The shape of things to come

Today’s GDP data confirmed the recovery had taken quite a hold in Labour’s final months of office.

National output was up by a huge 1.1 per cent in the second quarter of 2010 with good growth across the board. Services output was up 0.9 per cent; government and other services rose 0.9 per cent, production output rose 1.0 per cent, manufacturing was up 1.6% and construction output was up a huge 6.6 per cent.

So, the question now is what kind of recovery lies ahead?

If growth carries on at last quarter’s pace we could start to see unemployment coming down fairly soon.  And this week there was some news to support the idea that economic momentum was gathering. The CBI’s industrial production figures showed this week that more firms were feeling a rise in local orders and exports, and retail sales, perhaps boosted by the World Cup, beat analysts’ expectations.

But a couple of big problems loom.

First, it’s hard to tell just how high growth needs to go before unemployment starts falling.

During the recession, firms have been ‘hoarding labour’. Instead of laying people off, workers have been put on shorter hours. As growth now returns, we’re seeing a sharp rise in productivity as output goes up – but hours stay fairly fixed. The ONS has a neat summary. Simply put, firms are getting more out their existing workers; they’re taking new people on. We just don’t know how long this ‘unhoarding’ is going to take.

Second, and just as serious is the weak state of confidence now acting as a hand-brake on business investment and consumer spending.

Abroad there are siren voices warning that coordinated austerity is damping down global growth, which could hit UK exports. Nouriel Roubini, an economist who can boast he predicted the crash warned this week global growth was heading for a sharp slowdown towards the end of the year and in testimony to the Senate Banking Committee this week, Fed chief Ben Bernanke said the economic outlook looked ‘unusually uncertain’.

Here at home, the minutes of July’s Monetary Policy Committee released on Wednesday, concluded that the economy had now “deteriorated a little”. Bank of England officials said that while the impact of the budget measures on the economy were “hard to gauge,” it was “likely that they had pushed down a little on the most likely path for output.” The medium-term outlook for growth “might have weakened too.”

None of this is good for confidence.

In the boardroom ’private sector thrift’ is still halting a flow of new funds into the kind of investment we need for future growth (on which there is a good discussion at the Economist, here) as British industry gets cold feet about the future. This, as Lord Skidelsky explained this week, is simply a consequence of the New Unease triggered by the Government’s economic plan;

“Actually…we have as a rule only the vaguest idea of any but the most direct consequences of our acts.” [wrote Keynes]. This made investment, which is always a bet on the future, dependent on fluctuating states of confidence. Financial markets, through which investment is made, were always liable to collapse when something happened to disturb business confidence.

So, why is business worried?

Quite simply because the government is about to sack potentially hundreds of thousands of public sector workers. If there aren’t private sector jobs for them to go to soon, then unemployment is going to liable to rocket.

We already know that consumers who are lucky enough to have a job are not seeing the recovery fatten up their pay packets.  Last week we learned average earnings growth including bonuses decreased in the year to May 2010, from the April rate of 4.1 per cent to 2.7 per cent in May 2010. That doesn’t bode well for a bounce back in consumer spending.

Yet it could get even worse. The government’s economic plan needs a very fast revival in the private sector’s animal spirits to create jobs for potentially hundreds of thousands of lay-offs from the public sector. In Birmingham for example, a 9% cut to the city’s 156,000 public service workers could put unemployment to almost 18%. Without opportunities to go to, unemployment in towns and cities across Britain is set to spiral to levels seen in countries like Spain.