Scottish Economy Watch

Labour Market Recovery Continues

The latest labour market data published this morning show that conditions in both the Scottish and UK labour markets continue to improve. In the latest quarter, August - October, employment rose by nearly eleven thousand (10,651) in Scotland an increase of 0.4%. UK employment rose by 250,000, an increase of 0.8%. Unemployment fell by more than seven thousand (-7,352) in Scotland, a fall of -3.6%, to a rate of 7.1%. In the UK, unemployment also fell by just under one hundred thousand (-98,718), a fall of -4.0%, to a rate of 7.4%.

So while both countries enjoyed an improvement in jobs and unemployment, the improvement in the UK in this quarter was slightly better than in Scotland.

The chart below shows where both Scotland and the UK now stand in jobs terms in their recovery.

UK employment is now about 2% above its pre-recession peak whereas in Scotland it is nearly at the peak but at -0.2% below just not there yet.

The next chart shows our estimate of 'real' compared with actual unemployment in Scotland.

This shows a slight widening again between the two because the numbers inactive rose again by more than ten thousand (10,456) in the latest quarter.

Finally, it would appear that there is still plenty of slack for growth in the Scottish labour market and more than in the UK as the chart of employment to working population shows.

The ratio in Scotland now stands at -2.9% below the pre-recession peak compared to 2.2% in the UK.

With earnings growth almost flat, and inflation falling, these data offer further evidence that there is still no justification for the Bank of England to 'apply the brakes', in the form of a rise in interest rates. This is likely to be the case even when the unemployment rate falls below 7%.

Austerity and the Recovery

Last night on Newsnight Scotland, Gordon Brewer subjected John Swinney and other non-Coalition politicians to some pretty tough questioning on the austerity and the UK recovery. As a presenter and interviewer it is normal to play 'devil's advocate' and challenge the beliefs, suppositions and arguments of interviewees, especially politicians. However, the ferocity of Brewer's onslaught seemed to me to go beyond what is required from an interviewer. Clearly, an interviewer must give due weight to and allow balance between the arguments of opposing sides. But he or she should, in my book, also pay heed to the truth - in this case the theory and evidence on the role of austerity in its effect on the level of GDP and its rate of growth.

Brewer made several assertions. The most important of which were:

1. Economic recovery justifies the austerity policy of the Coalition Government.

2. The scale of the UK output loss meant that other countries would recover faster than UK, so the fact that UK GDP currently remains about -2.5% below its pre-recession peak cannot be used as a criticism of the policy of austerity.

3. The austerity policy was necessary to address the UK's credibility with markets in the face of rising UK Government debt.

4. The OBR believes that "it will eventually become a sustainable recovery."

None of these assertions is unambiguously correct.

The first assertion is simple to dismiss. Economic theory tells us that a fiscal consolidation will lower the level of GDP and the rate of growth. But it will be temporary. Eventually the resources made unemployed by the austerity will move into other uses as market prices adjust, growth will pick up and the level of GDP rise. For non-technical discussions of this see Jonathan Portes, Director of the National Economic Institute for Social and Economic Research (NIESR), and Simon Wren Lewis, of Oxford University. However, some of the loss of GDP and unemployment could be permanent if there are hysteresis effects for which there is a real possibility - see this paper by Larry Summers and Brad Delong. These effects are difficult to model and the OBR makes no allowance for them at all.

So, even with austerity an economy will recover and when it recovers it may exhibit quite strong growth. None of which is to demonstrate that austerity has been a wise policy or "a good thing".

To underline the point that austerity has had a negative effect on the level of GDP in the UK here is the OBR's own graph which shows the effect of the different phases of the UK's fiscal consolidation.

Chart 2.26: Implied impacts of discretionary fiscal policy on the level of GDP

The assertion that the scale of output loss implies that the UK would have had a slower recovery than others is simply wrong. Indeed, you can argue the opposite: a big drop in output should be associated with a big bounce back in growth analogous to the bouncing ball phenomenon: the harder you throw the bigger the bounce.

Bank of England economists, who clearly have no political axe to grind show the UK recovery from the recent recession to be weaker than almost any comparator - see the chart below

Figure 1.  Evolution of GDP around recessions (a) and banking crises

Sources: OECD, Reinhart, C.M and Rogoff, K.S (2008), Thomson Reuters Datastream and Bank calculations.

(a) Defined as at least two consecutive quarters of falling output.
(b) Where data are available, covers the G20 advanced economies over the period from 1960 to 2006.
(c) Spain (1977), Norway (1987) Finland (1991), Sweden (1991) and Japan (1992), as defined in Reinhart, C.M and Rogoff, K.S (2008) 'This time is different. Eight centuries of financial folly'.
(d) Zero denotes the pre-recession peak in GDP, or the peak in GDP during the year of the banking crisis, as listed in footnote (c).

As I have said in earlier posts the reason for the UK's weaker recovery is weak UK export performance and fiscal consolidation - see this research from Fulcrum here.

The third assertion, has been well addressed by Paul Krugman in his references to the "confidence fairy". There is just no evidence that a country with its own currency and ability to print money will be at risk of default as debt rises. UK 10-year bond yields were low before the Coalition came to power and have stayed low. They rise when economic growth occurs as the attractiveness of equities increases relative to government bonds. This is happening now. But would the Chancellor say now that this is due to a loss of confidence in his stewardship?

Finally, the OBR did not say in its latest Economic and Fiscal Outlook that " it will eventually become a sustainable recovery." In its view the recovery is being driven by household spending fuelled by falling savings not rising income and housing investment. Real incomes of households need to rise and that will only happen according to the OBR if productivity growth improves. Which begs the question are current UK Government policies towards investment and skill formation appropriate to the task?

All of this is a lot more nuanced and complicated than was allowed to be the case on Newsnight Scotland last night.

 

Scottish Labour Income: A Puzzle

The publication of the latest Scottish National Accounts Project (SNAP) quarterly accounts data on 13 November offers some interesting insights into, and raises a few questions about, the behaviour of labour income in Scotland.

Back in November 2012 I noted that contrary to a recently expressed STUC view, drawing on UK data, that labour income shares were falling, there appeared little evidence for this in Scotland from the SNAP data. The latest revised SNAP data to the second quarter of this year are presented in the chart below.

These data still show that the labour income share was rising in Scotland between 1998 and 2001. This might suggest that there is an absence of secular decline but clearly we do not know what was happening to the share before 1998. What is clear from the latest data though is that the share was declining from 2001 to 2011 - from 66% to just above 60% - whereas in the earlier data such a fall was not so evident.

However, the new data also show a clear uptick after the third quarter of 2011 with the share rising from just above 60% to nearly 64% of GVA and then dipping slightly.

The next chart shows the absolute real compensation of employees.

What the two charts suggest is that between 2001 and 2008 while the share of GDP going to labour was falling real compensation of employees was rising. This implies that labour income was growing but more slowly than non-labour income - e.g. profits - until the start of the Great Recession. However, once the recession started to bite and jobs were shed labour compensation fell and its share also fell, indicating that non-labour income held up much better during the recession.

But the experience after the third quarter 2011 is more difficult to explain.

Both total employee compensation and its income share began to rise. The first response is to suggest that rising total employee compensation is due to net job creation. But the data don't support this. Employment picked up from the trough of the recession in the middle of 2010 but then fell back again in 2011. The recent surge in employment did not occur until the end of last year. But the data do show growth in average employee compensation, as the next chart shows.

What we don't know is what this means! The rise in average compensation peaked in the third quarter of 2012, when job creation picked up again. That might be explained by more part-time jobs being created but the fall in full-time employment and rise in part-time employment pre-dates the change.

So, we have a puzzle. Labour income has been rising from 2011 until recently both overall and as a share of GDP. This appears mainly to be due to rising average remuneration and not net job creation. But I am not clear why average remuneration should have been rising when full-time employment was falling and part-time employment was increasing. Moreover, we know that at the UK level average earnings have been growing more slowly than consumer price inflation, implying a fall in real incomes and the implications that must have for household demand. Yet, from these Scottish data a fall in real incomes is less evident - although it must be noted that I have used a GDP deflator and not the CPI index to estimated real compensation.

Could this be one reason why household spending in Scotland has been stronger than anticipated?