Tuesday, 24 September 2013

Living it up - throwing a light on living standards

Since 2009 the UK has been in a liquidity trap, where depressed consumer spending has contributed to an overall shortage in demand.  This demand shortfall played its part in creating the “flatlining” economy that Ed Balls was so fond of.
We won't remember them!
The main reason for this lack of demand has been the squeeze on private sector pay and living standards, this squeeze has been vicious and this is because disposable income is “marginal”.  A wage earner on average income of £37,000 only has about £15,000 of disposable income a year after paying for taxes, housing costs, utilities and transport.  Since 2008 pay increases have been less than 2% a year and prices have increased at 3.5%.  Five years of real earnings decline at 1.5% annually means a reduction of £2,600 or a whopping 17% of disposable income. This squeeze was combined with a rise in the saving rate, as Britons have lowered their debt-to-income ratios.  
Households have increased saving for two reasons:  firstly because low interest rates have decimated returns and people need to put more money into their pension and other savings and secondly because job insecurity has forced us all to be more sensible with our money.   All in all debts have reduced by a quarter in four years.  As consumer spending makes up over 60% of our economy the combined effect of inflation and increased savings on static incomes has enforced period of low growth on the UK economy.  In real terms the UK economy shrunk by 4% between 2008 and the end 2012.
Our miserable economic performance would normally be reflected in very high levels of unemployment but weirdly, while the public sector has been shrunk through necessity, the private sector has created over 1.3m new jobs.  It’s difficult to square the circle on this – a depressed economy, falling incomes but rising employment.  Some on the Left tell us that these new jobs are unskilled low paid jobs and some of this gloominess might be warranted but it has been overdone.
The truth is that British employers have used our flexible labour market to do a number of ”innovative” things:
1. They use variable pay ( bonuses, commissions and overtime) to flex their employee costs, so that they can retain staff even when there is limited work and profits
2. They have used Zero Hours contracts – where there is no commitment on the number of hours staff will be asked to work – to offer part time work to for over 1m people who might otherwise be out of a job
3. At the top end Lawyers and Accounts have offered sabbaticals and short time working for professions who can afford to do without for a while
4. There has also been a migration from expensive labour full time staff to lower costs labour part-time workers
The sum of these measures means that the growth in jobs has out-stripped GDP dramatically, or more specifically the amount produced per worker has fallen considerably.  This could be described as a productivity disaster but it might also be a productivity opportunity.  The Bank of England is relying spare capacity (people could produce more in the same number of hours) in our economy to provide growth without inflation.
The big question is what will happen as the economy recovers.  Labour think that poor productivity will bite us in the backside and that as we grow employers will have to employ more low cost staff to satisfy demand.  But in the real world it’s clear that good companies are sitting on a lot of spare capacity and that current workforce will be able to deliver more.  This increased production, without any increase in fixed costs will increase profits and, importantly, will drive higher wages, bigger bonuses and more overtime for those currently in work.  As I explained early because disposable income is so “marginal” small increases will feed directly through into take-home pay and this will in turn drive spending which in-turn drives, orders for more work – a virtuous circle.  We are at the tipping point right now for this change, where the previously squeezed middle should see a very rapid growth in their take home pay.
Politically this is quite binary.  If there is no spare capacity in the economy, at current rates of employment, Labour should win the next election; if however, there is substantial spare capacity then the boot will be on the other foot and the coalition will be returned for a second term.  So the stakes couldn't be higher.  The politician with most to lose is Ed Balls, who missed the recovery when it was pain for all to see and now is betting the farm on the fact that lower living standards will throw the coalition from power.  My hunch is that by Christmas a large proportion of the private sector workforce will be feeling a lot better off and ready to live it up a little.
The office party 2013 could be a ripper!

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