Does the new economic order really threaten growth?
11 May 2011
Today’s (11 May) FT reports that the UK’s prospects for recovery could be far worse than expected. Their analysis warns that some of the key high-value sectors that prop up the UK economy – such as financial services and the North Sea oil industry – have contracted more quickly than the rest of the economy, and will not rebound quickly.
Many economists – including the Office for Budget Responsibility, which provides official forecasts of economic growth – have observed a phenomenon known as “labour hoarding” during the recession. This means that UK firms have reduced their workforces by less than their output has fallen – in other words, they’re holding on to workers but seeing their productivity fall. From 2008 to 2010, economic output fell by 4.7%, but the workforce by just 2.4%.
This hoarding effect ought to be good for the economy, since firms should be able to get their workers back up to full productivity more quickly. However, it has also given rise to fears of a “jobless” recovery, since firms need to hire fewer people than they otherwise would.
However, the FT claims that this labour hoarding effect is partly “illusory”. In fact, they argue it has largely occurred because job losses have been concentrated in high-value, high-productivity sectors, which has distorted the picture for the economy as whole. This is a cause for concern according to the FT, because it means that companies are likely to hit their “production limit” sooner, increasing pressures on inflation.
You should be relieved to hear, then, that we believe the FT’s analysis is not the whole story. It is true that the loss of high productivity jobs must by definition have a disproportionate impact on average productivity. But in fact, the majority of job losses have been concentrated in lower-value parts of the economy – personal services, retail, construction and the like. Of the 780,000 jobs lost since the start of 2008, only 267,000 – roughly a third – have been lost from high-value parts of the economy. And this effect is almost entirely due to the free-fall in manufacturing during the recession, not financial services.
Moreover, the contribution of financial services to the economy appears to be overestimated. Financial services is a high-value part of the economy, and it grew rapidly before the recession. However, it accounts for less than 8% of GDP, less than 4% of jobs, and it is in fact less productive than the much larger business services sector.
Since 2008, financial services shed 60,000 jobs, while business services gained almost 120,000. In these, the highest value parts of the UK economy, the UK has actually gained jobs. This doesn’t reflect a decline in the highest value parts of the UK economy – it represents a shift of resources from an over-inflated bubble to a sustainable driver of growth in the knowledge economy.
This reinforces two key messages about the UK economy. First of all, the recovery will be driven by job growth in the UK’s most productive and sustainable areas – particularly business services and manufacturing. Second, a narrow focus on the economic value of financial services is entirely misguided – business services are bigger, more productive, and contribute far more to a balanced UK economy.