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Hold on tight, it’s the double dip

A double-dip recession remains possible and with it far higher unemployment

The recession in the UK trundles along, much to the amazement of many. On 22 December, the Office for National Statistics (ONS) made it clear that GDP in the third quarter of 2009 fell by a revised 0.2 per cent, compared to the preliminary estimate of -0.4 per cent. That gives six quarters in a row of negative growth. Output has dropped by slightly over 6 per cent since its peak. Various publications from the Bank of England over the Christmas period were also quite downbeat.

First, the Bank reported that lending to British businesses fell for the ninth straight month in October as firms continued to pay down debt rather than take on new borrowing. It also reported that annual growth rates across all business sizes continued to weaken; total net consumer credit flows remained negative; and demand for loans by both businesses and consumers was expected to remain "subdued" during 2010.

Second, the Bank's regional agents reported that investment intentions remained weak, with many firms planning to hold or reduce spending still further during 2010. Indeed, few contacts anticipated any marked increase in demand over the next few months. They reported that many small- and medium-sized firms had been rejected for finance or that the terms of their existing borrowing had been tightened.

Overly bullish

Third, the minutes of the Monetary Policy Committee's December meeting made it clear that it was very much in "wait and see" mode. The MPC expressed concern over the lack of growth in money supply and at the relatively weak growth in exports, given sterling's depreciation and the bounce-back in world trade.

Some media reports said these minutes suggested that the MPC was done with quantitative easing. How they would know this is unclear, and it is certainly not my reading of the situation: the committee quite rightly made it clear that it will respond to events as the data arrives and that it has not ruled out anything. These minutes are considerably less optimistic and more balanced than the November inflation report, with its overly bullish, and essentially unbelievable, growth forecasts.

In another upbeat assessment, David Smith in the Sunday Times argued that "best of all is the job market" and claimed that the unemployment numbers suggest the economy has been recovering for some months. I am glad he is so confident. He went on to say: "One of the worst labour-market forecasters, interestingly, has been Danny Blanchflower, formerly of the Bank of England's Monetary Policy Committee, who was appointed to the MPC for his labour-market expertise." Ooh, that hurt. Let me set the record straight.

Unemployment is lower than it would have been because of monetary and fiscal stimulus but will likely rise again in 2010 as the stimulus is removed. The Business Secretary, Peter Mandelson, announced university funding cuts of £398m for the coming financial year, with universities fined if they overreach their admissions quota. Youth unemployment will inevitably rise because of this ill-considered measure. It is probably a little early, therefore, to declare victory on the jobs front.

A further worry is that incomes are down. Non-labour incomes have fallen because of the low rates of interest on savings, and the latest release of the average weekly earnings index of pay in the private sector suggests that earnings growth has turned negative. Self-employment incomes, in all likelihood, have collapsed. So the pain has been shared more evenly than in previous recessions.

Unfortunately, earnings are not going to pick up any time soon. Chancellor Alistair Darling pledged to cap public-sector pay increases at 1 per cent. The latest monthly business survey by the British Chambers of Commerce (BCC) showed that 63 per cent of businesses are planning wage freezes or pay cuts next year, while 18 per cent are considering the removal of benefits, such as bonuses and gym membership.

Newly published ONS data also suggests that UK households have hugely increased their savings in order to pay off debts. The average household saved almost £300 a month in the three months to September 2009, the largest amount for any quarter ever. But lower incomes together with higher savings implies lower spending, and fewer jobs in the future.

The Bank of England's regional agents also noted that firms had relatively few plans to increase permanent staffing levels significantly. Apparently, a number of companies are to let headcount drift down by not replacing staff who leave, which is bad news for the class of 2010, which graduates this summer. A major risk, the agents noted, is that employment may fall further if the rate of insolvencies picks up sharply. This is plausible given the deterioration in firms' balance sheets.

Spending in reverse

The December BCC survey found that two-thirds of firms plan to operate at the same or reduced capacity levels in the first quarter of 2010 - a strong indicator that business believes that demand and the trading environment will remain uncertain. This evidence is consistent with the results of the BCC's November survey, in which firms reported that a lack of customer demand would be the biggest obstacle over the next year.

In the inimitable words of Yogi Berra, it ain't over till it's over.

But why has the UK labour market outperformed the US, where unemployment has risen to over 10 per cent? Wages are not more flexible in the UK and the shock has been greater over here, because of the relatively large size of the financial sector and the greater rise in house prices. Spending has been helped in the UK by the high proportion of tracker mortgage-holders, who have benefited from low interest rates. But this will go into reverse when rates are increased. We entered recession after the US and will likely emerge later, and there is probably quite a lot more pain to come on the jobs front when the fiscal stimulus is removed. I hope I am wrong.

In his New Year message, the director general of the CBI, Richard Lambert, noted that many businesses are still worried about the possibility of a double-dip recession and what that would mean for jobs. So am I.

David Blanchflower is the Bruce V Rauner professor of economics at Dartmouth College, New Hampshire, and the University of Stirling


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David Blanchflower is economics editor of the New Statesman and professor of economics at Dartmouth College, New Hampshire

This article first appeared in the 11 January 2010 issue of the New Statesman, Obama: the year of living dangerously

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Q&A: What are tax credits and how do they work?

All you need to know about the government's plan to cut tax credits.

What are tax credits?

Tax credits are payments made regularly by the state into bank accounts to support families with children, or those who are in low-paid jobs. There are two types of tax credit: the working tax credit and the child tax credit.

What are they for?

To redistribute income to those less able to get by, or to provide for their children, on what they earn.

Are they similar to tax relief?

No. They don’t have much to do with tax. They’re more of a welfare thing. You don’t need to be a taxpayer to receive tax credits. It’s just that, unlike other benefits, they are based on the tax year and paid via the tax office.

Who is eligible?

Anyone aged over 16 (for child tax credits) and over 25 (for working tax credits) who normally lives in the UK can apply for them, depending on their income, the hours they work, whether they have a disability, and whether they pay for childcare.

What are their circumstances?

The more you earn, the less you are likely to receive. Single claimants must work at least 16 hours a week. Let’s take a full-time worker: if you work at least 30 hours a week, you are generally eligible for working tax credits if you earn less than £13,253 a year (if you’re single and don’t have children), or less than £18,023 (jointly as part of a couple without children but working at least 30 hours a week).

And for families?

A family with children and an income below about £32,200 can claim child tax credit. It used to be that the more children you have, the more you are eligible to receive – but George Osborne in his most recent Budget has limited child tax credit to two children.

How much money do you receive?

Again, this depends on your circumstances. The basic payment for a single claimant, or a joint claim by a couple, of working tax credits is £1,940 for the tax year. You can then receive extra, depending on your circumstances. For example, single parents can receive up to an additional £2,010, on top of the basic £1,940 payment; people who work more than 30 hours a week can receive up to an extra £810; and disabled workers up to £2,970. The average award of tax credit is £6,340 per year. Child tax credit claimants get £545 per year as a flat payment, plus £2,780 per child.

How many people claim tax credits?

About 4.5m people – the vast majority of these people (around 4m) have children.

How much does it cost the taxpayer?

The estimation is that they will cost the government £30bn in April 2015/16. That’s around 14 per cent of the £220bn welfare budget, which the Tories have pledged to cut by £12bn.

Who introduced this system?

New Labour. Gordon Brown, when he was Chancellor, developed tax credits in his first term. The system as we know it was established in April 2003.

Why did they do this?

To lift working people out of poverty, and to remove the disincentives to work believed to have been inculcated by welfare. The tax credit system made it more attractive for people depending on benefits to work, and gave those in low-paid jobs a helping hand.

Did it work?

Yes. Tax credits’ biggest achievement was lifting a record number of children out of poverty since the war. The proportion of children living below the poverty line fell from 35 per cent in 1998/9 to 19 per cent in 2012/13.

So what’s the problem?

Well, it’s a bit of a weird system in that it lets companies pay wages that are too low to live on without the state supplementing them. Many also criticise tax credits for allowing the minimum wage – also brought in by New Labour – to stagnate (ie. not keep up with the rate of inflation). David Cameron has called the system of taxing low earners and then handing them some money back via tax credits a “ridiculous merry-go-round”.

Then it’s a good thing to scrap them?

It would be fine if all those low earners and families struggling to get by would be given support in place of tax credits – a living wage, for example.

And that’s why the Tories are introducing a living wage...

That’s what they call it. But it’s not. The Chancellor announced in his most recent Budget a new minimum wage of £7.20 an hour for over-25s, rising to £9 by 2020. He called this the “national living wage” – it’s not, because the current living wage (which is calculated by the Living Wage Foundation, and currently non-compulsory) is already £9.15 in London and £7.85 in the rest of the country.

Will people be better off?

No. Quite the reverse. The IFS has said this slightly higher national minimum wage will not compensate working families who will be subjected to tax credit cuts; it is arithmetically impossible. The IFS director, Paul Johnson, commented: “Unequivocally, tax credit recipients in work will be made worse off by the measures in the Budget on average.” It has been calculated that 3.2m low-paid workers will have their pay packets cut by an average of £1,350 a year.

Could the government change its policy to avoid this?

The Prime Minister and his frontbenchers have been pretty stubborn about pushing on with the plan. In spite of criticism from all angles – the IFS, campaigners, Labour, The Sun – Cameron has ruled out a review of the policy in the Autumn Statement, which is on 25 November. But there is an alternative. The chair of parliament’s Work & Pensions Select Committee and Labour MP Frank Field has proposed what he calls a “cost neutral” tweak to the tax credit cuts.

How would this alternative work?

Currently, if your income is less than £6,420, you will receive the maximum amount of tax credits. That threshold is called the gross income threshold. Field wants to introduce a second gross income threshold of £13,100 (what you earn if you work 35 hours a week on minimum wage). Those earning a salary between those two thresholds would have their tax credits reduced at a slower rate on whatever they earn above £6,420 up to £13,100. The percentage of what you earn above the basic threshold that is deducted from your tax credits is called the taper rate, and it is currently at 41 per cent. In contrast to this plan, the Tories want to halve the income threshold to £3,850 a year and increase the taper rate to 48 per cent once you hit that threshold, which basically means you lose more tax credits, faster, the more you earn.

When will the tax credit cuts come in?

They will be imposed from April next year, barring a u-turn.

Anoosh Chakelian is deputy web editor at the New Statesman.