Economic commentary - July 2010: Welcome to the age of austerity

The emergency Budget marked the formal start of the age of austerity, with harsh public spending cuts expected to have a big impact on pay awards, unemployment and economic growth, says XpertHR benchmarking editor, Michael Carty.

Summer 2010 officially started on Monday 21 June 2010. A day later, on Tuesday 22 June 2010, Chancellor George Osborne delivered his emergency Budget, marking the official starting point of the long-heralded "age of austerity". Osborne used the emergency Budget - "seen by Treasury insiders as 'the Budget for the whole parliament'" (according to FT.com) - to sketch the outlines of a package of swingeing cuts to public spending to be enacted over the coming years. These are designed to tackle the deficit and enable future economic growth.

It might be argued that with the emergency Budget, the UK continues to lead in its response to the ongoing global economic crisis. Just as in 2009, Gordon Brown claimed that the UK was leading the world on enacting fiscal stimulus measures, so in 2010 many G20 nations look set to follow Osborne's lead in enacting harsh austerity measures.

Making drastic cuts to public spending while economic growth remains weak is nonetheless a high-risk strategy. There have been no end of commentators warning that the stakes are high. Examples include the following:

• "[T]he cure could be [...] worse than the disease," according to Michael White in the Guardian.
• "[A]s a result of this reckless Budget the UK will suffer a double-dip recession or worse, not least because there is no room for interest-rate cuts, although lots of additional quantitative easing (QE) from the Bank of England could soften the blow," according to economist David Blanchflower.

June 2010 brought much-needed clarity on what is to be done with regard to the economy. The coalition Government revealed the broad shape of its economic strategy, and filled in quite a bit of detail. It remains to be seen what impact these policies will have.

Setting the stage for the age of austerity

The cuts started early in the coalition Government's tenure. May saw preliminary public spending cuts worth £6.2 billion, described by Deputy Prime Minister Nick Clegg as a vital measure to "buy time with the markets" and "signal willingness" on austerity measures). These were followed in mid-June by the freezing or cancellation of £10.5 billion worth of projects that had been approved in the closing days of the Labour Government.

But the emergency Budget was always going to be the main course. It was preceded by an extended build-up, with significant input from Prime Minister David Cameron, Clegg, and the newly-created Office for Budget Responsibility (OBR). As Sunday Times economics editor David Smith noted: "Rarely has so much effort been devoted to preparing people for the unpalatable."

Cameron's speech on Monday 7 June 2010 set the tone, blaming Labour for the impact on the UK of the global economic crisis, and for the inevitable consequences of the coalition Government's package of corrective austerity measures. He also co-opted some of the terms used by his harshest critics. Cameron stated that - unless correct measures were taken -"Britain's economy would begin an inevitable slide into decline." This is similar to economist David Blanchflower's warnings of an economic "death spiral," although Blanchflower locates the threat in cutting spending too quickly.

Emergency Budget in focus

Osborne continued Cameron's tone in the emergency Budget speech, declaring it to be "the unavoidable Budget," and promising that its measures would help avert "catastrophe". He also employed numerous variations on the phrase "tough but fair" throughout the hour-long speech.

Personneltoday.com offers detailed guidance on the key points of the emergency Budget 2010 for HR practitioners. These include - but are by no means limited to - raising the national insurance contribution threshold for employers and extending the planned public sector pay freeze (affecting all but the lowest-paid workers) from one to two years.

Osborne also announced a comprehensive spending review (CSR) to be delivered on Wednesday 20 October 2010.

The emergency Budget sketched out economic policy all the way to the 2015 general election. But crucially, it does not tell the whole story. As XpertHR's Mark Crail noted in XpertHR's live blog coverage of the emergency Budget: "There must be more to come. This, of course, is just the first tranche. There will be more in the autumn, more next spring and so on. It's going to be a long, hard haul."

Another participant in the live blog, academic Roger Seifert, expects the October 2010 CSR to deliver further pain for public sector workers, with serious implications for public sector industrial relations. According to Seifert: "The real impact will be clear later when the government announces the detail of its plans for the public sector. It will be harder to manage public service workforces, it will be harder to deliver the current quality and quantity of public services, and it will lead to real unrest among public sector staff."

In his statement on the emergency Budget, CIPD chief economic advisor Dr John Philpott argues that, taken together, the measures set out in the emergency Budget will not serve to accelerate economic growth: "The 2010 emergency Budget is not the beginning of the end of the UK's post-recession economic difficulty but the start of a period of painfully slow growth, falling living standards, and prolonged high unemployment."

Economic growth prospects

To coincide with the emergency Budget, the OBR set out its independent forecast on the scale of the economic challenges faced by the UK (PDF format, 2.5MB). Growth in gross domestic product (GDP) is forecast to rise by 1.2% in 2010, almost doubling to 2.3% in 2011. This compares with GDP growth of between 3% and 3.5% forecast in Alistair Darling's final Budget, just three months earlier on 25 March 2010.

Pay awards hold at 1%

The two-year pay freeze for many public sector workers will inevitably have a significant impact on whole-economy pay trends in the medium-term. But for now, there is stability in the headline pay award, according to latest data on whole-economy pay trends from the IRS pay databank.

The median basic pay increase stands at 1% in the three months to 31 May 2010. This is unchanged from the figure recorded for each of the four preceding rolling quarters so far in 2010. However, it is 0.6 percentage points above the figure recorded a year ago (0.4%).

But this does not necessarily mean that a strong recovery in pay awards is in prospect.

Recent heightened inflation appears to have failed to exert any measurable impact on headline pay award.

Inflation falls back, but remains well ahead of pay awards

After a prolonged spike, inflation has fallen back slightly. Retail prices index (RPI) inflation rose by 5.1% over the 12 months to May 2010. This is down 0.2 percentage points from 5.3% a month ago.

If inflation refuses to fall back further, the Bank of England Monetary Policy Committee (MPC) may yet be forced to raise interest rates (which have been held at a record low of 0.5% for 16 consecutive months) later this year.

For now, the wide gap between pay and elevated RPI inflation means that UK workers' purchasing power is effectively reduced. Headline RPI is now 4.1 percentage points above the median whole economy pay award, which stands at 1% over the three months to 30 April 2010, according to latest data from IRS for XpertHR. This is the second-widest gap between pay and inflation to be recorded in the 26-year history of the IRS pay databank. The widest-ever gap - of 4.3 percentage points - was recorded last month.

National minimum wage increase 2010/2011: A crutch for pay awards?

On Monday 21 June 2010 - one day prior to the emergency Budget - the Government confirmed that the 2010/2011 national minimum wage increase will go ahead as planned. This will see the national minimum wage adult rate increase by 2.2% to £5.93 per hour (up from its current rate of £5.80 per hour) with effect from 1 October 2010, as originally announced in Alistair Darling's final Budget on 25 March 2010.

With pay freezes still common, it is quite possible that the 2.2% national minimum wage uprating could look like "the only show in town" when it comes to pay awards settling in the closing months of 2010.

The October 2010 national minimum wage increase could outperform whole-economy pay awards. Indeed, the OBR Budget forecasts report includes a prediction that wages and salaries will increase by 1.2% on average over the course of 2010. At 2.2%, the October 2010 national minimum wage increase is consequently set one percentage point above the OBR's expected headline wages and salaries increase for the year as a whole.

Employment lawyer Anna Y Birtwistle -Associate at CM Murray LLP - offered an interesting theory via Twitter on why the coalition Government might have chosen to honour such a comparatively generous national minimum wage increase at a time of austerity measures,. Birtwistle says: "Perhaps the thinking is that you can't cut benefits on the one hand whilst cutting minimum wage as there would be no incentive to work?"

Unemployment rate rises to 7.9%; inactivity hits "record high"

Unemployment continues to rise. The headline unemployment rate (on the ILO definition) rose to 7.9% over the three months to April 2010, while the inactivity rate hit what the Office for National Statistics (ONS) describes as a "record high" of 21.5%.

The OBR's Budget forecast report included a prediction that the headline unemployment rate will reach "a peak of 8.1% by the end of the year. Thereafter, the more rapid increase in employment is sufficient to lower unemployment, so that the ILO unemployment rate falls to 6% in 2015."

A number of economic commentators argue that the OBR's expectations for unemployment are optimistic. For example, the CIPD expects that "a mass cull of public sector jobs" combined with economic austerity measures will drive up unemployment and dampen movement in whole-economy pay awards over the coming years. CIPD chief economic advisor John Philpott argues that - as a direct result of public spending cuts - "rather than peaking at 8% this year, unemployment will continue to rise toward three million (10%) by the time Mr Osborne's measures take full effect."

The CIPD's gloomy prognosis appears to be corroborated by leaked Treasury data which estimate that up to 600,000 public sector jobs and up to 700,000 private sector jobs could be lost by 2015 as a direct result of spending cuts set out in the emergency Budget.

Public sector HR could also be hit hard by public spending cuts. Speaking to Personnel Today, Philpott warned that public spending cuts are also likely to result in extensive job losses for public sector HR practitioners. However, he said that if this should happen, it would not happen immediately. Philpott said:

"It's not inconceivable the affect on some parts of HR could be delayed because they will have to implement the initial phase of the cuts and then be cut themselves."

The age of austerity

The emergency Budget has ushered in the "age of austerity". The coming years are likely to see a "new normal" emerge in the UK economy, with significant implications for pay awards, unemployment and GDP growth.

As noted above, cutting public spending could affect the UK's faltering return to economic growth. David Blanchflower expresses concern as to the source of the required growth. He says: "The issue is: where is the growth coming from in the economy? It is not going to come from the public sector and I see no evidence at all that private firms are investing or hiring."

Regardless of the ultimate success or otherwise of Osborne's economic strategy, challenging times are definitely in prospect for HR and pay practitioners over the coming years. It is consequently ever more essential that all decisions relating to pay and employment conditions are supported by absolutely reliable benchmarking and job pricing data.

• Key bargaining statistics on pay, prices and employment for July 2010