Sunday, August 21, 2011
Misery index explains why we're all so glum
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

The misery index, invented by the late Arthur Okun more than three decades ago, is simply the sum of a country’s inflation and unemployment rates. Given that low inflation and low unemployment are the central aims of economic policy, the higher the index, the worse the authorities are doing.

So why mention it now? Because last week brought news of both rising unemployment and rising inflation. And at 12.5 (a May unemployment rate of 8% coincided with an inflation rate of 4.5%) it is at its highest since February 1994.

It is more than double its recent low point - we are twice as miserable - as September 2004, when it was just 5.8. For most of the 2000s, it was between 6 and 8.

The misery index tells us why consumer confidence is so depressed and people reluctant to spend. Indeed, while there may have been more to worry about when the banks were collapsing and the economy shrinking fast, the misery index is higher now than during the recession proper.

Let me deal with the two components of the index, starting with unemployment. Though the latest figures were gloomier than we have been used to in recent months, and any amount of unemployment is a waste, the story of Britain’s jobless rate is essentially a stable one.

Having risen during the recession, the unemployment rate has been stuck around 8% since mid-2009. This is not unusual. In the early 1990s unemployment remained above 10% until 1994, two years into the recovery. In the 1980s it took even longer, the rate not dropping into single figures until late 1987, more than six years after the start of a recovery that began in 1981.

Some tried to inject a bit too much excitement into the figures. Danny Blanchflower, former member of the Bank of England’s monetary policy committee, urged George Osborne to “get his facts straight” on jobs, arguing that a 6.9m drop in total weekly hours worked in the economy in the year to the second quarter equated to nearly 200,000 lost jobs. He forget the extra bank holiday in April, which by rights should have resulted in an even bigger drop in hours worked during the quarter - an important fact to get straight.

Others sought to generate heat by claiming that every job created in the past year - and more - has gone to foreigners. The Office for National Statistics was asking for trouble when it started producing data for “UK-born” and “non-UK born” employment.

My best reading is that a significant chunk of the 241,000 rise in employment in the past year has gone to recent migrants but certainly not all of it.

Employment among those born in the accession countries (the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, the Slovak Republic and Slovenia) has for example risen 106,000 in the past year. Most of the rest of the rise in non-UK born employment does not appear to refelct recent migration and some if it is among UK nationals. The perception that foreigners are taking all available jobs does not, however, help the government’s cause.

Neither does the struggle to make inroads into youth unemployment, currently 20.2% among 16-24 year-olds, and higher fcr young men than young women. Again, unemployment in this age group is not trending in any direction, and 278,000 out of the 949,000 unemployed are in full-time education. But unemployment in this age group is an undoubted problem.

Overall, the job market is behaving as you would expect. The economy is growing, stripping out distortions, by 1.5% to 2% a year, I would estimate. That is enough to generate growth in employment, 25,000 in the latest three months, but not enough to absorb the increase in the workforce. So unemployment will at best stay where it is in the coming year or so, or at worse rise further, particularly if falling markets continue to undermine confidence. This bit of the misery index is not going to become more cheerful in a hurry.

You expect unemployment to be high in the aftermath of a recession. You do not expect high unemployment to be accompanied by high inflation, which is what we have and why the misery has intensified. After hitting 4.5% in May, Britain’s rate dropped to 4.2% in June before bouncing back to 4.4% last month. According to the Bank, it is on its way to 5% or more.

One easy way of looking at its impact is on retail sales. Consumers spent 4.3% more last month than a year earlier but all this was accounted for higher prices, leaving volumes flat. Had inflation been lower, consumers might have boosted growth, rather than running to stand still.

Sit down with anybody senior at the Bank and they will tell you, as this month’s inflation report said: “Inflation has been pushed up by rises in energy and import prices, and the increase in the standard rate of Vat.” There is, in other words, no domestically-generated inflation.

Look through the latest consumer prices index , however, and you see plenty of price rises that fit the Bank’s description, but also quite a lot that do not. So the cost of insurance has risen by 13.6% over the past year; recreational and cultural services are up 5.5%; car maintenance and repair 4.6%; postal services 10.5%; education 5.3%; hospital services also 5.3%, and so on. Tools and equipment for home and garden have risen by 14.5% in the past year.

Some of these price rises reflect the Bank’s factors but others appear to indicate a shift in pricing behaviour. As an obsessive, watcher of prices it seems to me retailers may now be trying a different tack, by re-stocking for the autumn at significantly higher prices.

I have no proof of this beyond the anecdotal but one explanation may be that if customers are inured to the idea of higher inflation, it becomes much easier to push through increases. If, at the same time firms have given up on the idea of selling at greater volumes, they may be seeking instead to boost margins. The Bank is watching for this very closely through its network of regional agents.

We see this in microcosm in petrol prices, which should have come down long ago under the impact of a significant fall in crude oil prices. Once they might have done. This time they have not.

So all this is rather worrying. There are many reasons why inflation should fall over the next 12 months, most notably January’s Vat hike dropping out of the year-on-year comparison. But firms set prices, not the authorities. If they do not want to play ball, inflation could stay uncomfortably high. And so will the misery index.