Brace yourself for the hurricane

Three of the most important sectors of the economy are slowing sharply, making a double-dip recessio

Last weekend was the Labor Day holiday in the United States. We headed south to New Jersey, while everyone else was heading north to
New Hampshire. Don't ask why. We ended up getting lost, mostly because the father-in-law won't go on toll roads as a matter of principle. He would rather spend an extra $10 on gas than pay a $1 toll, and he isn't even Scottish! On the way to the beach, by mistake, we ended up driving down the unforgettable Main Street of Paterson, New Jersey, of Rubin "Hurricane" Carter and Bob Dylan fame. Not that scenic.

Because of worries about Earl, the hurricane that wasn't, there were fewer people on the beach and boardwalk at Seaside Heights than we expected. But the waves were up and the surfers were out and it was still packed. It's just along the coast from Asbury Park, Bruce Springsteen's home town. The Jersey shore is quite an experience: you have to pay $10 per person per day to get on the beach, and No Dogs Ever. We even bought a pizza one yard across. The sun shone, but it was difficult to forget the gloomy economic outlook.

Slow before the storm

The news from the Markit/CIPS Purchasing Managers' Index in the UK, released at the beginning of the month, was bad. The surveys of the service, manufacturing and construction sectors are good indicators of business confidence. A reading of 50 implies no change; above 50, expansion; below 50, contraction.

The recovery of the UK service sector continued to lose momentum in August. The services index (shown alongside the manufacturing and construction indices on the chart) was down to 51.3 from 53.1 in July, indicating that activity rose at a much slower rate than seen earlier in the year. New business activity also slowed.

In response, service-sector companies cut employment numbers at the strongest rate since last October.

David Noble, chief executive of CIPS (the Chartered Institute of Purchasing and Supply), said that "stuttering growth is causing considerable disquiet in the services sector and doesn't bode well for employment levels . . . Austerity measures and the upcoming increase in VAT appear to be weighing down on confidence."

Recovery in manufacturing continued in August, but the growth in production, new orders and employment slowed further than in pre­vious months, despite a highly competitive exchange rate. The index fell from 56.9 in July to 54.3, its lowest level since last November.

The growth of UK construction also weakened sharply. The index fell from 54.1 to 52.1, led by a slowdown in residential construction. The expansion rate of new orders weakened for the third successive month. Jobs continued to be cut. Confidence in the sector improved slightly, though concerns over public spending cuts remained.

The slowdown in construction was confirmed by the latest forecasts from the Construction Products Association (CPA), published on 6 September. The CPA suggests that construction is heading for a double dip and will be the first major industry sector to fall back into recession following a temporary recovery in the first six months of this year. The CPA forecasts that, despite strong growth in the spring and early summer, output will fall in the remaining months of 2010 and the decline will continue into the first part of 2011.

Figures from the Office for National Statistics showed that the total volume of new construction orders in the second quarter of 2010 fell by 14 per cent compared with the first quarter, and by 9 per cent compared to the same period in 2009. The only sector showing a growth in new orders was private industrial.

According to the CPA's economics director, Noble Francis, the implications of the data "are clear. The double-digit fall in construction new orders will lead to a fall in construction output near term; and with construction accounting for around 9 per cent of GDP, this can only delay recovery for the economy as a whole."

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Jonathan Loynes of Capital Economics said: "The three major sectors of the economy are now slowing sharply in tandem. The dangers of a double dip are growing alarmingly."

There was further bad news for the Chancellor in a joint document from the International Monetary Fund and International Labour Organisation, which argued that premature fiscal consolidation could damage growth and lead to even larger deficits and debts. "The most effective way to reduce deficits and debt ratios is likely to be through sustainable growth," the document stated. "A strong and sustained expansion would boost tax revenues and lead to lower expenditure on unemployment benefits and other social protection expenditures."

It added: "Abrupt shifts in fiscal policy stances, in many countries at the same time, could destabilise recovery and weaken future growth. A credible and gradual return to fiscal stability over several years is likely to be a more successful strategy . . ."

Dangerous gamble

The recovery is clearly slowing in the UK, where the housing market seems to be turning down again. Nationwide reported that house prices had fallen by almost 1 per cent in August, and poor lending data suggests more house-price drops are on the way.

The latest data on US jobs was also bad news. Unemployment increased to 9.6 per cent, while non-farm payroll employment changed little (-54,000) in August. President Obama is likely to announce further stimulus measures shortly, but Britain's Chancellor, George Osborne, is doing the opposite. This is a giant risk, without historical precedent.

On 2 September, Martin Wolf argued in the FT: "If the government were wrong on its gamble on recovery through retrenchment, the result would be a disaster for the country, not to mention the coalition." Even Boris Johnson has expressed worries about a double dip. The data suggests that an economic hurricane is barrelling down on the British Isles. And the chances are this isn't going to be a sideswipe. It's heading straight for the coast. Watch out.

David Blanchflower is a labour economist and a professor at Dartmouth College, New Hampshire, and the University of Stirling