Economic commentary February 2011: Putting 'Osbornomics' to the test

One month in, and it would appear that 2011 is set to be a pivotal year for the UK economy. The Coalition Government's package of economic austerity measures is now kicking into gear, and its implications are beginning to be felt across the economy.

Writing in the Guardian, John Ross described the Coalition Government's economic strategy as "Osbornomics." Ross defines Osbornomics as follows:

[T]he Coalition's claim that increased spending can only increase the deficit and so drastic spending cuts are required.

Here, we focus on the impact of Osbornomics, assess the latest readings from key economic indicators (showing a collapse in growth coinciding with sharp rises in unemployment and inflation), and also look at how HR is dealing with the challenging economic circumstances.

UK economic recovery goes into reverse

The past month has brought the scale of the economic challenge facing Osborne into stark relief.

Economic recovery has gone into reverse, with latest data showing a collapse into negative territory in the closing months of 2010. Gross domestic product (GDP) registered growth of -0.5% in the fourth quarter of 2010 (down 1.2 percentage points from a revised estimate of 0.7% GDP growth for the third quarter).

The sharp fall in GDP growth will inevitably fuel fears that a double-dip recession could be in prospect for the UK economy. Earlier in the month, the CEBR estimated that the risk of a double-dip recession had doubled to one in five in January 2011 (up from one in ten in October 2010).

However, a double-dip recession is not necessarily guaranteed. Speaking to the Guardian, Chris Williamson of Markit argued that the GDP figures had been depressed by the extreme weather conditions experienced in December 2010, and could therefore be prone to upward revision over the coming months. According to Williamson:

The headline number overstates the extent to which growth has weakened. The coldest December for a century affected many businesses, especially in construction, and accounted for much of the decline.

Cameron: "A lot of the heavy lifting will happen in 2011"

At the start of the year, British Chambers of Commerce (BCC) chief economist David Kern offered his prescription for successful economic recovery:

The MPC [The Bank of England Monetary Policy Committee] and the Government must act forcefully to support growth.

The MPC did its part to meet the BCC's wishes. It maintained its current expansionary policy by holding interest rates at 0.5% for yet another month. Interest rates are fast approaching their two-year anniversary at this record-low level, although circumstances could yet force an increase.

The Government, meanwhile, could not be accused of failing to take forceful action. During January 2011, it confirmed the abolition of the default retirement age, set about reforming the employment tribunal system and announced sweeping NHS reforms. It also issued a wave of upbeat rhetoric on UK economic prospects:

• Prime Minister David Cameron stated in his New Year message that - as regards rebalancing the economy - "a lot of the heavy lifting will happen in 2011," but promised that austerity would result in a "really bright future."
• Chancellor George Osborne bookended January 2011 with robust defences of his economic strategy. At the start of the month he said that the January 2011 VAT rise will "increase employment." At the end of the month, he asserted that "we will not be blown off course by bad weather," and promised that the "ambition" of his 2011 Budget (to be delivered next month, on Wednesday 23 March 2011) is "to turn the tide on the forces of stagnation."
  

Osbornomics: Will the gamble pay off?

Many economic commentators continue to question the advisability of Osbornomics. For example:

• David Blanchflower argues that "the UK was never in a danger zone. But we may well be in one soon."
• The UK's austerity measures are "unsustainable," and cannot "be implemented without pushing the economy into a recession," argues hedge fund manager George Soros.

But research from the Financial Times suggests that this is not necessarily the consensus view. Its poll of 78 economists (including 10 former MPC members) found that many consider Osborne's approach "a big gamble, but one that was likely to pay off," and that "the recovery had sufficient momentum to avoid a deep double-dip."

If Osbornomics is a gamble, what will determine its outcome? Sunday Times economics editor David Smith identifies the critical factors:

There are two big questions about Britain's economy this year. One is whether inflation will come down after yet another 'temporary' blip. The other is whether the recovery can survive both tax increases and spending cuts.

These factors are finely balanced. Economic growth could bounce back in 2011. But things could equally go awry.

Inflation: Are we "sitting on an inflationary volcano"?

Persistently high inflation represents a headache for policymakers, with rising commodity prices keeping inflation elevated even before the inevitably inflationary impact of the January 2011 VAT increase kicks in. The crisis in Egypt is also causing a sharp increase in oil prices, which will inevitably feed through into inflation. Latest official data on inflation show a sharp rise on key measures:

• Retail prices index (RPI) inflation rose to 4.8% in December 2010. This is double the rate recorded a year ago (2.4% in December 2009).
• Consumer prices index (CPI) inflation hit 3.7% in December 2010 (compared with 2.9% in December 2009).

Yet the current levels of inflation are comparatively subdued by historical standards. Writing in the Observer, William Keegan points out that "this kind of inflation is not in the same league as that of the 1970s or even the 1980s. The real worry continues to be the delicacy of the recovery."

The risk remains that if elevated inflation persists, the MPC could be perceived to have lost control of inflation. This is by no means impossible: Ray Barrell of NIESR warns that "we could be sitting on an inflationary volcano."

Many commentators are concerned that persistently high inflation could force the MPC to hike interest rates in order to rein in inflation, a policy which could in turn halt economic recovery.

The MPC is currently holding its nerve, by refusing to raise interest rates in order to combat inflation. Indeed, MPC member Adam Posen contends that rising unemployment and the impact of austerity measures on consumer spending will inevitably drive CPI inflation "well below" the Government's 2% target rate.

Nonetheless, a rate rise in the near future cannot be entirely ruled out.

Will high inflation result in demands for higher wages?

The level of pay awards is of critical importance to UK economic recovery, according to BBC economics editor Stephanie Flanders.

Ongoing high inflation is reducing UK workers' purchasing power. She argues that it is therefore possible that the resulting "squeeze in incomes will eventually lead people in work to demand - and obtain - higher wages to compensate them for their losses."

Flanders believes that a key factor in whether the MPC is forced to raise interest rates is therefore the extent to which high inflation feeds into upward wage pressures.

Higher wage increases would constrain private sector job creation, in turn keeping unemployment high. But it would also have other consequences. Flanders says:

A broad-based rise in wages would also, almost certainly, trigger a response from the MPC. Naturally, the committee that sets Britain's official interest rates will be watching the inflation figures over the next few months. But they will be looking just as closely at what happens to wages.

These sentiments were echoed by Bank of England Governor Mervyn King in a speech on Tuesday 25 January 2011. King said:

[T]here are upside risks to inflation. Further rises in world commodity and energy prices cannot be ruled out, and attempts to resist their implications for real take-home pay by pushing up wages would require a response by the MPC.

Pay is therefore pivotal in 2011. However, some commentators argue that there is little likelihood of a sharp recovery in pay awards this year:

• "[T]here is no likelihood of an explosion in wage inflation," given the public sector pay freeze and hiring embargo, according to economist and former MPC member David Blanchflower.
• "[G]iven the rise in VAT and other price rises this year, real wages are likely to fall again. As a result, in 2011 real wages are likely to be no higher than they were in 2005. One has to go back to the 1920s to find a time when real wages fell over a period of six years." This is according to Mervyn King in his 25 January 2011 speech.
• The long-established relationship between RPI inflation and pay awards is "strained" in 2011, as affordability concerns are preventing private sector employers from matching RPI in pay settlements, says XpertHR pay editor Sheila Attwood.

Pay awards: Is 2% the "new normal"?

But while employers are failing to match inflation, whole-economy pay awards are nonetheless displaying a renewed stability. This is in sharp contrast to the collapse in the headline pay awards seen in the recession.

The median pay award was worth 2% over the three months to 31 December 2010, according to latest analysis from the XpertHR pay databank. This is 2.8 percentage points below RPI (currently at 4.8%).

The headline pay award has now held at 2% for each of the last six rolling quarters. But whether it proves as enduring as the protracted stability at 3% seen between April 2003 and November 2006 (subscription required) remains to be seen.

Will we see an erosion of employment rights in 2011?

An erosion of employment rights could be seen in 2011 as a by-product of austerity measures, argues CIPD chief economic advisor John Philpott. Philpott says:

I suspect that as 2011 unfolds there will be growing frustration that the rate of private-sector job creation is inadequate to offset mounting public-sector job cuts, and a related tendency for the business lobby to use this to support calls for a watering down of employment rights. Such calls should be resisted.

It is interesting to consider this commitment to combating any "watering down of employment rights" in light of the CIPD's August 2010 recommendations that the Government consider the removal of the right the right to strike from a significant section of the workforce.

The CIPD's Platform 2011: A Blueprint for Growth (PDF format, 5.83MB) report, which sets out its policy recommendations for the coming year, contains no mention of the right to take strike action. But as we shall see below, the Coalition Government has signalled that it is willing to consider amending the right to strike, if it deems such action necessary.

Unemployment rises, with young hit hardest

The full impact of public sector redundancies resulting from austerity measures has yet to feed through to unemployment figures. But the first official unemployment data release (PDF format, 330.9K) to be published by ONS in 2011 shows evidence of an unwelcome upward trend in unemployment on many measures.

Youth unemployment in particular is skyrocketing. The unemployment rate for 16 to 24 year olds rose to 20.3% in November 2010. This is "the highest figure since comparable records began in 1992," according to ONS.

Other key data on unemployment include the following:

• The headline unemployment rate (on the ILO definition) rose to 7.9% between September to November 2010. This is up 0.2 percentage points when compared with the rate seen in the previous rolling quarter (7.7%).
• The ILO unemployment level was 2.50 million over the period September to November 2010, up 49,000 on the previous quarter.
• The employment rate stood at 70.4% in the three months to November 2010 (down by 0.3 percentage points from 70.7% in the previous rolling three-month period).
• The inactivity rate rose to 23.4% over the three months to November 2010, up 0.2 percentage point on the quarter. The number of working age people who are inactive hit was 9.37 million.

Unemployment will inevitably climb higher over the coming months, according to some commentators:

• Austerity measures mean "a slower recovery and an even longer delay before unemployment falls," in the view of Joseph Stiglitz.
• The "unprecedented" size and speed of cuts could result in 200,000 council job losses in England (comprising 150,000 directly employed council workers and 50,000 contractors/agency staff), according to GMB national officer Brian Strutton.

The longer-term consequences of Osbornomics

The GMB union is not the only voice to comment on the pace and scale of the programme of spending cuts and radical reforms being enacted by the Coalition Government. Rick - pseudonymous author of the Flip Chart Fairy Tales blog - argues that "Britain does not need to be bounced into a distressed fire-sale reform of public services just because David Cameron is in a hurry." In a separate post, he expresses particular concern over the NHS reforms.

Debate has also been rife as to the implications of economic austerity measures for the social fabric of the UK. For example, some argue that reduced investment might affect the economic wellbeing of major UK cities. Writing in the Telegraph, Professor Colin R Talbot claimed that - as public spending cuts begin to be felt in Manchester - the city is starting to resemble "an episode of Life on Mars."

It remains to be seen if the spending cuts central to Osbornomics will be greeted with renewed popular militancy in the shape of strike action and wider social unrest. In a January 2011 article on this topic for Holyrood magazine (which covers the Scottish Parliament and policymaking in Scotland), I noted that such militancy cannot be ruled out:

With levels of union membership and of labour disputes currently low, strikes and wider social unrest might seem unlikely in 2011. But it is by no means impossible that they could occur. [...] A year ago, few would have predicted the violent scenes at the December 2010 student protests in Westminster. Similar reactions from the UK workforce might seem unlikely at present, but cannot be ruled out as 2011 unfolds.

Should widespread strike action materialise, Osborne has indicated that he is willing to face the unions head on. Speaking at last week's World Economic Forum in Davos, he said that the Coalition Government is "prepared to consider changes to the law around strikes - as a last resort."

Benchmarking the HR agenda for 2011

But while the ultimate impact of austerity measures on the UK economy has yet to be seen, it seems certain that they will exert some degree of influence on the work of most UK HR professionals, whether directly or indirectly.

A major XpertHR benchmarking survey on HR roles and responsibilities (XpertHR benchmarking subscription required) assesses the current status of the UK HR profession, and its preparedness for the challenges ahead.

The XpertHR benchmarking research reveals that private sector HR is beginning to restore order after a turbulent couple of years (subscription required). Rebuilding employee engagement and morale are identified as top priorities for 2011, and there are also signs of a re-emergence of recruitment as a priority.

But the impact of Osbornomics means that public sector HR departments are only just beginning to experience challenges similar to those faced by their private sector counterparts during the recession. In the public sector, restructuring, change management, redundancies and other cost-cutting exercises top the HR agenda for the coming year.

• Key bargaining statistics on pay, prices and employment for February 2011