Economic commentary - November 2009

Pay freezes have dominated private sector reward over the past year, and look set to hit the public sector in 2010. But rising unemployment could pose the biggest threat to economic recovery, says XpertHR benchmarking editor Michael Carty.

Today (Sunday 1 November 2009) marks Samhain - the Celtic new year. It is appropriate then that our latest monthly economic commentary includes both a look back at the key trends in pay awards over the past year, and a look ahead to the implications for employment and pay of the 2010 general election.

October 2009 saw recent signs of tentative progress towards economic recovery dealt a severe blow by the preliminary official data on gross domestic product (GDP) for the third quarter of 2009, which showed a surprise fall of 0.4 percentage points (PDF format, 100K). These estimates wrong-footed economic commentators by failing to deliver the expected return to economic growth, which would have signalled the end of the current recession.

However, it should be borne in mind that these figures are estimates, and that as these are subsequently revised, the UK economy could yet be revealed to have returned to growth in the third quarter of 2009.

Nonetheless, the situation remains precarious, with retail prices index (RPI) inflation falling back further into the red and pay awards depressed, while high and rising unemployment represents a particular threat.

Pay freezes dominate

Our colleagues at IRS have published their annual analysis of whole economy pay trends (subscription required), which finds that the 2008/2009 pay bargaining round -  the period 1 September 2008 to 31 August 2009 - saw the long run of relative stability in pay awards come to an abrupt end. A year ago, pay awards had settled at a new benchmark of 3.5% in the 2007/08 bargaining round. But the past 12 months have seen the full impact of the recession take its toll on reward.

IRS pay specialist Rachel Sharp observes:

"A new 'pay floor' has been established in the 2008/09 bargaining round, with the headline pay award standing at nil for the first time in the 25 years since IRS began collecting data."

The IRS headline pay award collapsed to nil over the three months to 31 July 2009 according to latest revised data. And it has remained at this level for the two successive rolling quarters (which includes the first rolling quarter of the 2009/2010 bargaining round: the three months to 30 September 2009).

Pay freezes have become the most common pay award over the 2008/2009 bargaining round, comprising more than one-third (34.9%) of pay deals monitored by IRS researchers. But a breakdown by sector reveals that pay freezes have - to date - largely been confined to the private sector. In the private sector, the proportion of pay freezes ranges from 13% of settlements in the not-for-profit sector to more than half (55%) of those in general manufacturing  and three-fifths (61%) in construction. In contrast, pay freezes represent just 5% of public sector pay awards concluded during the 2008/2009 bargaining round.

Public sector pay outpaces private sector... for now

There is no question that public sector pay rises have outperformed the public sector in the 2008/2009 bargaining round. Over the 12 months to 31 August 2009, the median public sector pay award stands at 2.3%, while the private sector median is 1.5%.

This stark sectoral pay divide could reverse over the coming year. The latest IRS analysis of pay prospects for the coming year (subscription required) finds that private sector pay awards may pick up to some extent if the anticipated economic upturn gathers pace.

Pay freezes are likely to remain a feature of private sector pay for some time, with more than one-quarter (27.3%) of pay groups unlikely to receive a pay rise over the coming year. But pay freezes may no longer be the dominant award. Overall, private sector employers forecast a median pay award of 2% for 2009/2010.

This reflects a more optimistic outlook among employers as regards trading conditions. As IRS notes:

"[E]mployers may be reaching a turning point where pay rises can be expected to show signs of gently picking up as and when the economic background improves in the bargaining round ahead - particularly if inflation starts to rise."

However, the anticipated resurgence in private sector pay awards is contingent on economic recovery. IRS says many employers "may continue to freeze pay if business conditions do not improve".

While private sector pay awards could recover, it is all but certain that the ongoing stability in public sector pay awards will disappear over the coming year.

Conference season sees pay take centre stage

Public sector pay has assumed a critical role in the political landscape as we approach the 2010 general election. Over the past month, the prospect of public sector pay freezes has moved rapidly up the political agenda.

Late September and early October 2009 saw the annual conference season for the UK's leading political parties, with the general election campaign machine starting to crank into gear. Each of the main parties used its conference to set out its stand on how to lead the country out of the current economic crisis.

Public sector pay will be in the firing line no matter who wins the 2010 general election, as the new Government will need urgently to tackle the budget deficit by slashing public spending.

The Liberal Democrats' plans include proposals for a long-term public sector pay freeze.

Labour mixes economic optimism with promises of cuts...

The Labour party's message on the economy over the past few weeks is a curious combination of boosterism and promises of widespread cutbacks.

Gordon Brown talked up the prospects for the UK economy to make a stronger than expected return to growth in the coming months in an interview with the Telegraph on 10 October 2009. Brown hailed a return to what he termed "upgrowth", and predicted that "the economy will grow by one and half per cent next year."

The Telegraph noted that:

"Mr Brown's relatively upbeat assessment of the likely rate of recovery appears at odds with the Treasury's own forecasts of annual growth of 1.25% and the predictions of bodies such as the IMF and CBI of 0.9%."

Brown went further still in a pocast on the Number 10 website on Saturday 24 October 2009, in which he stated that "the battle to stop this global downturn becoming a second Great Depression is being won. [...] My pledge to you is [...] to see Britain's economy return to growth by the end of the year."

A more tempered tone was taken a few weeks earlier, at the 2009 Labour party conference, which saw employment issues take centre stage, with new policies on tackling unemployment, pension reforms and childcare up for discussion. Labour also took the opportunity to prepare the ground for the cuts in public spending that are likely to be set out in Chancellor Alistair Darling's Pre-Budget Report 2009 speech - expected later this month.

In his conference speech, Brown made reference to the Government's need to "make choices about taxation and public spending" to tackle the budget deficit. Brown continued:

"[W]e will raise tax at the very top, cut costs, have realistic public sector pay settlements, make savings we know we can and in 2011 raise National Insurance by half a percent."

So what constitutes "realistic" public sector pay settlements? A definition was quickly provided. Labour sought to steal a march on the opposition by calling for a mix of pay freezes and "minimal pay rises" (of up to 1%) in 2010 for public servants covered by pay review bodies on the eve of the Conservative party conference.

...while Tories herald a new "age of austerity"

One day later, Shadow Chancellor George Osborne criticised the Government's plans for public sector pay. Osborne  told the Conservative party conference:

"What the Government announced yesterday will not be enough. It covers less than a fifth of the public sector workforce. You will see that whoever wins the election is going to have to ask from 2011 each part of the public sector to accept a one year pay freeze."

Osborne said that a Conservative government would freeze the pay of all public servants currently earning £18,000 or above per year.

In general, the Conservative party's outline plans for public spending cuts go further than those set out by Labour. This approach is in line with the overriding Conservative party message on the economy first set out by David Cameron back in April 2009, that the UK must prepare for an "age of austerity".

However, the Conservatives have yet to publish their manifesto for the 2010 general election, meaning that there is still room to manoeuvre on these issues. As the BBC's Robert Peston notes:

"[I]t is significant that the most draconian of Mr Osborne's plutocrat-bashing ideas - viz a possible tax on bonuses and a slash-and-burn approach to top public servants' pay - are not firm pledges."

Former Bank of England Monetary Policy Committee member David Blanchflower meanwhile argues that the Conservative proposals for public spending could jeopardise the UK economy's prospects for recovery. In Blanchflower's view:

"Lesson one in a deep recession is you don't cut public spending until you are into the boom phase. [...] The consequence of cutting too soon is to drive the economy into a depression. That means rapidly rising unemployment, social disorder, rising poverty, falling living standards and even soup kitchens. The Tory economic proposals have the potential to push the British economy into a death spiral of decline that would be almost impossible to reverse for a generation."

Whether Blanchflower's gloomy prognosis proves accurate remains to be seen. But what is more certain is that a new Government could have widespread implications for UK employment regulation. Our colleagues on XpertHR have weighed in with a detailed video analysis of the outlook for employment law following the 2010 general election.

Unemployment still rising, but at a slower rate

It is also inevitable that unemployment will represent a critical concern for the Government, regardless of who wins the election. For yet another month, unemployment has continued to rise. According to latest official unemployment data (PDF format, 345.9K):

• the headline unemployment rate (on the ILO definition) hit 7.9% over the period June to August 2009, a rise of 0.3 percentage points on the rate for the three months to May 2009; and
• the ILO unemployment level was 2.47 million, up 88,000 on the three months to May 2009, and up 677,000 on the same period a year ago.

CIPD chief economist John Philpott observes that the pace at which unemployment is rising is moderating. Philpott says:

"My feeling is that it will peak at around three million [during 2010], which is a little bit better than we thought six months ago."

But the current moderation in the rise of unemployment could be short-lived, given the inevitability of public sector job cuts. As Sunday Times economics editor David Smith notes, public sector pay restraint will not be sufficient to save jobs:

"[P]ublic sector employment will have to be cut, even with the wage freeze."

The Pre-Budget Report 2009 could well provide the first indication as to the exact number of public sector job losses that will be made. In the meantime, some commentators speculate that the extent of public sector job cuts will be severe. For example, Vicky Redwood of macroeconomic research consultants Capital Economics expects around three-quarters of a million public sector jobs to go. Redwood says:

"We think the fiscal squeeze could require around 750,000 job losses in the public sector, meaning unemployment should easily surpass three million."

Double-dip recession risk: Are we on the second leg of the W?

As we noted last month, many economic commentators continue to warn of a "double-dip recession". One such scenario is a "W-shaped" recession, in which economic growth declines then returns to recovery, only to dip back into recession again before at last making a full recovery.

Times business editor David Wighton explains how a "W-shaped" recession could easily emerge from the current circumstances, and the critical role that unemployment will play. According to Wighton:

"[E]ven assuming that private sector unemployment peaks in the middle of next year, we might then be hit with the threat of widespread job losses in the public sector as the new government seeks to control the ballooning deficit. That could easily knock the wind out of consumer confidence, propelling us down the third leg of the W."

A still more troubling scenario was depicted by the Ernst & Young ITEM club, which argued that the UK economy is set for a protracted "VW-shaped recovery". Martin Sorrell of the WPP advertising agency, meanwhile, proposed a more elaborate range of metaphors for recovery. Sorrell predicts that the global economic recovery will be "LUV-shaped" (comprising an "L-shaped recovery" for western Europe, "U-shaped" for north America and "V-shaped" for the other major world economies).

Pay-setting in uncertain times

While it remains possible that the UK will exit the recession in the near future, economic recovery is by no means guaranteed. This in turn makes pay-setting decisions for the 2009/2010 pay bargaining round all the more problematic. Employers are therefore well advised to ensure that they understand what impact their reward decisions are going to have on their abilities to recruit, retain and motivate employees. One way to build a true understanding of how pay and benefits stack up against competitors and others in the wider labour market is to take part in a salary survey.

• Key bargaining statistics on pay, prices and employment for November 2009