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Destination double dip? How will the UK labour market, businesses and employees respond to economic uncertainty and austerity?

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The frigid state of the UK economy is unlikely to thaw in the near term, with the second leg of a ‘double-dip’ recession forecast to take hold throughout 2012.

The Centre for Economics and Business Research (CEBR) expects any downturn to have longer-lasting effects compared to recent episodes of economic malaise, given the legacy left by the 2008 financial crisis. We expect GDP only to return to pre-2008 levels in 2015, after seven years of slow recovery. This is longer than the three years it took to reclaim pre-recession GDP levels after the 1992 downturn.

Interest rates are likely to be held steady at the historic low of 0.5%, as the Bank of England continues to try and stimulate lending. Amid the glum outlook, more positive factors are emerging. The business-to-business service sector, which includes firms providing HR services, is in a position to capitalise on the difficult environment by offering efficiency and cost savings to other companies.

Languid growth in private consumption will contribute to the disappointing economic performance, as households are still laden with debt, and the UK labour market remains in turmoil. Government spending cuts will place downward pressure on GDP growth, with much more public sector austerity scheduled for the coming years: annual government spending is expected to be squeezed by 10.7% by 2016 (£33 billion per year). Uncertainty about the economy's future has subdued investment by businesses, which choose to hoard cash as both the real and financial economy falter. Indeed, financial markets have stayed jittery in recent months, as European countries scramble to resolve their sovereign debt crises. Failure to do so could bring about deep recession in mainland Europe, which would deliver an even harder hit to UK growth. CEBR predicts a 60% chance of a eurozone breakup in 2012 and, with the euro area being a main trading partner of the UK, a financial collapse there could precipitate a deeper recession in the UK, possibly to the tune of a 1.1% GDP contraction.

Squeezed standards of living

Public sector pay freezes and recession-squeezed private sector budgets have resulted in downward pressure on wages, despite recent high price inflation. We forecast this restrained wage growth to continue, as the excess supply of labour in the market will not reduce any time soon. The latest figures show 2.7 million people out of work, a rise of 200,000 since mid-2011.

Household incomes are likely to be effectively flat until 2013 in real terms, when gradual improvement in the economy should begin to produce modest income rises. This will certainly not herald a return to pre-recession levels of income growth; consumer spending will reflect that. An average middle-class family had £651 of weekly disposable income in 2007, but this has fallen to £609 in 2012, and is set to rise only to £626 by 2016.

Cost-of-living increases are still elevated in the short term, with December's annual consumer inflation rate at 4.2% - fortunately, we expect this to be reined in to approximately 2% in the coming year. Inflation should hover around this level in the next few years, but there are caveats. First, unforeseeable disruptions to commodity supplies, such as conflict in the Middle East, can trigger fast and significant rises in consumer prices. Second, in seeking to remedy a lack of lending in the financial system, the Bank of England may dramatically increase the supply of money, which would result in some price inflation.

While this low rate of inflation is good news to shoppers in 2012, the grim reality for the UK consumer is that price rises are likely to outstrip income growth in the long term. The share of expenditure spent on basics such as food and clothing will increase, as escalating wages in exporters - such as China - increase the costs of producing consumer goods. Western shoppers accustomed to rock-bottom prices will have to make difficult adjustments.

Labour market woes

The UK labour market is fragile. Prolonged austerity will lead to public sector employment continuing to shrink in coming years; the Government's hope that private sector enterprises will 'pick up the slack' still looks unrealistic (Chart 1). In a 2012 recession, the private sector will have employment problems enough of its own, without being relied upon to offset jobs shed from the public sector.

The redressing of a UK productivity gap will be a contributor to this downward trend in employment. More managers will swallow the bitter pill of downsizing, having retained workforces during the 2008-2009 downturn, in the hope of avoiding rehiring costs upon the economy's recovery.

Now, as we slip back into recession and with a gloomy outlook stubbornly fixed for the near future, pressure to reduce payroll will result in more workers being released back into the labour market.

Our forecast is a loss of another 230,000 jobs this year, with this downward trajectory continuing until mid-2014, at which point the number of unemployed will be approaching three million. This all translates to a buyers' market for labour, with the number of unemployed people per vacancy forecasted to leap upwards and remain above 7.0 throughout the next couple of years, illustrating fierce competition for jobs (see Chart 2).

The economic situation is particularly difficult for young people, with the 18-24 age range experiencing over 20% unemployment. This is a troubling statistic, even exceeding the levels of youth unemployment seen during the recession of the early 1990s (Chart 3, above).

Even more troubling is the extent of the long-term unemployed within that number, with over 30% of Jobseekers' Allowance claimants in the age group having claimed benefits for six months or more. This represents a doubling over the past year, an upward trend unlikely to be reversed in the near term.

Such prolonged under-employment can have long-lasting effects. Losses of confidence, erosion of abilities and poorer health and outlook are all associated with long bouts of unemployment. These all have negative social consequences, as well as lessening productivity.

Silver lining?

Against this bleak economic background, those providing business-to-business (B2B) services are in a position of some opportunity. B2B is one of the UK's most important sectors, with CEBR forecasts highlighting it as one of the few bright spots for the UK economy over the next five years. Falling revenues and squeezed budgets will see firms in all sectors seeking to streamline their business models. Calculations about whether to outsource certain activities become more crucial. For example, the strong trend toward ICT outsourcing looks set to persist, with businesses continuing to find significant operational expenditure (opex) and capital expenditure (capex) savings in external provision of bespoke software, storage and support.

Cloud computing is spreading rapidly, as the cost savings and business possibilities become apparent - CEBR predicts the UK economy to see £102 billion in benefits from its propagation in the first five years of this decade. ICT services firms themselves are expected to see turnover increase by 13.6% in the period from 2011 to 2016.

The only B2B sector set to outperform ICT is the management activities and consultancy service sector, which gives assistance to businesses via organisational, financial and HR planning. Although smaller in size than ICT, it is expected to see spending on its services increase by 19.1% between 2011 and 2016. Intensifying global competition, coupled with the extended poor economic climate in the UK, will force businesses to adjust quickly. This will help propel the growth of business services, with the management activities sector enabling other B2B firms to become more efficient.

These activities overlap with HR in every business. Over the coming years, it will be the task of HR professionals to develop productivity from a large pool of available labour, a significant proportion of whom may have substantial periods of unemployment in their recent past.

Opportunely, HR practices have transformed since the recession of the early 1990s, with strictly resumé- and experience-based appraisal comparatively less dominant, compared with behavioural approaches. It will be difficult, but vital, for managers to identify talents and potential with less work history to evaluate from.

Weathering the double-dip

As we head for the 'double-dip' recession, economic conditions are presenting a deeply challenging landscape to businesses. The tough times are likely to endure throughout this year and HR will play a fundamental role in how each business approaches the downturn, as human capital questions become even more central to business strategy. While reductions in headcount are a logical step in cost reduction, cutting far too quickly could prove regrettable. There are sectors, such as B2B, that are discovering prospects amid the gloom. Not to invest in identifying and retaining talent may represent a missed opportunity once the recovery begins.

Shehan Mohamed and Osman Ismail are economists at the Centre for Economics and Business Research (CEBR)