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The short-term employment vs productivity trade-off

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Back in the seventies, a visit to the car wash was an exciting time for children. The huge automatic brushes; lashings of foam of different colours, signifying different stages of the cleaning cycle; and finally the ludicrously powerful ‘hair-dryers’ at the end, all contributed to a most agreeable outing. A coin (probably a 50 pence piece) was inserted and the whole process proceeded with no further human intervention, other than drivers having to swiftly wind up their windows lest they were inundated by the kaleidoscopic foam.

The design of these machines changed a little over the years but the principles remained the same. By the noughties, inflation meant that there had to be someone to take the money and start the machine, since no-one could be expected to insert £6 or £7 in coins. Then, about ten years ago, the machines disappeared. Nowadays, drivers visit ‘hand car washes’ where six or more workers may be involved in the washing and leathering process.

Last week we learned that the participation rate in the UK labour market of those aged 16 to 64 had risen again to another all-time high of 74.5%. While this is to be welcomed, it is an unfortunate fact that productivity has flat-lined since 2007. In the long term, increases in productivity are the only driver of higher GDP per capita, which is the closest proxy for standard of living. The car wash example is but one of many where relatively cheap labour continues to be substituted for capital as businesses have chosen to employ rather than invest.

There are myriad arguments for the social desirability of high levels of employment, but much depends on what work people are doing, particularly if it used to be done by machines. There is already plenty of anecdotal evidence that some businesses are preparing to reverse the trend and bring in more mechanisation as the new National Living Wage rises to its target of 60% of median earnings by 2020. In the short term, this will increase productivity at the expense of employment. In the long run, however, as has been the case for 200 years, investment in technology is the only way to secure employment and raise living standards.

Last week brought some cautiously good news on the UK economy. Higher fuel prices caused by the post-referendum fall in GBP/USD caused CPI to tick up a notch to 0.6% year on year, although core CPI actually fell from 1.4% to 1.3%, demonstrating that we still face a deflationary threat and the fall in the pound is good news overall. Unemployment remained at 4.9% and employment increased by a very strong 172,000 in the three months to June compared with the three months to March – and by 606,000 in the three months to June compared with the same period last year. Average earnings in the three months to June were 2.4% higher than in the same period a year ago, meaning that real earnings are rising by either 1.8% or by just 0.5%, depending whether CPI at 0.6% or RPI at 1.9% is applied to the nominal figure.

It was the retail sales figures, though, that had the most impact. On the basis that these increased by 5.4% excluding fuel and autos year-on-year in July, it seems the indefatigable British consumer has been unfazed by Brexit. Including fuel and autos, the figure was +5.9%. However, some car dealerships have pretty low growth expectations following the record sales that were achieved last year. If there were any growth at all in car sales between now and Christmas, that would be regarded in many quarters as an almost miraculous result.

Despite the strong labour market data, which as discussed, may be a double-edged sword, it is far too soon to tell what the impact of June’s referendum will be. The most ardent Brexiteers were quick to point out that all is well with the UK, though at this stage that is something of a moot point. What is in no doubt, is that there is a disparity between the apparent optimism of the consumer and the more generally downbeat prognostications of business. Either the business community is underestimating the resilience of the economy – and particularly the benefits of the weaker pound in an era of competitive devaluation – or the consumer is blissfully unaware of the storm clouds on the horizon. We must hope for the former, even as Mark Carney prepares for the latter.

This week is a little short on data releases. Wednesday sees the BBA mortgage approvals which are expected to reflect the cooling in the UK housing market, with a slight fall to 38,000 in July. The second estimate of UK Q2 GDP, due on Friday, is expected to confirm the preliminary reading of +0.6% q/q and +2.2% y/y. In the Eurozone, tomorrow sees manufacturing and services PMI for August – expected to come in at 52.0 and 52.8 respectively. In the US, we shall see the August PMI for manufacturing (tomorrow, expected 52.7) and services (Thursday, expected 51.8) and the second estimate of Q2 GDP (Friday, expected 1.1% annualised).

Market watchers will be eagerly awaiting Janet Yellen’s speech on Friday at the annual meeting of central bankers at Jackson Hole. Expect relatively upbeat comments on the US economy, designed to leave the markets in no doubt that a rate rise later this year has not been ruled out. Whether one is actually on the cards is a different matter, but the Fed Chair will certainly be insisting that, given the right data, it is.

All views expressed in this bulletin are the author’s own and are based on information available at the time of writing

AUTHOR SPOTLIGHT

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