Sunday, October 22, 2006
Misery threatens our high streets
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

It never rains but it pours. Misery loves company. Bad things always come in threes. I could go on but you get the drift. When problems arise they do not do so in an isolated way. It happens in everyday life and it happens to the economy.

The name of Arthur Okun is not that well known these days. An American economist who served as chairman of the president’s Council of Economic Advisers in the 1960s, he died in 1980 at only 52.

He left us “Okun’s law” on the relationship between unemployment and the wider economy (higher unemployment reduces gross domestic product and vice versa).

He also left us some memorable quotes. Increasing taxes on the rich to help the poor would always produce disappointing results because: “The money must be carried from the rich to the poor in a leaky bucket. Some of it will simply disappear in transit, so the poor will not receive all the money that is taken from the rich.”

Okun also gave us — perhaps his most enduring contribution — the “misery” or “discomfort” index. This was measured by simply adding the inflation and unemployment rates together, and he used it to underline how much things were going wrong in the 1970s.

Okun’s misery index is relevant today in Britain. Figures last week showed that inflation, measured by the retail prices index (RPI), rose to 3.6% in September, the highest since the summer of 1998. Unemployment was also up, with the Labour Force Survey measure at its highest since the spring of 2000. Adding the two together — 5.5% unemployment and 3.6% inflation — gives the highest misery index for more than eight years.

A few caveats are in order. The reason the Bank of England was never asked to target the “raw” RPI was that it goes up when interest rates rise because it includes mortgage payments. Thus, action by the Bank’s monetary policy committee (MPC) to reduce inflation has the perverse effect of raising it, at least in the short term. Last month’s increase in RPI inflation from 3.4% to 3.6% was explained by the fact that mortgage rates were falling in September last year but rose last month.

Other inflation measures — RPIX (excluding mortgage interest payments) and CPI (the consumer prices index) — showed small falls, to 3.2% and 2.4% respectively, on the back of falling petrol prices. But they seem likely to rise next month. And if, as universally expected, the MPC raises Bank rate next month (respectable third quarter growth figures on Friday were the final hurdle), raw RPI inflation will reach 4% over the winter months.

There is also a caveat to the unemployment numbers. In the past, it was straightforward. The number of jobs went down and the jobless total went up. You did not have to be Mr Micawber to conclude that the result of this was misery. Now we have simul- taneously rising employment — up 120,000 in the latest quarter and more than a quarter of a million over the past year — and unemployment, which on its broadest definition rose by 45,000 in the latest three months and is up 276,000 in a year.

It is not all due to immigration. The workforce is growing for natural reasons and because more older people are gaining or staying in employment. But the net result is that Britain needs to be generating more than half a million jobs a year to keep unemployment down. That may change. Immigration from eastern Europe is unlikely to continue at the same pace as in the past two years, so this particular storm may be passing.

If all this is not outright misery (try telling that to the unemployed) it is, to use Okun’s other description, a source of discomfort. A year or so ago, Britain did not have either an inflation or an unemployment problem. Now, while they have to be set in context, it has a bit of both.

This is not on the scale of earlier episodes of misery - you do not have to go back that far to find a time when both inflation and unemployment were in double figures - but it is a little disturbing. And it has consequences.

I noted earlier that bad luck comes in threes. The other interesting thing happening in the labour market, at least according to the official figures, is the absence of pay pressures. Regular pay — average earnings excluding bonuses — rose by only 3.6% in the 12 months to August, and has been on a declining trend for the past 18 months.

The sharp-eyed will have spotted that the growth in earnings is running at exactly the same rate as RPI inflation. This means, more or less, zero growth in real pay — a powerful squeeze. Higher energy prices, and higher mortgage rates, are biting. Something has to give. There could be significantly higher pay settlements over the winter, which is the Bank’s big worry.

In the old days that would have been a racing certainty. We would be looking with trepidation at prospects for the January pay round, and the unleashing of the wage-price spiral. But things have changed. Big wage increases seem unlikely, despite the provocation of high RPI inflation - still the favoured measure of wage bargainers. NHS staff should get no more than 1.5% increases in basic pay, according to the government’s evidence to the pay review bodies for doctors, dentists and nurses.

That, if accepted, will not necessarily be typical. But many people may have to accept wage and salary rises that barely keep pace with inflation.

So, more likely in my view, is that consumer spending will be hit. Last month’s retail sales figures showed a drop of 0.4% — those mid-season sales by clothing retailers earlier this month should have been a clue, and could be the shape of things o come. Retailers raised their prices in September, testing out the willingness of customers to pay more. They may now have to cut them to stimulate spending, as some already are.

When real incomes are squeezed and consumer credit growth is declining, it is hard to be upbeat about the spending outlook — even when employment is rising. Misery may be finding its way to our high streets and shopping malls.

PS A visitor from Mars might think it a bit odd that a debate is raging about tax cuts, and Treasury ministers are trumpeting the risks to their “hard-won stability” at a time when the public finances are in such a poor state. Public spending has risen nearly twice as fast as government revenues in the past 12 months and the public sector’s net debt has risen by £40 billion (to £486.7 billion or 37.6% of gross domestic product).

I’m fed up with the debate over whether Gordon Brown will meet his fiscal rules, because we know, if there was any danger of not meeting them, they would be fudged. More to the point is whether there is any conceivable way of cutting taxes when the public finances are in this state.

One popular theory in Westminster is that Brown will kill several birds with one stone by cutting taxes ahead of the election. Lord Forsyth’s Tax Reform Commission, which reported to the Conservative party but whose ideas are now in the public domain, offered a range of simplification and reduction options, some of which the chancellor could grab. They include abolition of the gimmicky 10% starting rate of income tax, a cut in the basic rate to 20%, a corporation tax rate of 25% and a long overdue shake-up of capital taxes, including abolition of inheritance tax.

But do the public finances allow tax cuts? Only if lower taxes can be demonstrated to generate “dynamic” effects on growth and revenues, something the Treasury is programmed to be cautious about, or if public spending comes under tighter control than I think is likely, notwithstanding the tough talk about next year’s spending review.

The state of the public finances is one problem for the Tory leadership, the other is the fear of being seen by voters as public spending slashers. Lord Harris of High Cross - Ralph Harris - was with Arthur Seldon a founder of the Institute of Economic Affairs. He died last week. His advice to David Cameron and George Osborne would have been simple: If you believe in something do it, don't dither. He will be missed.

From The Sunday Times. September 22 2006

Comments

Funny how nobody ever factors in our enormous and ever-increasing subsidy to the European Union...

Posted by: Peter at October 23, 2006 02:31 PM
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