Economic commentary - October 2009

The UK could already have exited the 2008/2009 recession, but economic recovery remains precarious with a relapse back into recession possible. Against this background, reward issues are assuming a central importance, says XpertHR benchmarking editor Michael Carty.

For yet another month, pay awards are plumbing the depths of record lows and unemployment is on the rise. But at the same time evidence continues to emerge that the UK economy is "slowly and uncertainly" making its way towards a recovery from the 2008/09 recession, as my colleague Mark Crail noted in last month's economic commentary.

Mixed prospects for UK economic recovery

However, UK economic recovery is looking ever slower and more uncertain. Recent weeks have seen a number of commentators express varying degrees of caution as to the UK's prospects. For example:

• While global economic recovery "may be coming a little earlier and it may be slightly stronger" than previously expected, the UK is in serious danger of being left behind (PDF format, 1.14MB), says the OECD. The OECD expects the UK economy to contract by 4.7% in 2009, compared with its previous estimate of 4.3% fall in gross domestic product (GDP).
• The UK recession could already be over, according to latest GDP projections from the National Institute of Economic and Social Research (NIESR). This sentiment was echoed by Bank of England governor Mervyn King. King stated in a speech to the Treasury Committee (PDF format, 18.2K) that "there are now signs that growth has resumed in the third quarter".
• The UK economy is likely to experience a "jobs-light recovery", says the CIPD. It defines this as "modest sustained economic recovery sufficient only to enable a gradual increase in net job creation, with recruitment only slightly exceeding redundancies, continued high unemployment, and no prospect of a return to the pre-recession rate of unemployment before 2015 at the earliest."

Chancellor Alistair Darling, meanwhile, counsels a cautious approach. According to Darling:

"There are encouraging signs here and in other countries abroad but it's not time to break out the flags yet. We have to be cautious. You've got the biggest dip in 60 years, there are encouraging signs but after a dip of this magnitude it will take time to recover. There are a lot of obstacles to be negotiated but I believe that we will see a return to growth at the turn of the year."

One of the biggest obstacles will be persistent unemployment, which is likely to prove significantly more sluggish than other economic indicators in emerging from its current doldrums.

Unemployment is on track to top three million...

Unemployment is a lagging indicator, meaning that it will continue to rise, even once economic recovery is fully underway. It is therefore entirely unsurprising that unemployment figures published in September 2009 registered yet another sharp rise.

Latest official unemployment data (PDF format, 336.5K) show the following:

• The headline unemployment rate (on the ILO definition) once again rose sharply, hitting 7.9% over the period May to July 2009, up 0.7 percentage points on the rate for the three months to April 2009.
• The ILO unemployment level was 2.47 million, up 210,000 on the three months to April 2009, and up 743,000 on the same period a year ago.

There is consensus among economic commentators that unemployment remains on course to top three million. For example, the latest economic forecast from the British Chambers of Commerce (BCC) (PDF format, 139.3K) predicts "further increases in UK unemployment, but at a much reduced pace: from 2.43 million, or 7.8% of the workforce, in April-June 2009, to a peak of just over three million, or 9.6% of the workforce, around mid-2010."

...but the labour market is showing some signs of life

But before we get too carried away with the doom and gloom surrounding the labour market, a number of recent surveys suggest hiring activity might be about to bounce back:

• A weak resurgence in jobs might be about to take place, according to September 2009 data from Manpower. It says: "UK employers are reporting improved hiring plans for the first time in three years, giving job seekers a much needed glimmer of hope."
• Recruitment to both permanent and temporary positions is on the rise, suggesting that employers are becoming more confident in their hiring decisions, according to the Recruitment and Employment Confederation (REC) and KPMG. Latest REC data show the first rise in permanent appointments for 17 months and the first increase in temporary billings since July 2008.

Inflation still in the red for now

Retail prices index (RPI) inflation - the most important inflation measure for private sector pay setters - remains stuck in negative territory but is showing some signs of resurgence (PDF format, 202K), according to latest official data. RPI inflation ran at -1.3% in August 2009, up 0.1 percentage point on the figure recorded one month previously (-1.4% in July 2009). Many commentators expect RPI to continue to rise, returning to positive territory in the first quarter of 2010.

But the current prolonged period of negative inflation on the RPI measure is likely to have a pronounced impact on pay awards in the coming months. Movements in RPI inflation traditionally take a few months to affect movements in pay awards. The risk consequently remains of a negative wage-price spiral developing, in which negative inflation pulls down pay awards, in turn constraining workers' purchasing power and thereby forcing further cuts in prices.

Another significant development likely to affect pay awards in the closing months of 2009 is the latest national minimum wage increase.

National minimum wage rises by 1.2%

Today (Thursday 1 October  2009) sees the national minimum wage adult rate increase by 1.2%, taking it to £5.80 per hour.

Attention is already turning to what we can expect from the October 2010 national minimum wage increase. Interestingly, the Low Pay Commission refused to rule out a return to higher national minimum wage increases for October 2010 in its 2009 report (PDF format, 5MB).

Whatever the eventual level of the 2010 national minimum wage increase, it is certain that this year's low uprating will have a pronounced impact on the IRS headline pay award. But rather than pull whole economy pay awards down, current circumstances mean the 1.2% national minimum wage increase could serve to keep the headline pay award above zero, given the prevalence of pay freezes in the wider economy.

Indeed, when measured against the latest trends in pay awards, the 1.2% national minimum wage uprating could almost be argued to represent a highly competitive increase.

Pay awards remain depressed

Latest data from pay specialists at IRS show that pay awards remained depressed at 1% over the three months to 31 August 2009.

Pay freezes continue to account for more than one in three (37.6%) pay awards, although this is down slightly on the proportion recorded one month previously (41.3%).

A breakdown by broad industry sector reveals a striking difference between headline pay awards in the private sector and the public sector. Among private sector employers, the median pay award over the three months to 31 August 2009 was in line with the whole economy median, at 1%. In contrast, the median public sector pay award remained stable at 2.3% over the 12 months to 31 August 2009.

But this stability in public sector pay awards is unlikely to continue for much longer.

Storm clouds gather for 2010 public sector pay increase

Things look set to turn distinctly stormy with regard to public sector pay over the coming year. Public sector workers are likely to see their 2010 pay awards radically constrained by the recession and by the Government's need to make radical public spending cuts. Latest research from the Institute for Fiscal Studies (IFS) suggest that a Labour government would be likely to cut departmental spending by 8.6% between 2011 and 2014.

Gordon Brown's speech to the 2009 TUC conference on 15 September 2009 marked his first public use of the word "cuts" in reference to the Government's public spending plans for 2010 and beyond. Brown's speech also included a commitment to "agreeing realistic public sector pay settlements throughout" as one measure to help ensure "sustainable public finances", the BBC reports.

Public sector jobs also look set to fall victim to spending cuts, in turn exacerbating unemployment in the medium term. The TUC issued a grim warning at its conference that swingeing public sector job cuts could plunge the UK back into recession in 2010.

Are we facing a double-dip recession?

Perhaps the most worrying development over the past month is the rising chorus of economic commentators warning of the risk that any economic recovery could be very short-lived, and that a relapse back into recession is a distinct possibility.

For example, Royal Bank of Scotland chief executive Stephen Hester argued in a BBC interview that "a rather gradual emergence from recession" would be of greatest long-term benefit, as it would allow the UK economy to "rebalance". In Hester's view, too rapid a return to strong growth risks creating a situation "where the economy is highly unstable, or, worst case, we actually have another down period".

The starkest such warning comes from US economist Nouriel Roubini, who argues that the global economy faces "a big risk of a double-dip recession". In Roubini's words:

"There are now two reasons why there is a rising risk of a double-dip W-shaped recession. For a start, there are risks associated with exit strategies from the massive monetary and fiscal easing: policymakers are damned if they do and damned if they don't. [...] Another reason to fear a double-dip recession is that oil, energy and food prices are now rising faster than economic fundamentals warrant, and could be driven higher by excessive liquidity chasing assets and by speculative demand."

Pay awards could play a key role in UK economic recovery

The risk of heightened inflation mentioned by Roubini - and underlined by warnings from the Bank of England's Monetary Policy Committee that inflation could rise "sharply" in the immediate future (PDF format, 91.7K) - is worrisome for those involved in pay setting, particularly for those currently engaged in negotiating pay settlements for January 2010.

It can be argued that rising prices are less of a problem for workers and the wider economy if wage growth can keep pace with or even outpace inflation.

The headline pay award has collapsed to unprecedented lows over recent months, but nonetheless remains well ahead of the current negative rate of RPI inflation.

A strong resurgence in inflation could therefore produce a vicious circle, helping to slow or even reverse economic recovery. As we noted above, pay awards are likely to remain weak in 2010, and could well collapse further as the delayed impact of current negative RPI inflation feeds through, even as the economy recovers and inflation rises.

And if pay awards cannot keep pace with inflation, consumer spending will be further constrained, with potentially dire consequences for future economic growth.

Any ongoing weakness in pay awards could also result in discontent among workers. Private sector employers who have frozen pay during the first half of 2009 are likely to come under increasing pressure from workers not to freeze pay for a second consecutive year if business starts to pick up, according to FT.com.

Pay awards will play a key role in economic recovery (or otherwise) over the coming year.
It is therefore more important than ever that pay practitioners ensure their decisions are informed by the most up-to-date and reliable benchmarking data, for the good of their own organisation and for the wider economy.

• Key bargaining statistics on pay, prices and employment for October 2009