable communities with fewer social problems? We can see the pain of the fall in house prices, but we cannot yet catch much of a feeling for the benefits which undoubtedly exist.

The third issue is whether this time round, things really will be different: that we will in another 10 or 20 years' time see this period of growth as the time when the economy really came right and started to perform rather better than that of most other developed countries instead of rather worse. It is perfectly possible. In the past, it has always been at this stage in the economic cycle that we have blown it. This time, I think - providing we carry on feeling nervous and insecure - things may just come right.