By Azad Zangana, European economist, Schroders
The biggest conundrum being considered by UK economists is the recent divergence between employment and GDP growth. While year-on-year growth has slowed markedly over the past year, annual employment growth has surged. It is very rare to see rising employment and falling GDP.
The initial response from economists has been to question the accuracy of the UK’s growth numbers, after all, they have been surprisingly weak for the past year. We have forecast weaker growth for some time, and so we do not believe that the strong employment data is compelling enough alone to question the accuracy of the GDP numbers. In our view, the fiscal numbers support the story of an economy in recession. As the government progresses with its austerity programme, the public sector has continued to reduce its headcount. However, the private sector has more than offset the loss in public sector jobs, leading to a net increase of 236,000 new jobs in the three months to June. Although the private sector has done its part in bringing down the rate of unemployment, the quality of the new jobs being created are not necessarily equal to the jobs that have been lost in the public sector.
The low rate of insolvencies could be to blame for the lack of job losses. Unlike the sharp rise in insolvencies seen during the relatively shallow recession of the early 1990s, the two most recent recessions were nowhere near as destructive. This is partly thanks to banks being more willing to renegotiate the terms of loans, but also thanks to monetary stimulus from the Bank of England in the form of interest rate cuts. A similar situation happened in Japan as it began its lost decade. Companies and more specifically banks were not allowed to fail, leading to zombie industries continuing to operate despite there being better use for the capital they employed. A corporate shake-out may have been favoured by past Conservative governments, but given the nature of the current coalition government and the climate of austerity, the government has had to look at alternative solutions. In July, the government launched the Funding for Lending Scheme, which is designed to incentivise banks to lend more to the real economy, through the provision of cheaper wholesale financing.
The Bank of England this month reported that £1.2bn was subsequently taken up by the banking sector. It is too early to tell if it will substantially boost lending and economic growth, however, we expect some increase in loans, which could help stabilise the economy going into the second half of the year. In our view, the government should continue to tackle the structural deficit (the proportion of the deficit that is not affected by the growth), but allow the cyclical part of the deficit to soften the downturn of the economy. At the same time, we believe that the government should attempt to use the near record yields it is enjoying to help boost investment in the economy. While the government is doing this by providing guarantees to some infrastructure projects, we feel that more direct action is required. The government has been reluctant to increase investment directly for fear of a negative reaction from investors. However, the recent strong performance of gilts versus US Treasuries and German bunds suggests investors are comfortable with the government’s austerity plans and outlook.
The government should consider more schemes where revenue streams can be legally tied to the repayment of special municipal bonds. We believe that such bonds would be in demand among the pension community, especially in this low yielding environment. The productivity puzzle in the UK cannot be explained by the disproportionate rise in part-time workers, or the rise in unpaid and government subsidised workers. However, the huge increase in the self-employed could be partly to blame as these workers tend to be less productive working individually compared to a collective in a firm. Another factor could be the smaller than expected rise in insolvencies, which has probably allowed less productive firms to survive longer than they should have. As for the government, the Funding for Lending Scheme has the potential to help stabilise the economy, but it should consider wider investment projects. Finally, the Chancellor should hold-off tightening fiscal policy further. If we are correct on our call of a Greek exit for next year, the UK economy will need all the support it can get.
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