Rebalancing comes to the employment market

Unemployed people queue at a Jobcentre Plus at Gateshead, England (Photo: AP)

The headlines on the latest unemployment statistics from the ONS are grim. Unemployment has reached 8.1 per cent – it's highest value since 1996. In terms of numbers (as opposed to percentages), it's at its highest level since 1994. The last times unemployment exceeded 8.0 per cent on the way up were in the first quarter of 1991 and the final quarter of 1980 – not auspicious precedents.

Below the raw headlines, something rather interesting is happening – something predicted by a number of economists for some time. Despite the recession being the worst since the 1920s, unemployment has not so far even reached the heights of the 1990s. The 2008/9 recession was deeper than that of 1979-81. If the same peak unemployment rate had been reached as at that time (11.9 per cent), the number of people unemployed would have been 3.8 million. Many economists – including yours truly – suggested that figures as high as 3.5 million were likely. By unemployment has so far not exceeded 2.6 million.

One factor here – perhaps the most important, really – is that unemployment is what economists call a "lagging indicator". In other words, unemployment reaches its peak after recessions have ended (it lags behind). For example, in the 1980s the recession ended in early 1982, but unemployment continued to rise until 1984. Perhaps the main rises in unemployment are yet to come?

Another factor was a suite of responses by the labour market to the recession. In the 1980s the rise in unemployment was intimately connected with huge rises in wages in 1980 (rising 22.6 per cent in the year to October 1980, at a time when inflation was 15.4 per cent and falling), as workers tried to keep up with rapidly rising inflation and didn't believe the government when it said inflation would come down. When inflation did in fact fall (going down below 4 per cent by early 1983), workers were stranded on uncompetitive salaries and less productive workers being fired was, in fact, a sine qua non for growth to recover.

By contrast, during the current recession workers have accepted a combination of salary freezes or even cuts, non-payment of bonuses, loss of overtime, and part-time working. Hours worked by full-time workers fell significantly during the recession – from 37.3 hours per week on average in 2007 and early 2008 (a figure that had been pretty stable since 2002) to just 36.5 hours by mid-2009 (the lowest figure since comparable records began). Whilst the number of full-time workers fell by 990,000 from early 2008 to early 2010, the number of part-time workers actually rose, by around 570,000.

Such strategies helped firms continue without firing workers for a time, but if there is a further down-leg in the recession, such arrangements are unlikely to be sustainable. Alternatively, if the economy begins to recover more solidly, workers are unlikely to be content to continue to have their real salaries eroded by inflation, to miss out on opportunities for over-time or bonuses, or to have full-time work. A likely sine qua non of recovery is that firms fire their less productive part-time workers and instead allow their full-time workers to earn more.

The latest data suggest that this might indeed have started to happen. For whilst the total number of people in employment has fallen nearly 180,000 over the past quarter, that is entirely accounted for by a 180,000 fall in the number of part-time workers. Over the past year, the number in full-time employment has actually risen, by around 120,000, but there has been a 170,000 drop in part-time employment. Average hours worked are back to 37.0 per week.

This factor is probably also reflected in recent trends in salaries, which have started to pick up again in recent months, now rising at around 2.8 per cent per year, versus just 0.5 per cent in mid-2009.

The last thing to point out, for now, is that although fiscal consolidations have often been associated with faster growth, even in the short-term, they are almost invariably associated with rising unemployment – e.g. see here. I am a strong supporter of the Coalition's fiscal consolidation programme, but I always found the government's claim that unemployment would be likely to fall during it to be greatly at variance with theory and evidence.

Either way – further down-leg or recovery phase - unemployment is likely to rise further from here.