A sad little sojourn to Britain …

I have been doing work on international trends in unemployment today and spent some time on the UK economy. Of-course, Britain is in the news at present because its polity is melting down rapidly. We have been laughing a bit I am sure about the so-called rorts scandal, especially the story about the ducks not liking their island anyway. I laughed anyway. I also applauded the skilled research that tracked the island down on Google Earth. Anyway, the rorts scandal is a sideshow in a much bigger problem that is unfolding in Britain at present. Its labour market is in free fall!

This chart taken from the Office for National Statistics shows a demand-side failure in the British economy. You can tell that it is a demand-side event (that is, deficient aggregate spending) because the rising unemployment rate (right panel) is being mirrored by a falling employment rate (left panel). The total number of people in employment has fallen sharply over the last year. All other labour market indicators are also bad (vacancies down; wages growth down; participation rates down).

In the year to March 2009, the official unemployment rate rose by 1.8 per cent.

It is hard to find recent underemployment data for the UK but the data I have seen suggests that the rule of thumb – double the official unemployment rate to get a rough estimate of broad labour underutilisation – is a reasonable approximation.

The UK unemployment rate in March 2009 soared to 7.1 per cent with 592,000 workers losing their jobs over the 12 months from March 2008. Overall, some 2.22 million workers are now unemployed and the rate of decline in the labour market is the worst since the 1981 recession.

So adopting the rule of thumb we might conclude that around 14 per cent of Britain’s available labour force are without sufficient work (2.22 million without any work!). That sounds like something that needs a very strong correction.

Further, the composition of the unemployment is very worrying. This graph (dated 2004) is from Office for National Statistics shows that unemployment is concentrated among the non-White ethnic groups in the UK.

Further, the recent data available from the Office confirms that across all ethnic groups:

… unemployment was highest among young people aged under 25. Over 40 per cent of young Bangladeshi men were unemployed. Young Black African men, Pakistani men and women, Black Caribbean men and women, and men belonging to the Mixed group had unemployment rates in excess of 20 per cent. The comparable unemployment rate for young White British men was 12 per cent and 9 per cent for young White British women.

The State Economic Minister of Turkey once said that “as long as an atmosphere of wealth and stability, which fails to grow inline with the world economy, exists, global terror and similar situations will prevail … We don’t have the option of failing in the struggle against unemployment, both on national and global scales. (Source).

In 2002, a Special Report from the United States Instiute of Peace – Islamic Extremists: How Do They Mobilize Support? said:

Another prime factor in the rise of extremism is the failure of many governments in the Muslim world to address the overwhelming challenges of development arising from rapid social, demographic, and economic changes over the past century. It is no accident that many of the extremist groups in Pakistan, for example, are centered in mid-sized towns whose populations have grown exponentially in recent decades because of rural-to-urban migration. Of the 140 million people living in Pakistan today, most are poor and susceptible at some level to the blandishments of extremist groups, who claim to have answers to questions that their own government has unsuccessfully addressed or simply ignored. Throughout the Muslim world, extremist religious groups tend to be most influential in locations where local governments are the least effective in addressing developmental challenges.

While there is a major industry out there denying any relationship at all between unemployment and terrorism the research evidence points to the opposite conclusion. It is not so much poverty that drives political instability (many of the poorest countries are free of terrorist insurgencies) but the alienation, lack of hope, and lack of connection with the mainstream social milieu that creates a cohort ripe for recruitment.

I have often though that instead of the term the War on Terror we might have better called it the the War on the Unemployed Islamic Youth!

The work I am doing as a consultant to the Asian Development Bank at the moment includes a thorough macroeconomic risk assessment for Pakistan. In that work, I have stressed the urgency of direct job creation to alleviate the danger of instability brought about by the alienation that unemployment generates.

So given all that we might ask the question: What is dominating economic news in Britain this week?

You won’t be surprised at all by the answer!

The headline Brown May Hurt U.K. Credit Rating By Naming Balls as Chancellor tells us that Debt Hysteria 101 is back for another day. While we are getting bombarded with the hysteria here we can feel somewhat comforted that the British are also drowning in the irrelevance of the hysteria as well.

According to this Bloomerg report, the UK Prime Minister, beset with massive political problems that have to be terminal, is now seeking a way to extend his tenure. He has decided to make use of the forced Cabinet reshuffle to sideline the “Chancellor of the Exchequer Alistair Darling” and replace him with “Ed Balls”.

Why would he do that? The conjecture is that Darling has pushed a neo-liberal ‘get the budget back into surplus’ line relentlessly, which the PM thinks will undermine his political chances in the next national election.

The reporters then quote someone from the “markets” who says:

Given that the U.K. rating is already on a knife edge, the case for a downgrade would become much stronger … The plans as currently set out are barely credible.

The reporters say in reaction to this statement:

Behind in the polls and facing a challenge from within his Labour Party, Brown is boosting government spending to rescue the economy from its worst recession since World War II. That jars with a warning from Standard & Poor’s that the U.K. may not be able to keep its top-notch credit rating as its debt nears 100 percent of gross domestic product or $2.1 trillion.

Can you believe this? The labour market is deteriorating rapidly; 14 odd percentage of its available workforce is not being used effectively (7 per cent not at all) – and the ratings agencies are trying to remain relevant by threatening to downgrade a sovereign government as if it has the same solvency risk as a corporation.

The UK Government, no matter how badly managed at present, no matter how many duck islands it has built with public spending, has no solvency risk. None. Not a bit!

No serious policy decision considered by the British government or any sovereign government for that matter should ever include a moment’s consideration of what the ratings agencies might or might not do.

The problem seems to be that the Chancellor of the Exchequer bought this nonsense hook line and sinker and announced that they would start cutting spending growth to meet some quantitative budget target that was intended to impress the financial markets (and the rating agencies). Darling has always advocated budget austerity.

It is clear that the Government has to increase net spending to underwrite employment and finance non-government saving intentions. If it doesn’t do that the budget deficit will just keep rising anyway as a consequence of the automatic stabilisers.

It is nonsensical for the Government to target some budget outcome. They cannot control that outcome anyway. The budget deficit outcome is what we call an endogenous event in the economy – that is, determined by the overall system. In particular the saving and investment decisions of the private sector play a big role in determining the size of the fiscal balance.

The Bloomberg reporters don’t get it. They are content to conclude by quoting another financial market type who says:

The concern has to be that in the run up to an election they boost discretionary spending … It would be a comic irony if Labour were to screw up a AAA rating. It would be a defining moment they would take years to get away from.

Since when has it been a concern that a government actually reduces unemployment using its fiscal powers?

And the comedy here are these characters with bloated pay checks who think the ratings agencies are important. See my blog – Ratings agencies and higher interest rates – on why they are not important to a sovereign government.

What the Government has to be doing is ensuring that net spending growth closes the non-government spending gap. That is the only way they will arrest the decline in the labour market and restore hope to the communities that are being devastated by the downturn.

If all Governments around the world follow suit we might also have a more peaceful future.