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Economic Outlook

Why has unemployment not risen more in


the recession?
Key points

• The recession has resulted in the steepest fall in GDP since the 1930s yet the decline in employment has
been surprisingly modest. Current estimates show the fall in employment to be less severe than in earlier
recessions despite the severity of the fall in GDP. The steep fall in estimated GDP combined with a more
moderate fall in employment and hours suggests a sharp fall in labour productivity that is more marked
than the early 80s and much greater and more prolonged than the early 90s.

• The UK experience has been very different to that of the US where a less severe GDP fall has been met
with much steeper cuts in employment and hours and a sharp rise – rather than a fall – in labour
productivity. Closer to home, Spain and Ireland have suffered even bigger employment falls than the US
but the impact of the recession on employment in Germany and France has been much more muted.
Employment in Germany has actually been broadly stable across the recession.

• An increase in public sector jobs has helped keep UK employment levels up, but employment in public
sector and related jobs has also grown in other countries including Spain, Ireland and the US.

• UK corporate profitability has fallen in the recession but remains at levels close to historical averages
despite the steepness of the fall in GDP. This can be attributed to a combination of the impact of sterling
depreciation, which has allowed companies to push up sterling prices for exports, and pay restraint.
Relatively good corporate profitability levels may also have helped alleviate the employment situation.

• What employment falls there have been appear to have been achieved rather less through redundancies
and more as a result of recruitment freezes than in previous recessions. The rest has been a sharp fall in
employment amongst the under-25s with older age groups escaping relatively lightly.

• The possibility of measurement errors in the data complicates the analysis. The severity of GDP declines
in past recessions has often been revised down in subsequent estimates and there is a possibility that
the LFS exaggerates the current level of employment. Taken together, it is possible that a mixture of
measurement error and public sector employment growth could explain much of the apparent fall in UK
labour productivity.

• The implications for the future depend on the extent of any measurement errors. If the official data are
correct then there will have to be a period of flat employment to allow labour productivity to return to
trend. If the data are exaggerating the extent of the fall in labour productivity, the prospects for
employment growth look much better.

• The remaining downside concerns the prospects for public sector employment growth. Public sector jobs
have increased recently but will go into reverse by 2011 – if not before – and the overall strength of
employment in the UK will depend on whether the private sector can make up for public sector cutbacks.

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Economic Outlook

Introduction

Although the UK economy has just gone through the


UK: ILO employment
deepest recession, defined in terms of the GDP Cyclical peak = 100
contraction, since the 1930s, the impact on the labour 101

market has not been anywhere near as severe as 100 1978Q3-1983Q4


1989Q1-1994Q2
99
might have been expected. As recently as May 2009 2007Q1-2009Q3
98
the consensus forecast for Claimant Count
97
Unemployment in 2009Q4 was 2.1 million, yet the
96
outturn has been barely over 1.7 million. The surprise
95
labour market resilience also shows up in the
94
employment data. The chart on the right shows 93
comparative indices of ILO employment across the 92
current and last two major recessions in the UK. In -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Source : Haver Analytics quarters from cyclical peak
both the early 80s and early 90s, UK employment
continued to decline for approximately three years after the cyclical peak. The 2009Q3 data, however, shows
that employment has already levelled off this time around. Although this is just a single observation, which
will be subject to revision, it is consistent with movements in the claimant count unemployment data (which is
an administrative count and not subject to revision) which has increased more slowly than expected and
actually fell in November. The broader ILO definition of unemployment has displayed a similar levelling off.

The sharp fall in GDP combined with a relatively muted


decline in employment has led to a sharp fall in UK: GDP per person employed
Cyclical peak = 100
measured labour productivity. The chart to the right 112
shows that this is not a unique phenomenon. Labour 110

productivity initially fell in each of the last two 108 1978Q3-1983Q4


106 1989Q1-1994Q2
recessions, especially in the early 80s, but this time the 2007Q1-2009Q3
104
fall has been much longer than in the early 90s and 102
much more pronounced that in the early 80s. Labour 100
productivity is defined here as GDP divided by ILO 98

employment. There has been a steeper fall in 96


94
employment measured by the alternative workforce
92
jobs measure and a correspondingly lower decline in -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Source : Haver Analytics quarters from the cyclical peak in employment
GDP per job (with most of the difference being in the
2009Q3 estimates), but even here the decline is much
less than in previous recessions.

Although the levelling off of employment and unemployment is to be welcomed it does throw up a number of
questions, including why has it happened and what are the likely consequences for the future. This article
seeks to examine these questions in a number of ways including looking at comparative international
experience, compositional aspects, the flexibility of the labour market, the age dimension of employment
changes and the possibility that official statistics might be misleading us.

International comparisons

The experience in the UK has been completely different to that of the US. Despite a bigger fall in GDP,
employment in the UK has fallen by much less than in the US. Measuring the changes between the first half
of 2008 and an average of Q2 and Q3 of 2009, UK GDP fell by 5.9% compared to a fall of just 3.4% in the
US, yet the decline in UK employment (ILO definition) at 2% was much less than the fall of 4.5% in the US
(see table). This cannot be accounted for by changes in average hours worked as that actually fell by more

6 WHY HAS UNEMPLOYMENT NOT RISEN MORE IN THE RECESSION? JANUARY 2010
Economic Outlook

in the US than in the UK, so the underlying cause of the UK/US difference has been the differential changes
in labour productivity – or GDP per hour worked. Here the differences are startling. US employers appear to
have reacted to the recession by slashing jobs and overtime with the result that hours worked fell steeply and
labour productivity shot up by 5%. The UK has also experienced reduced overtime plus a bigger reduction in
full-time jobs (both of which have contributed to the fall in average hours worked) and job cuts, but labour
productivity, measured in terms of GDP per hour has actually fallen by 2.8%. The decline in average hours
worked in the UK has helped to mitigate the impact of the recession on employment but its extent is by no
means unusual and it is actually less than in the US so it cannot explain why employment has not fallen by
more that estimated. For whatever reason, UK employers appear to have been less willing to reduce labour
inputs in line with falling production than their US counterparts. Further, US companies have reacted to the
challenges of recession by slashing jobs and pushing up productivity while UK productivity has actually fallen.

The US & UK Compared


Labour Productivity
2008H1 2009Q2/3 % change
GDP (PPPs, $US) per hour worked
55
USA
GDP (2005 $) 3348 3234 -3.4
GDP per hour 46.8 49.2 5.0 50
Hours Worked 71503 65796 -8.0 US
Average Hours 39.1 37.7 -3.7
45
Persons in Employment 140.6 134.4 -4.5

UK 40 UK
GDP (2005 $) 611 575 -5.9
GDP per hour 49.8 48.3 -2.8
Hours Worked 12277 11885 -3.2 35
Average Hours 32.0 31.6 -1.2
Persons in Employment 29.5 28.9 -2.0
30
1995 1997 1999 2001 2003 2005 2007 2009
Source: Oxford Economics calculations Source : Oxford Economics/Haver Analytics

Employment Change, 2008Q1-2009Q3 Relative Unit Labour Costs


per cent % change since 2007Q1
2 15

0 10

-2
5

0
-4
-5
-6
-10
-8
-15
-10
-20
-12
-25
Germany France Italy UK US Spain Ireland
Ireland Spain Germany US UK
Source : Oxford Economics/Haver Analytics Source : IMF

The UK-US comparison shows a very different labour market reaction to the recession but broader
international comparisons shown an even wider range of experience. Spain and Ireland have actually seen
bigger employment falls than the US. Both of these countries have seen construction booms collapse,
housing bubbles burst and a fall out from financial services and, consequently, might have been expected to
have been hit hard. Both the US and UK, however, also share some of these characteristics so might have
been expected to have done equally badly. Spain and Ireland, however, have suffered from their exposure to
international trade and from a strong euro. The UK, on the other hand, has had its exposure to falling
international demand mitigated by a 25% depreciation of sterling against the euro since early 2007.

At the other extreme, a number of countries have escaped the recession with even more muted employment
falls than the UK. The best example here is Germany where employment has actually increased across the

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Economic Outlook

recession. This was helped by a number of agreements between employers, unions and government that
promoted temporary working and temporary shutdowns in reaction to falling demand but, nonetheless, the
comparison with the US, not to mention Spain and Ireland is very marked.

One lingering concern remains for the UK – is the smaller fall in UK employment simply due to there being a
longer lag, for whatever reason, between declines in output and employment? We think that this is unlikely
but, given the scale of the loss of labour productivity, a labour market relapse cannot be totally ruled out.

Compositional effects

There has been a marked sectoral pattern to the recession, much the same as in previous recessions. There
have been steep job cuts in manufacturing and
UK: Public sector employment
construction (workforce jobs fell by 10% and 7% Cyclical peak = 100
respectively between 2008Q1 and 2009Q3) but 104 1978Q3-1983Q4
services industries have been rather less affected, 1989Q1-1994Q2
103 2007Q1-2009Q3
although workforce jobs in financial and business
services have fallen by 4.4% since the start of 2008. 102

There has actually been an increase of over 3% in jobs 101


in public administration, education and health over the
100
same period, as policy has strived to preserve job
levels by maintaining government spending levels. 99

98
The weakness of employment in manufacturing shows -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
up well in the regional unemployment figures where by Source : Haver Analytics quarters from the cyclical peak in employment

far the biggest increases have been in the more


manufacturing-orientated West Midlands and the lowest increases have been in London, the South East and
the East of England.

The buoyancy of public sector employment will have helped all regions and it has actually been a key factor
in keeping employment levels up when compared with previous recessions. The movement of workforce jobs
excluding public administration, education and health in
UK: Workforce Jobs excluding Public
this recession is not that different to that seen in the administration, Education & Health
early 80s and 90s although the rate of decline has Cyclical peak = 100
102
started to ease despite the fall in GDP being much
1978Q3-1983Q4
more severe this time. 100 1989Q1-1994Q2
2007Q1-2009Q3
98
Public sector employment has also been quite buoyant
in some other countries, including Ireland and Spain 96

(and in the US if we include private education and 94

health to get a closer comparison), so the buoyancy of 92


public sector jobs alone cannot explain the relative
90
strength of the UK labour market when compared to -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Ireland, Spain and the US. Source : Haver Analytics quarters from the cyclical peak in employment

Labour market flexibility, costs and profitability

On the basis of the evidence presented above, it appears that the true Anglo-Saxon economies who display
the flexibility to sharply reduce employment in reaction to falling demand now include Spain, Ireland and the
US, which appears to have shifted in towards the continental model! It is certainly the case that whereas the
easing of wage growth in the UK and the ability of employers to impose pay freezes or pay cuts in a number
of cases (and the willingness of employees to accept pay restraint as an alternative to job cuts) is a sign of a

8 WHY HAS UNEMPLOYMENT NOT RISEN MORE IN THE RECESSION? JANUARY 2010
Economic Outlook

type of labour market flexibility. The apparent willingness of employers to hoard labour, however, presumably
in expectation of better times to come is not usually thought of as a sign of labour market flexibility and it is in
sharp contrast to what has happened in the US which is usually thought of as the most flexible labour market.

Pay restraint, has, however, undoubtedly helped in the UK. UK real earnings (average earnings divided by
the GDP deflator) are now lower than before the recession in contrast to the US where there has been a
marginal increase. This has helped the UK to hang on to the competitive advantage it gained from the
depreciation of sterling. The chart on relative unit labour costs on the previous page emphasises this point.
Relative unit labour costs show unit labour costs in manufacturing in a country measured in a common
currency relative to those of its main trading partners. Although the data refer specifically to manufacturing
they give a general impression of the competitiveness of the whole economy. The UK has seen a massive
gain in competitiveness as, incidentally, has the US. This has been largely due to the falling value of sterling,
but pay restraint has stopped the competitive advantage caused by currency depreciation being frittered
away in higher pay settlements.

Interestingly, Germany has also seen an improvement


UK: Unemployment & profitability
in relative unit labour costs since early 2007 whereas ILO Unemployment Return on Capital (%), inverted
Spain and Ireland have seen a worsening of their 11 -8

competitive position as a result of the strong euro. This 10 -9

illustrates how some economies can live more easily Profitability of -10
9 Non-Financial
with a strong exchange rate while others have seen Comapnies -11
8
their international competitiveness suffer from -12
7
belonging to a common currency zone. The negative -13
correlation between changes in employment and 6
-14
relative unit labour costs (both illustrated in the charts 5 -15
on the previous page) is also very marked, Unemployment
4 -16
emphasising the importance of international 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
Source : ONS
competitiveness to restricting employment falls during
a recession.

The UK’s relative export prices have hardly changed


UK: Private sector employment & profitability
despite the big depreciation of sterling. This had led %/year %
Employment
some commentators to suggest that the UK has failed 5
(LHS) Profitability
16
4 (RHS)
to take advantage of sterling’s fall by cutting prices and 15
3
gaining market share. Exports, however, are hard to 2
14

grow in a recession and the big advantage that UK 1 13

companies have gained from sterling depreciation (and 0 12

pay restraint) has been an ability to mitigate the impact -1 11


-2
of the recession on profitability. Profitability has been 10
-3
closely linked to unemployment and employment -4 9
growth in the past (see charts to the right) and it could -5 8
be that many companies have not faced the scale of 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
Source : ONS
financial pressure that would force them into the large
scale layoffs that we experienced in past recessions. In this context, it may be significant that, although the
profitability of UK companies has fallen in the recession, it remains well above the levels experienced in the
early 90s and that this contrasts with companies in the US who saw a much sharper fall in profitability at the
end of 2008.

This explanation sees companies using exchange rate depreciation and pay restraint as a way of maintaining
profitability, but sterling also fell in the early 90s and profitability still crashed. The peak-to-trough fall in
relative unit labour costs in the early 90s, however, was only around half of that realised this time, so this

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Economic Outlook

explanation may still hold water. There may also have been other ways of maintaining profitability in the
recent recession. Some companies, for example, may have failed to pass on the December 2009 VAT cut. In
contrast, VAT increased in 1991 and some companies may have been forced to absorb some of the cost.

A further factor that might explain the smaller shakeout this time around is the behaviour of debtors. There is
a wealth of anecdotal evidence that suggests that HMRC and banks have given companies more leeway in
making payments in this recession than they had before. The greater flexibility to manage their finances will
also have helped them to maintain headcount.

A downside to employment stability

For whatever reason, it appears that UK companies, especially in the service sector, have been more
reluctant to make people redundant during this recession compared to previous recessions. As employment
has still been shrinking, this has often been at the cost of
UK: Change in ILO unemployment rate by age
a recruitment freeze. This could also help to explain the 2008Q1-2009Q3
muted reaction of employment to the recession as it 7

takes longer to reduce headcount through a recruitment 6

freeze than it does through redundancies. The result 5


has been that there has been a marked age dimension
4
to changes in employment and unemployment over the
3
recession.
2
The younger age groups have lost out from the
1
weakness of recruitment while the older age groups have
0
been far less affected. In fact, in employment terms, the 18-24 25-49 50+
recession has largely been an under-25s phenomenon Source : Haver Analytics

with only modest falls being recorded (by the Labour


Force Survey) for those aged between 25 and the state retirement age, and rapid growth actually being
recorded for those in employment beyond the state retirement age.

This is in stark contrast to previous recessions where the impact was much more evenly spread and where
employers often took the opportunity of recession to rid themselves of large numbers of older workers
through early retirement or compulsory redundancy.

Older workers who lost their jobs in previous recessions often worked in manual jobs in manufacturing or
mining. Today, older workers are much more likely to work in services and employers do not seem to have
the same imperative in getting rid of them. This maybe because older workers have skills which are valued
by employers and, as they are less likely to be manual workers, because physical ability is less of a job
requirement. Whatever the reasons, this has benefited older workers at the expense of the young. The
downside to all of this is that there is a danger of long-term unemployment setting in amongst younger people
creating a phenomenon known as “the lost generation” whereby new entrants to the labour market at the
peak of the recession fail to get a job and in one or two years time – when the employment situation improves
– they are passed over by employers in favour of the next wave of scool and university leavers.

Are measurement errors responsible?

Although the difficulties of the young unemployed are undoubtedly real, there is some debate over the extent
to which the official data may have painted a false picture of the recession. The potential for error come from
two sources, an exaggeration of the fall in GDP in the official statistics and an underestimation of the fall in
employment:

10 WHY HAS UNEMPLOYMENT NOT RISEN MORE IN THE RECESSION? JANUARY 2010
Economic Outlook

GDP – the official data show that the current recession


is the worst since the 1930s. As yet, however, we are UK: GDP and employment
%/year
relying on provisional estimates of GDP which may well 8
be revised up in the future. The initial estimates of the 6 GDP
peak to trough fall in GDP in the early 90s show an 4
estimated fall of 4.1% (1990Q2 to 1992Q2) whereas
2
the latest estimate show a fall of just 2.5%. This
0
revision is due to a mixture of new data,
-2
methodological changes and re-balancing exercises Employment
-4
(where the output-based estimate is reconciled with the
-6
expenditure-based estimate) and the ONS say that
-8
past upwards revisions do not mean that future 1975 1980 1985 1990 1995 2000 2005
revisions are likely to be upwards. Nonetheless, it is Source : Haver Analytics

an example of just how far GDP can be revised.

Employment and Hours – the employment data are based on either the Labour Force Survey or an
employer survey in the case of workforce jobs. The workforce jobs estimates are benchmarked
retrospectively to a larger survey known as the Annual Business Inquiry (ABI) each year and big revisions
often result. The results of the 2009 ABI will not be incorporated until much later this year.

The LFS is a large survey of individuals and households rather than employers and the proportions that it
derives (such as the unemployment and employment rates) should not be prone to major biases. The survey
results are converted into levels by grossing them up in line with old official population projections. This
means that any inaccuracies in the population projections will be repeated in the employment and hours data.
This could be a particular problem for 2009. The official population projections incorporate an extrapolation
of recent high levels of net immigration in to the UK. Annecdotal evidence suggest that immigration may
have fallen off sharply for some groups of central Europeans (notably Polish building workers) and that some
previous immigrants may have returned home. This would be consistent with the extent of the recession in
the construction and manufacturing industries where migrants tend to be concentrated. If this is the case, the
LFS estimates of employment and hours will be overstated and the fall in productivity exaggerated.
Incidentally, this decline in immigration and resulting slowing of labour force growth might also explain why
unemployment has not risen as much as we might have expected.

Were GDP to be revised up by 1.5% and hours worked revised down by 0.5%, the current estimate of a fall in
GDP per hour of 4% between the 2008Q2 peak and the latest observation in 2009Q3 would become a 2%
fall. This would be weaker than experienced in the early 90s but similar to the early 80s. We cannot predict
revisions but the possibility that they may occur should make us careful about reading too much into recent
data.

Implications for the future

If the official data are to be believed, there are potentially major implications for the employment outlook. If
there has been a sharp fall in GDP per hour then either real product wages (wages relative to the GDP
deflator) may have to fall substantially at some stage, or productivity will have to rebound eventually and
make up the lost ground. The first possibility would have a big impact on income from employment and the
prospects for consumer spending while the latter would imply a very flat employment profile until productivity
had recovered much of its losses. This would be the so called “jobless recovery” unless the recovery in UK
GDP were to be much stronger than expected.

The possibility of data revisions complicates this analysis considerably. If labour productivity has not fallen so
much, then there would be less need for it to recover and the prospects for employment and employment

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Economic Outlook

earnings in the future would look much brighter.

On balance some upwards revision of labour productivity does look likely on the basis of past experience but
the labour market out-turn from the recession will still look less severe than might have been expected on the
basis of previous recessions and much of that will be explained by a mixture of the reasonable state of UK
corporate profitability, in turn driven by wage restraint and sterlings’ depreciation, and by the continued
growth of public sector employment. The additional uncertainty will then be the extent to which any renewed
private sector employment growth can make up the difference when public sector employment starts to
contract from 2011.

12 WHY HAS UNEMPLOYMENT NOT RISEN MORE IN THE RECESSION? JANUARY 2010