Half way through the recession, but the worst unemployment is still to come – where are we now?

The Duncan Weldon Economics Matters Column

Given that it’s Bank Holiday Monday, I thought I might be, relatively, non-political for a change. This week saw the second estimate of first quarter GDP released, which gives some more detail on what drove the fall of 1.9% in UK GDP. In light of this, and given all the recent talk of ‘green shoots’, I think now might be a good time to set out exactly where we are economically.

To start, this is a bad recession and it would be pretty silly to pretend otherwise. The Q1 numbers were the third consecutive fall in GDP and given that the growth figure for Q2 2008 was zero, it has now been an entire year since the UK economy has grown at all.

This recession is broad based, the only sectors of the UK economy showing any growth are Government spending and agriculture. Household spending fell by the most since 1980, production fell by 5.3%, investment fell by 3.6%. If Government spending had fallen at the same rate has private sector output, the decline would have been more like 2.4%.

Overall the economy is now 4.1% smaller than it was a year ago. That’s a very big fall. Snowflake5 has some good analysis of the international comparisons, showing that the UK is actually doing comparatively better than France, Germany & Italy (not to mention Japan), but this is small comfort.

So, where does this leave all the talk of ‘green shoots’? There are certainly some signs for optimism out there. The FTSE is up strongly over the past two months, there are signs of some sort of stabilisation in the housing market, retail sales are surprisingly resilient, UK exporters are benefiting from weak sterling and, most importantly, some forward looking survey data is a bit more positive. That last point is crucial: every month there are several surveys of business opinion about current conditions and future plans. Over the last two or three months, whilst not rebounding strongly, these surveys are pointing to a bottom being found.

On a more technical note, there is reason for hope in the large fall in inventories last quarter. One third of the total decline in GDP came from firms running down stocks of unsold goods. This is strangely positive as, at some point, these stocks will have to be – at least partially – rebuiltÒ—, leading to an increase in production. It is possible that this rapid decline in inventories over the past few quarters is tied to the growth in ‘just in time manufacturing’, whereby global logistics chains are now far more responsive to global demand than in the past.

It is highly likely that the last quarter will prove to be the worst, with smaller falls in Q2 and Q3 as activity stabilises and inventories are restocked. However it is still likely that the economy will be shrinking until at least the end of this year, and very possibly into next. It could well be Q2 or Q3 2010 before growth returns. More crucially unemployment is what economists term a ‘lagging indicator’, i.e. it responds to economic growth after it has occurred.

So even if the economy does return to grow in Q2 in 2010 (still a year away) unemployment could keep climbing until late 2010. Once the recovery has started, it might not feel like a recovery for many.

There has been a lot of talk of the different shapes of recessions. Last year a lot of people hoped for a ‘V’ (a rapid fall followed by a rapid recovery), this looks unlikely. Many, myself included, worried about an ‘L’ (a sharp fall followed by little or no recovery, a la Japan in the 1990s). I now hope enough has been done (slashed interest rates, Government spending, VAT cut, quantitative easing, sterling’s fallen), to prevent this. Most likely now is a ‘U’, a fall followed by a slower recovery – although the risk of an ‘L’ would be increased if deflation took hold.

We are now more than half way through this recession and the worst in terms of GDP falls is hopefully behind us; though the worst in terms of unemployment lies ahead.

But the Government can be proud of doing its bit to smooth the recession, even if few people will want to hear that.