Hamish McRae: Shifting patterns in jobs leave us poised to greet recovery

Economic Life: It is even conceivable that there will be more people self-employed than in the public sector

The detail, as so often is the case in economics, is more interesting than the headlines. We have just had a wodge of information about the UK economy, including the unemployment figures and the quarterly Inflation Report from the Bank of England. The headlines for the former were that unemployment was still creeping up, though total employment was creeping up too, while the for the latter I suppose the main messages were that the Bank expected inflation to be below 2 per cent by the end of this year and there to be solid economic growth in 2013.

Click HERE to view 'UK economy inches forward' graphic

There is nothing wrong with this general response. The unemployment numbers, while bad, do sit alongside the more general point that increased employment in the private sector is just about managing to offset the loss of jobs in the public sector and that overall hours worked in the economy seems to be nudging upwards. This is consistent with slow growth rather than renewed recession.

As for the Bank's views, it is now towards the optimistic end of the scale in its expectations for the economy. It does not give precise forecasts for growth, preferring instead its famous fan charts, showing a range of probabilities, but a glance at the charts suggests the bank's collective expectation is for growth to be around 1.5 per cent this year and 3 per cent next. Contrast that with the National Institute's forecast of a contraction of 0.1 per cent this year and growth of 2.3 per cent in 2013. The National Institute has stuck its neck out with that gloomy prediction for this year and it will be interesting to see whether it will look very silly or be triumphantly vindicated. But the Bank has equally stuck its neck out in expecting a great leap forward (albeit from a long way back) next year. We will just have to wait and see. The detail within the new information, however is even more interesting.

Take, for a start, the way the different parts of the economy have fared over the past few years, as shown in the first graph. As you can see, manufacturing took a far greater hit from the recession than did services and has recovered far more slowly. Services output is within one percentage point of its peak, while manufacturing is still seven or eight off it. And the recovery of the onshore economy, that is excluding oil and gas output which is mostly offshore, is appreciably better than the total economy. A further point is service industries seem inherently more stable than manufacturing. That is not to suggest all this talk of rebalancing towards manufacturing is misplaced; simply to make the point that insofar as it is successful, it will lead to a less stable economy.

Another nugget from the Inflation Report was the shift to self-employment, shown in the other graph. We are now back up to the previous peak at 14 per cent of all employment and it is perfectly plausible, given the decline in public-sector jobs, that it will rise further through the next decade. The push to encourage the formation of more small companies, if successful, will be to increase self-employment. It is even conceivable that 10 or more years from now there will be more people self-employed than working in the public sector. That will have huge implications for government policy but also for society. The politics of a country with a rising proportion of people who work for themselves will be quite different from one with large numbers of state jobs.

It is tempting to see these shifts in party political terms. The first surge in self-employment took place after 1979 under the Tory governments; it reversed in the early years of Labour; now it is rising under the Coalition. But that is too mechanical, for as you can see the decline began in 1995, before Tony Blair came to power, and the recent rise began around 2003, long before Labour's 2010 defeat. Still, if the present trend continues, the self-employed will become a more important political lobby and the parties will have to think about what that might mean.

There are many other changes that these two reports highlight. For example there is the way in which immigrants have been successful at getting into employment, much more successful than people born and brought up in Britain. That has aroused a lot of debate and it will continue to do so: what are the characteristics that make immigrants successful in the labour market and what can we as a country learn from that?

Another point is the continuing shift to part-time employment. Is this a voluntary shift, with people preferring to cut their working hours, or are people being forced to downsize, so to speak, the amount of work they do? That too has policy implications, for so much of the employment legislation is designed for full-timers.

Put all this together and the story that emerges is that of an economy undergoing very rapid structural change. That is partly the result of recession and the slow recovery and partly a reversal of the surge in public spending that took place from the early 2000s through to 2009. But what is happening now seems to me to be a speeding up of shifts that would have taken place anyway and it shows the extent to which the UK economy is adapting to a quite different world. As demand recovers – and if the Bank is right, by this time next year it will be rising fast – we should have an economy better able to meet that demand without showing any inflationary pressures.

And that is one of the great uncertainties. How much spare capacity is there in the economy? There is certainly spare capacity in the labour market, and sadly so. But some capacity in the economy will not be needed as demand recovers: we may not need as large a financial sector, perhaps. But the more genuine spare capacity there is, the greater the possibility of recovering the ground lost during recession. It is unlikely that we will get back to the previous peak in output until some time next year. If it is the back end of the year, it will be six years from the previous peak. At some stage growth will head back to its long-term trend, but that still looks a while off.

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