Stresses and strains ahead in 2011
This will be most people’s first day at work in 2011 and it’s also the day when VAT goes up to 20 per cent, so this seems like a good time to look at the economic prospects for the year ahead. This isn’t a forecast (though I’ll refer to one or two forecasts from other people) but an attempt to sort out some of the pressures on the economy and how they reinforce and contradict each other.
What is going to compensate for the effect of the cuts? The Office for Budget Responsibility’s Economic and Fiscal Outlook, published in November, forecast that government consumption will fall 0.4 per cent and government investment will fall 15.3 per cent.
Household consumption is almost certainly not going to compensate for this. The OBR revised down their June forecasts, as they expect that household incomes will be depressed. They don’t expect wages to grow, with their projections not even reaching 1 per cent real growth till 2013; overall they expect household consumption to grow by just 0.1 per cent in 2011. The National Institute for Economic and Social Research thinks even that is too optimistic and does not expect any contribution to growth from consumer spending this year.
More detailed data on consumption support this conclusion. Major retailers and the British Retail Consortium are particularly gloomy about the likely impact of the VAT increase on consumer demand (though BRC believes that the sector will still create jobs). A report by the Centre for Retail Research estimated that the increase will cost the average family £520 – 98 per cent of retailers will ‘eventually’ pass the increase on to customers, two-thirds will do so straight away. This will depress sales in the first quarter of 2011 by £2.2 bn and cut growth by between 0.5 and 0.8 per cent.
The housing market is unlikely to act as a counterweight. The Bank of England’s agents report that pessimism about the economy is holding down demand for housing and it is likely that many people expect that the cuts will leave them with less money. The British Bankers’ Association reports that the annual growth rate in net mortgage lending has been trending downwards for some time and the main action is in remortgaging (mainly people changing the type of mortgage they have.) The number and value of mortgages are at very low levels, despite historically low interest rates. The Nationwide House Price Index has been moving south since the summer and the Nationwide expects the “slow drift down” of prices to continue in the first half of 2011 – and possibly the second half as well.
It is hard to be optimistic about the contribution of trade. An increase in net trade (the amount by which exports exceed imports) would be contrary to this country’s historic tendency to suck in imports and the third quarter balance of payments figures showed a deficit of £9.6 bn. The deficit in trade in goods was the highest ever recorded, only partially compensated for by an increase in the surplus in services. It is true that exports grew strongly, especially in manufacturing (exports of finished manufactured goods were nearly one fifth higher than in the third quarter of 2009) but import growth was even stronger. These disappointing figures were recorded despite a favourable exchange rate – if sterling appreciates this year the outlook for net trade will darken.
In 2010, business investment was much more encouraging. The latest figures, for the 3rd quarter, show an increase of 3.1 per cent from the previous quarter, 8.9 per cent from the third quarter of 2009. Total business investment is still more than one sixth lower than it was in the third quarter of 2007, however, indicating just how damaging the recession was. Manufacturing investment is only 0.8 per cent higher than it was in the third quarter of 2009, but the picture in services is rather better. Investment in distribution is up 21.6 per cent from the third quarter of 2009 (large chains have been taking advantage of low property prices to open new outlets); for other services the increase is smaller, but still healthy: 8.4 per cent. The OBR expects this performance to be maintained in 2011, rising by 8.6 per cent compared with 2010. The Bank of England’s agents’ reports rather support this: “investment intentions in both manufacturing and services continued to point to a moderate increase in investment over the next twelve months.”
Turning to output, the sense of a reasonably robust private sector is confirmed. The Insolvency Service reported a very low level of compulsory insolvencies (there have only been four quarters with lower figures in the past ten years) and the most recent figures from Experian show the business insolvency rate falling in November. The Index of Manufacturing in November was 5.8 per cent higher than in November 2009; the Markit Purchasing Managers’ Index for construction has been healthy and that for manufacturing very healthy.
The question is whether this will be maintained. The latest figures for the Index of Services show output 1.9 per cent higher in October than 12 months earlier but down 0.4 per cent on the previous month; similarly, the Index of Manufacturing, though well up on the year, was only 0.6 per cent up on the month; the wider Index of Production was 0.2 per cent down on the month. The Purchasing Managers’ Index for services (two thirds of our economy) has slowed down and Markit described the figures as “pointing to sluggish expansion in the near-term, we expect the sector to make a reduced contribution to UK economic growth in Q4. Moreover, the sector’s present growth profile suggests it is unlikely to generate any meaningful job creation and help to offset expected employment cuts in the public sector.”
OBR believes that there is only a one in ten chance of a double dip recession; NIESR is slightly less optimistic, putting the chances at one in six. These are still reasonably favourable – OBR believes the most likely result is that the economy will grow 2.1 per cent this year, NIESR 1.7 per cent.
On the other hand, there are rumbles of thunder over the horizon: the latest Quarterly National Accounts revised GDP growth for the third quarter downwards a little (the third time in a row that this has happened) and HMRC tax revenues came down.
OBR accept that their main scenario expects “a rebalancing of growth away from private consumption and toward business investment and net exports.” They recognise that this “has been a feature of many forecasters’ growth projections over recent years, but has not materialised.”
OBR’s ‘fan chart’ for GDP growth rightly indicates that the range of reasonable projections is very broad. Consumer confidence is low, construction is unlikely to make the large contribution to overall economic growth that it made in 2010 and growth in service output has been, as the Bank puts it, “modest” or “moderate”.
The private sector has performed very well this year but will it continue to do so? As the Bank of England’s agents have reported, exports have been the “primary driver” of growth in manufacturing; so it is significant that our main trading partners are also cutting public spending and holding down wages. On top of this there is the possibility that the Eurozone could take a further battering this year – the implications for UK exports would be severe.
It is possible that concerns about inflation may come to the fore this year. CPI inflation stands at 3.3 per cent, well above the Bank’s 2 per cent target. It seems that the Governor wants to avoid raising interest rates, but there is pressure to do so. That pressure will increase – the VAT increase will add 2 per cent to most prices and international fuel and commodity prices look likely to stay high or increase (the latter may not have a permanent effect on inflation, but they do strengthen the hands of inflation hawks.)
So it is possible (probable, even) that we will see calls for higher interest rates. If that happens the prospects for recovery will be worse. Some City forecasters expect interest rate rises and are already calculating the likely strengthening of sterling. Of course, this would strike at the strong export performance of recent months (we may still have a deficit, but it would be even worse with a stronger pound.) Obviously, business investment would decline and the impact on consumer demand would be catastrophic – households are already struggling to cope with wages that are falling real terms.
So what is the likely impact on the labour market? The Recruitment and Employment Confederation forecast that unemployment will rise from 2.5 to 2.65 million and the Chartered Institute for Personnel and Development puts it a little higher, at 2.7 million. Reed report that the number of job vacancies is already falling “steeply”, suggesting that the ratio of unemployed people to vacancies, already well over 5:1, is set to rise further. Last month’s employment figures showed an increase in unemployment, which rose over the politically important 2.5 million mark. Previously the overall employment and unemployment figures had been moving in the right direction, but this was fuelled by increases in part-time, temporary and self-employment. The number of people working in permanent full time jobs has been falling and the numbers in involuntary part-time and temporary employment have risen to record levels.
One of the surprising features of the last year has been the relatively small increase in private sector employment: 296,000, just 0.5 per cent. This may well be the other side of the coin of the comparatively small decrease in employment during the recession. Businesses did what they could to hang on to skilled and experienced workers; that meant that we didn’t see anything like the US explosion of unemployment, but it also means that firms didn’t need to take on so many workers in the recovery. The use of part-time and temporary jobs may also indicate that employers have been cautious about the strength of the recovery.
Overall, there is a risk of a second recession, but you have to say that the most likely outcome is a slow recovery, quite possibly slower than that predicted by the OBR. There is a definite risk of interest rate hikes that would do a great deal of damage.
Even with sustained growth, there is the danger of a jobless recovery, which would probably feed through to falling real wages, which would slow things down even more. One possibility is the emergence of a “left behind” cohort – people who lost their jobs (or never got one) during the recession and who fail to get jobs when everyone else is benefiting from the recovery.
Already, we have 943,000 unemployed people under 25 and 839,000 people of all ages who have been unemployed over 12 months – people who have had the Future Jobs Fund withdrawn and who face severe benefit cuts.
It’s a very uncertain picture, but most of the possible outcomes don’t look too appetising.