Hamish McRae: We should celebrate the fact that our economy is still creating jobs

Growth will come not from a revival in manufacturing but from demand for services
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The great puzzle over unemployment continues.

The great puzzle over unemployment continues.

Yes, it is going up, as you might reasonably expect given what is happening to the manufacturing industry – now in severe recession. But not only is the seasonally adjusted rise in unemployment tiny. It is also in sharp contrast to the string of job-loss announcements from companies, the slump in adverts for job vacancies, and the reported rise in employment. What's the explanation?

Start with what we know for sure. We know (see left-hand graph) that retail sales are extremely strong, as strong in fact as at any time since 1988. We know too (same graph) that manufacturing is in almost as severe a recession as in the early 1990s. One further point: retail sales are only about a third of consumption, the rest of the money being spent on buying services. If retail sales are strong it seems reasonable to assume that the rest of consumption is strong too, and that does seem to be the case.

We know too that employment is rising, partly because the figures say so but also because employment intentions of companies are still positive. The balance of companies planning to increase their labour force is still positive (right-hand graph) though the balance has come down quite sharply.

What might bind together these facts? Try this.

Point one: look for lags. Manufacturers are certainly shedding labour but there is a time lag between the announcement and the action. So while manufacturing employment is falling, the fall has yet to pick up real pace. (When figures seem to conflict with reality, time lags and a faulty seasonal adjustment are always two of the prime suspects. On this occasion the seasonal adjustment may be OK but I'm sure time lags are very important.)

Point two: think small. Small service industries – pubs, small builders, etc – may well still be increasing employment but are too small to be picked up on the radar. Since consumption is still rising quickly there must be continued demand for labour in these small businesses. Most official data tends to reflect what is happening in the big economy, whereas some of the most interesting stuff that is going on is in the small economy.

If this is right, we are seeing two big structural changes take place against a cyclical background. One structural change is a sharp shift from manufacturing to services (which has been widely noted), the other a sharp shift from large companies to small (which has not).

This second shift deserves further attention for it has seismic implications for the future. Expect the whole job market to weaken in the months ahead as the lags noted above take their effect and the redundancies that are currently being announced start to show up in the unemployment and the employment figures. It may be that as this change in the job market feeds through to our pay-packets the growth in consumption will tail off, which will in turn give a further downward twist to the job market.

So we are by no means in the clear yet. Indeed if the National Institute estimates of a flat GDP in the fourth quarter of last year prove right, our economy will be flirting with recession in the next few months. But the important policy implication is that growth will come not from a revival in manufacturing but rather from sustained demand for the output of our service industries, in particular the small ones.

Policy ought to reinforce this success. In other words we should use this downturn as an occasion to nudge the economy towards its future shape. We ought to try and assist the shift, rather that fret about it. In practical terms what might this mean? Here, in no particular order, are 10 ideas.

One, encourage self-employment. Most of the new jobs will come from small businesses and most small businesses start off with a person choosing to become self-employed – or having the choice made for them. At the moment many people, particularly in the computer world, are denied the right to be self-employed by being considered employed by companies to whom they sell their services.

Two, remove administrative blockages to business formation. By international standards we are pretty good – much better than Europe but somewhat worse than the US.

Three, learn from regional experience of how businesses are created. For example, the rate of formation varies from one part of the country to another. We should look at the reasons for this and see if lessons learnt in one area can be transported to others.

Four, have a short-term patch to simplify small business taxation. One of the criticisms of the Chancellor's otherwise competent stewardship of the economy is the added administrative burden placed on the business community.

Five, consider a more radical reform of personal taxation on the basis that being self-employed is just as normal as being employed. At the moment the structure of taxation is designed round PAYE, not self-employment.

Six, change pension legislation on the assumption all people will have personal pensions, whatever their employment. Assume, for example, that public sector employees should be making additional private pension provision from themselves.

Seven, encourage multiple employment. No job is safe. So the wise policy should be for people who want to, to be able to develop some private practice alongside their mainstream jobs. This is not compulsory, nor an invitation for people to short-change their principal employers. It is merely reinforcing an existing trend.

Eight, clear the way from more student employment. People learn from seeing jobs done: how they should not be done as well as how they should. One of our great strengths is the way the vigour of young people is being applied in the job market.

Nine, encourage older employment by removing tax incentives on retired people not to work. The current retirement age was fixed when life-spans were 10 years younger than they are now. Modest incremental changes in tax and pension legislation are needed to make the transition between work and retirement less stark.

And 10? I suggest we should celebrate the fact that our economy is still creating jobs, and focus on what is happening, rather than focusing on the fact some jobs are being lost. Fingers crossed, but something seems to be going right.