Business decisions drive the cycle - one year on

A year ago I blogged about the critical role that business decisions will take in determining the depth and duration of a downturn.

“Companies take four sets of decisions that are vital to macro-economic performance: about wages and prices; the level of investment spending (on plant and machinery and R&D); levels of stocks (inventories), and employment levels.”

So what has been happening in the intervening period?

Wages

There has been a dramatic weakening in basic pay settlements with the result that the annual growth of average earnings has fallen to its lowest level in many years. Pay is being squeezed by the rise in unemployment and the severe pressure on business cash-flows. Expect a further shift towards wage freezes and wage cuts in the second half of the year especially with retail price inflation now in negative territory.

Capital investment spending
The sharp fall in final demand for goods and services has prompted a decline in the real value of capital spending. Business investment has been hit by weakening demand, rising spare capacity, lower profits and a decline in business confidence. Low expected demand and the freezing of many financing options are the crucial factors influencing investment spending at the moment.

Stocks
The last six months has seen a large inventory adjustment - jargon for businesses cutting prices and lowering production so that they are not over-burdened by the costs of maintaining surplus stock.

Employment levels
As our final chart shows, total employment is now on a firm downward trajectory. The former MPC member Professor David Blanchflower has forecast that an extra million people might lose their job this year because of the fall-out from the recession.

Wages, investment, stocks and jobs - four critical areas for businesses which - in aggregate - have a hugely important on the short term macroeconomic performance of the economy. Will the second half of 2009 see a gradual improvement in all four areas? If so, optimism may return a little quicker than expected. Or, in contrast, is the UK at risk of another deflationary shock to demand and jobs? This article in the Times covers an interview with Yale economist Professor Robert Shiller who warns that the UK economy is fragile, brittle and exposed.