Economic commentary - August 2009

The summer holiday season is upon us, but the economic outlook is far from sunny, with pay awards and inflation in sharp decline while unemployment soars. Yet there remain reasons to be optimistic, says XpertHR benchmarking editor Michael Carty.

Last month, we looked at the desire among many economic commentators to accentuate the positive regarding the 2009 recession. But recent developments have been on the whole so dismal that even the most optimistic of commentators would be hard pushed to put a positive spin on the state of the economy at the start of August 2009.

As we stand now, there would seem to be a roughly equal possibility that things will either improve henceforth, or become significantly worse. And the strongest arguments for optimism point to a particularly unlikely source.

First the fair news...

The economic news has not been uniformly negative. Positive takes on the state of the UK economy to emerge over the past month include the following:

• "The worst of the recession is over," according to the British Chambers of Commerce (BCC). Their latest research detects "a marked strengthening in [manufacturers'] confidence following sharp declines over the previous two quarters."
• "The UK jobs market shows signs of life," according to the Recruitment and Employment Confederation (REC) and consultants KPMG.

Meanwhile, former Bank of England Monetary Policy Committee member David Blanchflower took a more measured view on the likely pace of economic recovery, stating that: "[W]e are probably out of the acute phase of the present recession, but the recovery is likely to be protracted."

...and then the foul

However, it is fair to say that recent weeks have seen the bad news significantly outweigh the good across a range of major economic indicators. For example, interest rates remain parked at a record low of 0.5%, while the news surrounding pay awards, inflation and unemployment keeps getting worse.

Pay awards showing unprecedented weakness in 2009

Bankers at Goldman Sachs might have enjoyed the spoils of a record bonus round in July 2009, but such largesse is conspicuous by its absence elsewhere in the reward landscape.

Latest IRS data show that the headline pay award - the median or midpoint in the range of pay awards monitored by Industrial Relations Services (IRS), part of the XpertHR group - for the three months to 30 June 2009 remains heavily subdued, at 1.3%.

But while the headline pay award shows unprecedented weakness, the picture at the lower end of the pay data is comparatively static. Over recent months, pay freezes have stayed contained at around one-in-three pay awards (accounting 37.4% of deals in the latest sample). And in spite of the wealth of headlines generated by high-profile pay cuts such as the 2.6% reduction in pilots' pay at British Airways, pay cuts actually remain rare. Pay cuts account for only a small handful of deals in the latest IRS data.

It would therefore seem unlikely at present that it will plunge down to zero, let alone fall into negative territory.

UK economy continues to shrink

UK economic growth - as measured by movements in gross domestic product (GDP) figures - registered a fifth successive quarterly fall in July 2009. Latest official data show that GDP decreased by 0.8% (PDF format, 100K) in the second quarter of 2009 compared with the first quarter. Yet this fifth successive quarterly fall in GDP growth can actually be interpreted as a comparatively positive development, as the rate of contraction appears to be easing.

But economic growth could soon return to positive territory. Recent reports from both NIESR and the Ernst & Young ITEM club set out their forecasts for GDP. Each expects negative economic growth in 2009, followed by a weak return to positive growth in 2010. However, the Ernst & Young report additionally notes that UK economic recovery could be greatly hindered by a full-scale swine flu pandemic.

Unemployment is on the rise...

The UK unemployment rate once again showed rapid and worrisome growth.

Latest official unemployment data show the following:

• the headline unemployment rate (on the ILO definition) rose to 7.6% over the period March to May 2009, up 0.9 percentage points on the rate for the period December 2008 to February 2009; and
• the ILO unemployment level was 2.38 million, up 281,000 on the three months to February 2009, and up 753,000 on the same period a year ago.

Regarding the latest unemployment data, CIPD chief economist John Philpott comments:

"The latest official jobs figures offer a litany of wretched new records, with the unprecedented 281,000 quarterly (March-May) rise in unemployment [...] the most wretched of all. Any optimism that unemployment will peak below three million next year before the jobs outlook starts to improve would appear to have evaporated."

...while inflation plumbs the depths

Inflation continues to fall sharply (PDF format, 196.3K), according to latest official data published on Tuesday 14 July 2009. These figures showed that:

• consumer prices index (CPI) inflation has undershot the Government's 2% target rate for first time since September 2007, falling to 1.8% in June 2009; and
• retail prices index (RPI) inflation - the most commonly-used inflation among private sector pay setters - has plunged further into negative territory, dropping to -1.6% in June 2009. This is the lowest rate of RPI since records began in 1948.

Economic commentators surveyed by IRS believe that RPI will return to positive growth in 2010 as the Bank of England's Monetary Policy Committee (MPC) starts to raise interest rates once more and economic growth picks up. But of course none of this is guaranteed.

Are we facing a downward wage-price spiral?

The ongoing collapse in RPI gives rise to the possibility of a vicious circle affecting pay and prices. A downward wage-price spiral could potentially develop over the coming months, with negative inflation pulling down pay awards, in turn constraining workers' purchasing power and thereby forcing further cuts in prices.

This is an exact mirror image of the situation a year ago, when the overriding fear was of an upward wage-price spiral.

Public sector pay: 'equity of misery' for 2010?

The risk of a downward wage-price spiral could be exacerbated further by movements in public sector pay in the coming year. Ironically, this time last year, pay specialists at IRS were commenting that public sector pay awards (running at 2.5% in June 2008) were pulling down the whole economy headline pay award (which stood at 3.2% a year ago). Now, the ongoing stability in public sector pay awards (which remain at 2.5% in June 2009) is propping up the whole economy median.

But this stability in public sector pay is unlikely to last much longer. Chancellor Alistair Darling indicated in a recent interview with Sky News that he is in the middle of making tough decisions on the future course of public sector pay awards. Darling said:

"Public sector pay obviously has got to reflect prevailing conditions and, in particular, inflation has come way down. We also have to be fair with regard to people who work in the private sector, many of whom have seen their pay conditions tighten. We will decide on our pay policy over the next few weeks."

NASUWT general secretary Chris Keates vehemently rejected the suggestion of such constraints on public sector pay. Keates said:

"The idea that you have to have some equity of misery, that because the private sector is suffering, the public sector must too is disgraceful. What [the Government] is doing is not understanding the role of public services in a recession - to sustain and rebuild the economy."

The aforementioned David Blanchflower gave an equally stark warning against cutting public spending:

"If you want to transform a recession into a depression, go ahead and cut public spending."

Weighing up the recession: do bankers' bonuses hold the key?

So pay awards, interest rates and inflation are all plumbing uncharted depths, while unemployment shows record growth. But things still might not be as bad as they seem. An illuminating longer-term perspective on the 2009 recession (PDF format, 215KB) comes from Bank of England executive director of financial stability Andrew G Haldane.

Haldane describes the wild economic growth seen between 1985 and 2006 as "the golden era". The current recession has reversed this growth. As Haldane's puts it:

"[Between 1985 and 2006, b]anking became the goose laying the golden eggs. There is no period in recent UK financial history which bears comparison. The past two years have undone most of those gains."

Perhaps controversially, Haldane believes that a return to the levels of banking performance seen in the "golden era" hold the key to exiting the recession. Haldane says:

"As unfashionable as it may sound, it is important that banks' profitability picks up, sharply and durably, in the period ahead. From a systemic perspective, this is in the interests of both the financial system and the real economy."

If Haldane is right, this would suggest that the brightest ray of hope in the current economic gloom comes from the aforementioned resurrection of colossal bonuses at Goldman Sachs and a return to strong performance at many other investment banks.

So could it really be the case that bankers' bonuses got us into this mess, and that it will be bankers' bonuses that lead us out of it?

Key bargaining statistics on pay, prices and employment for July 2009 (NB: Link not yet live)