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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