Blogs | August 24, 2012

How can the economy shrink and unemployment fall at the same time?

Alex asks: I see that in the United Kingdom growth and unemployment are declining at the same time. This seems unusual to me. Why is this happening?

 Ian answers: At first glance this does seem puzzling. Given that unemployment is such an important factor in people’s lives, let’s examine what might be happening. We would expect that when an economy shrinks – going into recession if the contraction lasts long enough – that unemployment would usually rise.
But, as you correctly point out, this doesn’t appear to be happening in the UK at the moment. The UK economy shrank 0.5% in the second quarter of 2012 (according to the first revision released today) on top of the falls in the previous two quarters. But the latest unemployment rate published by the International Labour Organisation (ILO) shows unemployment fell to 8% in June 2012, from 8.4% six months earlier.
In fact, this taps into a trend that has been developing over several years. UK production now is lower than its peak in 2007 yet about the same number of people are employed now than before the crisis. More people are producing less.

I’ll do it myself
If employment conditions are particularly tough, it might be that more people are working part-time rather than full-time or “doing it themselves” by launching their own businesses.
These circumstances help explain the declining unemployment part of the equation but only part of the reason for falling growth.
The Financial Times argues (behind a paywall) that it takes time for new businesses to reach full strength. If we compared worker productivity (the output per hour worked) between the new and old job, this would be smaller for the new one. The Office for National Statistics writes in The Productivity Conundrum that the UK's productivity experience "has close parallels in other large European economies".

Self “unemployment”
Studies of happiness regularly show that being without a job is one of the greatest sources of unhappiness. Some work is better than none. So working part-time or launching a business can be much better than not working at all.
Getting personal for a moment, I cast my mind back to when I was made redundant in 2003 and I made the decision to work independently on several projects. It wasn’t much fun – but it was a lot better than the alternative of sitting at home and waiting for the phone to ring. A joke at the time among those in a similar position was that we were not self employed but “self unemployed”.

But on pay day…
Low growth may not be depressing employment as much as in the past but it seems to be cutting the amount of money many people earn.
It affects workers who have to avoid being laid off as well as those who have lost or changed jobs. In these conditions, employees may be more willing to accept reduced hours and less willing to ask for a pay rise. So those with jobs may find their income falling – especially after inflation. UK data shows household incomes fell 2.5% after inflation since mid-2009.

Are the numbers actually correct?
Over the past few years there is little doubt that the output of the UK economy has fallen. However, the most recent figures may paint a gloomier picture than the reality. In particular, some question the accuracy of the latest UK growth figures (or GDP), with ING UK senior economist James Knightley writing in report ‘Believe it if you want to’ that the drop doesn’t seem to add up. Knightley writes the decline can partly be explained by extra holidays associated with the Queen’s Diamond Jubilee celebrations.
Businesses surveys, such as the Purchasing Managers Index (PMI) – which surveys medium to large businesses – suggest “flat-lining” as opposed to dramatic falls.

Work around
Employment is, sadly, often badly hit in recessions and typically takes many years to recover. This can be hard on individuals and families, who struggle to make ends meet.
So despite the apparent good news on the job figures, think carefully if you are tempted to chuck in your job in the hope of finding a better one soon. Although your current position may not please you completely, the alternative could be worse.


Ian Bright
Ian Bright

Senior economist at ING
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45 blogs

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