Low growth; more jobs?

Over the ten complete quarters that the current UK government has been in power, economic growth has been minus 3%, but total employment has risen by 1%.  For the last calendar year, the data show the size of the economy as unchanged but total employment up by over 550,000 or about 1.6%.  In contrast to the jobless recoveries seen in many Western countries after the 2001 downturn, the UK is experiencing a job-creating recession that is the cause of great head-scratching amongst economists.

Productivity is defined as total output divided by the amount of labour used to produce that output.  It is increasing productivity that produces the increases in the standard of living within an economy.  Historically, productivity growth in the UK economy has averaged about 1.5% per annum, but over the last ten quarters, the UK’s productivity has been averaging minus 1.5% per annum – indicating that the overall standard of living in the UK is declining.

Two sectors in particular account for much of the fall in productivity.  First, North Sea oil output has been in decline for some time now, and requires more effort and resource to produce that declining output.  Secondly, the banking sector (which delivered dramatic productivity growth before 2008) has seen a dramatic fall in output, with little change in total employment.  Many highly-paid bankers have lost their jobs, but the banks have had to hire just as many people in the compliance, risk and legal areas to deal with the aftermath of the banking crisis.

It is also undeniably true that the UK labour market has become very flexible with many businesses making much more use of variable pay structures through bonus systems, meaning that labour costs can be initially lowered by reducing the variable element of compensation, rather than immediately reducing the size of the workforce.  There are also many examples of businesses where workers have agreed to lower wages and benefits, to maintain their jobs.  Average wage growth in the UK has been below inflation for the last four years, so real wages have been falling steadily.

The statistics of the numbers of people employed also show a steep increase in the numbers of self-employed.  However, many of these are actually working very few hours, and so the official data show them as employed but in fact with very little economic output.

Elsewhere, surveys indicate that there is a degree of labour hoarding going on within companies, who fear that by reducing their workforce, they may lose key skills that they might not be able to replace in an upturn.  This however becomes progressively more difficult to maintain as time passes.  It also acts as a potential overhang to the unemployment rate and restrains business and consumer confidence.

The paradox of a job-creating recession reinforces the views and sentiments that were set out in our 2013 investment outlook: 2013 – Limited Growth and New Monetary Policy Regimes .  The UK economy is likely to continue to struggle in 2013.  However, the combination of (i) a governing coalition in the second half of its life and needing some positive economic news, and (ii) the summer arrival of a newly-imported Governor of the Bank of England, who is generally regarded as being much softer on inflation than Lord King, could well lead to a new direction in economic policy, which would bring long-term inflationary consequences.  We continue to recommend positions in index-linked gilts and gold for most investors, to act as a portfolio insurance policy against these inflationary possibilities.

The UK‘s choice – Perseverance or Printing

The UK economy grew by 1.0% in the third quarter, the fastest quarterly growth rate for five years.  After several quarters of negative data and a slump into double-dip recession, this would appear, at first sight, to be very good news.  Though the news is welcome, it cannot yet be described as good. First there are two, significant one-off items that should be stripped out; the Diamond Jubilee holiday last June is estimated to have reduced the economy by 0.5% in the second quarter.  Absent anything else happening, there would have been a statistical rebound in growth of that amount in the third quarter.  Additionally, in August the sales of Olympic tickets were estimated to have contributed 0.2% to economic growth.  This leaves 0.3% as the underlying figure for economic growth once these have been taken into account.  Rather surprisingly, in an age of government austerity, the increase in output of government services accounted for 0.36% in the third quarter, which leaves the non-government sector still in decline!

A clearer view would appear from looking at the data over the last twelve months as a whole.  Over this period, growth in the economy has been essentially zero, as it has been since the third quarter of 2008 when Lehman Brothers collapsed.  Four years of zero growth is a far better description of what has occurred than the sequence of recessions and recoveries that media headlines would imply.

The number of people employed in the UK recently reached an all-time high, beating the previous record set in 2007. However, the UK economy is actually 3% smaller than at the time of that peak in employment – this implies that productivity (the amount of output produced for each worker) in the economy has actually been falling, which is very unusual, and has been causing much head-scratching amongst economists.  The explanation comes from two sectors.  First, North Sea oil production has peaked and is becoming progressively more difficult and expensive to produce, so productivity is in decline.  The second area is financial services;  over the last five years there has been a 16% fall in measured output from banks and insurance companies with no significant decline in employment.

In a recent speech in Cardiff, Mervyn King, the Governor of the Bank of England, made it very clear that he believes that this period of zero or very low growth is likely to continue for some years.  He stated that Western banking systems had still not recognised the full extent of bad assets remaining on the books of the banks. Until the banks do this and recapitalise themselves, monetary policy alone (including QE) was not going to be able to solve the economies’ problems.  The effectiveness of QE is really limited to offsetting some of the weakness in demand that this consolidation of the banking sector would generate, rather than generating economic recovery.

Lord King’s perspective is that the policy choice for the UK (and indeed the other indebted Western countries) is between Perseverance and Printing.  As befits a Central Banker, he believes that Perseverance is the best path back towards economic growth.  This requires enduring more (un-quantified) years of near zero growth (as the banking system corrects itself and consumers and governments cut back their spending so that they can reduce their debts), while the Central Bank supports the economy through QE.  The alternative of Printing, which he would not endorse, but has been hinted at by Lord Turner, a potential successor to Lord King next year, is one of “helicopter money”, in which newly created money is handed out to the public.  This is clearly the inflationary solution to the debt problems facing Western economies.  However, it is not a solution that is yet being promoted, but the concern must be that the longer the period of low or zero growth, the more that politicians will seize on such ideas as a means of creating employment and growth, and hence votes.

It is for this reason that gold should have a key part of everyone’s portfolios, as the insurance policy that Printing overcomes Perseverance through a long period without growth.

UK austerity and the UK economic miracle – some surprising data

The official data produced by the independent UK Office for Budget Responsibility supporting the recent Budget, showed up a surprising fact about UK government spending. The major focus of the Coalition Government since it came to power in 2010 has been the control of government spending and consequent reduction in the budget deficit from the £170bn (and 11% of GDP) it inherited from the previous government. Yet the official data show that in each of the two fiscal years that this government has been in office, current government spending has risen in real terms, that is to say after inflation has been accounted for, and that in a two year period when inflation has been permanently above the Bank of England’s 2% target due mainly to the increases in VAT, which are part of the deficit reduction strategy.

It could thus be argued that in the UK, austerity has not yet even begun. That would not be entirely fair, since the measure of current government expenditure excludes capital or investment spending by government. Investment projects are possibly the easier areas of government spending to cut quickly, and there have been large real reductions in non-current government spending. Further, some parts of current spending were permitted to grow in real terms – these were health spending and overseas aid. In addition the automatic economic stabilisers of rising welfare entitlements and rising interest costs on the national debt, have meant that economic weakness tends to boost current government expenditure. Most areas of government spending have seen austerity cuts (with many more to come over the next few years), but for real government spending as a whole, there has been no reduction.

In fact history suggests that such a goal is very difficult to achieve. Mrs Thatcher’s government from 1979 to 1990 did not manage to reduce real government spending, and since then it has risen every year. In nominal (actual cash) terms UK government spending has never fallen year-on-year since 1945..

For the government, the plans for current spending reductions in the next few years imply that the really hard (and unpopular) work only starts now. This may well affect their poll ratings significantly for the next year or two without a clear improvement in economic growth. For the Opposition Labour Party, their claim that the government has been cutting too far and too fast, and that a slower pace of cuts would be more effective do not stand up to any scrutiny as real government spending has not yet even started to fall.



HSBC compiled some fascinating data for economic growth amongst the major Western economies for the first decade of this century.

2001-2010 average annual % growth rate               Overall                              Per Capita

Japan                                                                                                0.8                                       1.6

UK                                                                                                      1.5                                         1.2

Germany                                                                                           0.8                                        0.8

US                                                                                                       1.6                                         0.7

France                                                                                                1.2                                         0.6


There are several surprises here, first Japan’s “lost” decade, the subject of many lectures from Americans and Europeans, is actually a demographic issue. Per capita growth in Japan was double that of the US and Germany and France – Japan has for some time been very aware of its ageing issues and has invested heavily in automation and robotics in order to boost its productivity. Secondly the strength of the US economy is also mostly about demographics – in this case both a younger population than the other countries, arguably reflecting a greater openness to immigration.  Finally the strong performance in both columns of the UK economy – a recent paper from Corry, Valero and Van Reenen confirms this strong  performance and attributes it to service sector productivity factors such as technology and regulation (though NOT banking regulation!). Perhaps history will judge Gordon Brown’s stewardship of the UK economy in this decade more favourably than current commentators.