The labour market in 2013 – what’s in store?

Richard Exell looks at what the labour market has in store for 2013.

A couple of weeks ago I looked at the latest employment figures and the main point was that the headlines were very good.

This isn’t a flash in the pan; if we compare the latest figures (for August to October) with those for the same period in 2011:

Employment is up 499,000;

Unemployment is down 128,000;

• The number of unemployed people chasing each job vacancy has come down from 5.7 to 5.2.

In the first half of 2012 it looked as though the employment figures were flattered by strong growth in atypical employment.

It’s true that part-time employment accounts for 58 per cent of the employment growth over the past year; self-employment for 15 per cent; temporary employment for 19 per cent; and government schemes for 16 per cent (don’t add these up, they overlap) but there are 163,000 more employees working full-time than there were a year ago and this category has been growing more strongly in recent months.

Besides, the average weekly hours worked figure has risen 2.6 per cent over the past year, which indicates the increase in employment is real.

Will this be the story again next year? What are going to be the big labour market trends of 2013?

Of course, the government is pleased with the recent trend (a Labour government would have been pleased too) but they can’t have been expecting it.

David Smith’s annual league table for economic forecasters makes for remarkable reading – most forecasters give figures for claimant count unemployment (out of habit, more than anything) which in November stood at 1,575,100; a year ago, the lowest forecast was 1.6 million and the average was just under 1.8 million.

This is a warning for anyone forecasting the results for 2013. The Treasury’s latest monthly summary of City forecasters (pdf) includes a fascinating graph, showing how, since May, average forecast unemployment for 2013 has come down by more than 100,000.

See Graph 1:

So, I’ll take a deep breath before putting forward my predictions.

I think that, by the end of 2013:

Employment will be, at best, only marginally higher than it is now;

Unemployment, using the International Labour Organization definition, will still be more than 2.5 million;

Claimant count unemployment will be higher than it is now;

Youth unemployment will still be well over 900,000;

Pay will be rising faster in the private sector but public sector managers will find it increasingly difficult to maintain the pay freeze.

No one is 100% sure why employment has been rising but most labour market economists suspect this must have something to do with the fact jobs weren’t hit anywhere near as hard as expected during the first dip of the recession.

The 2008-9 recession lowered GDP by 6.5 per cent – if employment had fallen by the same amount, we could have expected unemployment to reach 3.5 million, but instead it peaked at just over 2.5 million. In the second dip output fell by 1.1 per cent; despite the recovery in the latest figures, output in the 12 months from Q4 2011 to Q3 2012 has essentially flatlined – but employment is up 1.7 per cent and unemployment is down 4.8 per cent.

Explanations for this mismatch vary.

A key issue is whether the fall in output is supply- or demand-related; the more it is due to supply factors, the smaller the output gap and the less room there is for expansionary policies. Recessions do hit the productive capacity of economies and the longer our current troubles continue the more the output gap will grow, but there is no consensus among economists about how big this gap is at present.

The Office for Budget Responsibility’s latest Economic and Fiscal Outlook (pdf) pointed out the average estimation for the major forecasters they look at was very close to their figure of 3.1 per cent, but the actual forecasts range from -5.2 to -0.8 per cent, with the National Institute for Economic and Social Research estimating -4.3 per cent and the International Monetary Fund -4.2 per cent.

The employment-GDP mismatch could be explained by the UK economy’s potential having taken an enormous hit from the global crisis – rising employment plus stagnant growth necessarily means falling productivity, which is what we would expect if the UK economy had, for instance, become horribly over-reliant on finance, and was less fitted to cope with the global economy emerging from the crisis.

But I don’t think that explains what we’re seeing. For one thing, if the problem was mainly supply-side I’d expect to see businesses experiencing capacity constraints as they struggled to cope with new circumstances, but the figures in the reports from the Bank of England’s Agents look much more like the result of persistent low demand.

See Graph 2:

The English Business Survey results (xlsx) on workforce utilisation point in the same direction, with two thirds of businesses saying their workforce was being used at a satisfactory level; 24 per cent over-stretched; and just 10 per cent under-utilised. I’d expect to see much more evidence of labour mismatch if we had taken a major hit to our economic potential.

The overall figures could look like this but disguise a serious mismatch at regional or industry level, but the figures are much the same for all regions. The figures for industrial sectors are similar too, except for the public sector, where workers are much more likely to be over-stretched (draw your own conclusions about why that might be).

A key factor has been what has happened to pay increases since the recession.

See Graph 3:

There has been a step change, with pay lagging inflation for three years. Businesses have been able to substitute labour for capital.

As Robin Chater, secretary-general of the Federation of European Employers, puts it:

“The UK is turning into an old-style third world country with low pay growth for most workers below managerial level, widening pay differentials and poor levels of capital investment.”

One result has been falling productivity, which is preferable to unemployment in the short-term, but is no long-term solution. Add to this the fact that, while underemployment may not be a complete explanation for the improving headlines, it is part of the story – the number of full-time employees is still lower than it was in the summer of 2009 and is 700,000 below the pre-recession peak.

So I don’t think there have been long term changes that would produce continuing improvements in the employment figures. And there are straws in the wind that indicate they may be about to change direction – see charts 1, 2, and 3 below.

Chart 1:

Chart 2:

Chart 3:

There is a strong chance the divergence of the GDP and employment trends will come to an end in 2013. With the OBR joining the list of organisations forecasting low growth next year, that indicates much less impressive employment growth. I don’t expect us to match the performance of past 12 months – which would see the employment rate pass 72 per cent – let alone reach the 73 per cent we had on the eve of the recession.

The chances are the unemployment rate will rise from the current figure of 7.8 per cent. The OBR and NIESR both forecast the eventual 2012 figure will be higher and the 2013 rate will be 8.2 per cent; the IMF gives a slightly higher figure, 8.3 per cent, but this is a negligible difference. This would produce an unemployment level about 150,000 higher by the end of next year.

The claimant count is consistently lower, so we might expect a smaller increase, but the government’s welfare policies, especially the continuing transfer of lone parents and disabled people from other working age benefits, are likely to produce a higher figure than we might otherwise see.

The City forecasters covered by the Treasury summary on average expect the claimant count to rise by 50,000 between Q4 2012 and Q4 2013, and the OBR forecasts 70,000 but 100,000 wouldn’t be a surprise.

In the last three months youth unemployment has fallen 72,000 to 945,000, but young people are not likely to be exempt from the tailing-off of the labour market recovery. The Work Programme has performed badly (with just two-and-a-half per cent of young people getting sustained jobs) taken together with low investment in support for young unemployed people it is unlikely the government’s programmes will make any difference.

The key factor will be the proportion of young people staying in education: this was the main reason for the recent improvement, but the impact of student fees may make further increases unlikely among those over school-leaving age.

The final element of my forecast is what will happen to pay. The OBR expects average earnings to rise 2.2 per cent in 2013, while CPI inflation will still be higher, at 2.5 per cent. This real terms pay cut would be higher than the 2012 reduction, where they expect 2.8 per cent inflation to be only marginally higher than 2.7 per cent earnings growth.

There are signs the overall averages for pay conceal increasing divergence between private and the public sector – where some of the lowest paid workers have 1 per cent increases and most of the rest have pay freezes.

There is also increased dispersion in the private sector, where some manufacturing and financial services workers have had pay settlements that have just about kept up with inflation whilst pay deals for other service sector workers have been coming down in recent months; Incomes Data Services has reported average settlements falling from 2.2 to 2.0 per cent.

In the coming year rising unemployment would be expected to hold back pay increases, but I wouldn’t expect freezes as stark as that in the public sector. A key question will be whether the government succeeds in holding down public sector pay increases below those in the private sector.

Obviously unions will be keen to challenge this policy; pay for workers with higher level qualifications is already comparatively low in the public sector – if managers find it becomes harder to attract sufficiently qualified and experienced recruits for key jobs they may start pressuring the government too.

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