2014 needs to see growth in both jobs and productivity


The economic context is very different from a year ago.  Entering 2013, the question was whether the UK would endure a “triple-dip” recession.  Economic forecasts kept pushing the recovery further into the future.  It is clear now that the UK economy is strengthening.  The independent economic forecast from the Office for Budget Responsibility (OBR), published alongside the Autumn Statement, revised its growth forecast for 2013 from 0.6% (made in March at the time of the Budget) to 1.4%.  This is a big revision that reflects the strong growth figures seen in the second and third quarters of this year.

The OBR forecast output growth of 2.4% in 2014.  Given the continued improvement we have seen during 2013 in a wide range of business confidence measures, there is a good chance this forecast will turn out to be an underestimate.

The risk of another crisis in the Eurozone appears to have diminished although it has not disappeared.  A politically-inspired crisis in Italy or Spain would still be a mighty challenge for the existing system.  The main domestic risk is that a recovery led by consumption and the housing market peters out once interest rates start rising, although this may be a more salient issue in 2015 or 2016.  Investment needs to increase, both for the immediate recovery and to generate the productivity gains that can sustain it.

Last year we talked about the “jobs enigma”, the ability of the UK labour market to generate jobs despite little or no output growth.  Perhaps we should be talking about the “jobs machine”.  A year ago, the OBR thought UK employment would reach 30 million in autumn 2015.  I said this might well happen before the next general election.  In fact, it’s already happened.  In the year to August to October 2013, the latest available figures, employment increased by almost half a million.

Since the Budget, the OBR appear to have changed their view about the employment potential of the UK economy.  Rather than seeing the employment growth of 2011 and 2012 as unsustainable, to be followed by a period of little employment growth while firms re-adjusted, they now expect jobs growth over the next five years.  In particular, employment growth of 300,000 in 2013 followed by a further million in employment over the period to 2018.  Some of this additional employment absorbs a growing population and increases economic activity among the labour force, but it is sufficient to bring unemployment down more rapidly than expected previously.  ILO unemployment is expected to reach 7% - the point at which the Bank of England intend to review the current stance of monetary policy – in the second quarter of 2015.

Even this revised view is probably an underestimate.  As noted above, growth could be higher than expected.  Indicators of recruitment intentions are all heading upwards and, in some cases, including our own Labour Market Outlook, to levels never seen before.  The claimant count has been falling very rapidly, down by over 230,000 in the last six months.  While we don’t understand precisely why it has fallen so much, it could be a lead indicator.  There are no signs yet of recruitment difficulties pushing up wage settlements.  So we could see employment rise by more than 300,000, perhaps by another half a million. If this turned out to be the case, the “magic” 7% unemployment rate will be reached during 2014.

2013 will be the fifth calendar year in a row when average earnings increase by less than prices.  This is unprecedented in at least the last seventy to eighty years, and possibly for much longer.  The OBR’s latest report shows this is because labour productivity – how much output is produced for each hour worked – fell in the early stages of the recession and has failed to recover.  Now, low productivity may be a consequence of our “jobs machine”.  If employment is growing when output is stagnant, productivity must be falling.  Compared with an alternative scenario of higher productivity (and pay for those in work), but a much higher level of unemployment (3 million +), this might still be seen as a beneficial outcome.

However, the lost productivity might also be because the recession did long-term damage to our growth potential, for example, by reducing the effectiveness of our financial system at channelling funds to business start-ups and investment.  The problem is that there is no clear understanding of what happened and this leads to uncertainty about how much spare capacity there is left for the UK to grow without causing inflationary pressures.

The OBR expect productivity growth to kick off in 2014 and to be maintained throughout the forecast period.  This seems a plausible assumption.  2014 will be the first year since 2007 when the economy grows by over 2%.  Businesses feel more confident about the future and this should lead to more investment in projects that will enhance productivity.

Resumed productivity growth means that the OBR expect earnings growth to increase from 1.5% in 2013 to 2.6% in 2014 and over 3% a year from 2015 onwards (see chart below).  However, the ONS average earnings series have been edging down during much of 2013 and our LMO data suggest that employers’ short-term expectations remain flat.  Given these data, it may take longer for wages to increase than the OBR expect.

 

As the chart shows, whether increased nominal earnings growth leads to increased real earnings depends on the measure of price inflation one chooses.  Using the Consumer Price Index (CPI), the OBR expect a small increase in average earnings in real terms in 2014 with more substantial increases thereafter.  However, using the Retail Price Index (RPI), average earnings are either flat or falling slightly in real terms all the way through to 2018.  This is because there is a big difference between the two measures of inflation, presumably because rising interest rates feed through to higher mortgage payments (included in the RPI but not in the CPI).

While the CPI is the “official” measure of inflation used by the Bank of England for inflation targeting, the RPI is the index most frequently used as a benchmark in wage settlements.  The divergence between the two suggests that the cost of living is going to remain high on the political agenda for years to come.

Making up some of the ground lost during the recession requires a higher rate of growth combining employment growth and productivity growth.

Increasing productivity means improving the supply side of the economy.  There is a substantial role for government as well as business.  A wide range of policies  are relevant including taxation, regulation, competition, business support and the modernisation of public infrastructure (the latest Plan for Growth document gives a flavour of the scope).

The people dimension is critical.  To improve productivity, we need to improve the skills of our workforce – distinctly average according to the recent OECD Survey of Adult Skills – and ensure that we get maximum value from these skills.

This means recruiting the right people into the organisation and investing in their training and development.  This includes recruitment practices that engage the interest of all sections of the labour force, which might require some tailoring of publicity and selection processes and a degree of outreach, such as engagement with schools.  It also means that HR must challenge managers, and sometimes itself, on assumptions made about the skills and experience required for a post, on the types of people it might suit, and how the job can be done (for example, considering applicants wanting to work on a part-time or flexible working basis).   Training and development needs to address future as well as current workforce needs.

Maximising workforce potential needs effective management and leadership.  This starts with the “bread and butter” of good line management reinforced by the systematic and consistent application of HR processes and systems that are fit for purpose.  It includes developing an organisational culture that supports and sustains corporate values, builds a shared sense of purpose and thus engages the workforce.

This also helps to build a culture that supports innovation, one that supports creativity, initiative and knowledge sharing within and between organisations and encourages a measured approach to risk-taking.  HR also has a crucial role to play in implementing the organisational change and workforce restructuring usually required to reap the rewards from investment in technology and new ways of doing things.

The last few years have shown that the UK can create jobs, even when times have been very difficult, and we do not want to lose that strength.  But the UK also needs to improve its productivity.  If 2012 and 2013 were years when employment exceeded expectations, 2014 needs to be a year when productivity exceeds expectations.

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  • Anonymous
    Anonymous

    Sound, sober overview. However I think three things need to be considered looking not just at the coming year but beyond

    1. The dvision both geographically and demographically in the UK needs to be addressed, in a soundbite - London is booming, Barnsley is not. Professionals are doing well, unskilled workers not

    2. Any long-term recovery needs to manufacturing and export led

    3. The relationship between profitability and growth is critically important