Hamish McRae: Two surprises show we're not in recession

Economic View: Our economy is now around 4 per cent bigger than it was last year, yup, 4 per cent

The British economy is becoming more and more interesting. This week we have had two positive surprises. On Tuesday we had the fall in inflation to 2.4 per cent, a much sharper decline than expected, with the prospect that it may be below 2 per cent by the autumn.

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Yesterday we had a further fall in unemployment on the International Labour Organisation measure, down to 8.1 per cent, and a rise in employment of 181,000 on the quarter.

The first is encouraging because it holds the prospect that inflation might be running below pay increases later this year. As you can see from the first graph, wage growth excluding bonuses is running at just under 2 per cent a year. It does not need to climb much to get it back to 2 per cent, just as inflation does not need to fall much to come below 2 per cent. If that were to happen we would start to experience a rise in real incomes after the sharpest squeeze on living standards for a generation.

Falling inflation also has an impact on real growth, for if inflation goes down and money GDP stays the same that translates directly into growth. If money GDP rises to 3 per cent and inflation is 3 per cent there is a zero rise in GDP; if inflation then falls to 2 per cent and money GDP is up by 3 per cent, that gives you 1 per cent real growth.

But it is this second surprise, on the labour market, that is really exciting because it is one more nail in the coffin to the idea that the economy is in recession. The employment rate is up. The inactivity rate is down. The number of hours worked is up. Full-time jobs are up as well as part-time ones. Employment is up as well as self-employment. The private sector is creating five jobs for every one lost in the public sector. (The employment rate and hours worked are shown in the next two graphs.) It is plausible that in a few months that the total number of people in employment in this country may past its previous peak.

That is not an economy that is shrinking – or rather it could only be an economy that were shrinking were productivity plunging. That is improbable, given that these new jobs are entirely in the private sector.

Add in other data, such as rising car sales, reasonably strong retail sales, good tax receipts on VAT, and so on, and the picture emerges of an economy that must be growing, albeit slowly.

It is true that there are some labour market indicators that are going the wrong way: claimant count unemployment, probably the result of reclassification for people with disability claims, youth unemployment, and jobs for UK-born people as opposed to foreign-born ones. But these reflect wider social issues, serious ones to be sure, rather than telling us much about the economy.

This theme, that the GDP figures are wrong as they understate real growth, will be a familiar one to readers of these pages. But I had not realised quite how wrong previous data had been until I had another look at the scale of upward revisions that have been coming through almost unnoticed, including a batch last month.

The final graph shows the big picture of these. As you can see, the UK economy is now reckoned to be substantially larger than in previous estimates. The biggest revisions, going right back to the 1970s, came through late last year, but we have just had another set further upgrading growth numbers. The original estimates are shown, together with these two revisions. As you can see the boom was much larger than originally thought, and as a result the trough was not nearly as far down.

Taken together, these suggest that our economy is now around 4 per cent larger than was estimated a year ago, yup, 4 per cent.

If you take in early revisions, the understatement was even larger.

I point this out not to attack the Office for National Statistics because it is genuinely difficult to get to grips with anything as large and amorphous as a country's economy. It is simply to point out that people should use their common sense when trying to interpret what is happening to the economy, rather than agonise about the last decimal point of the data. Some numbers, such as tax receipts and national insurance contributions, are pretty firm. You can count how much money is coming in and no employer pays national insurance for people not on the payroll. Other numbers are not firm at all, and GDP figures are among the most nebulous. Beware next week when the second-quarter figures come out.

There is a further point to be made. Another bit of data came through this week, which would be consistent with the "our economy is bigger than we thought" theme. It is the results from the 2011 census. The numbers of people in the UK shot up during the past decade, rising to some 63.1 million, about half a million more than was previously thought.

We don't know whether this surge was partly the result of previous under-counting, nor even whether we are still under-counting. There are people who, for obvious reasons, do not want to reveal themselves to the census enumerators. But from the macro-economic perspective this surge would be consistent with a number of things.

One is that the economy did indeed grow strongly during the past decade: it sort of validated the red line on that bottom right-hand graph. It suggests too that job opportunities have been strong. There are some migrants who go on benefit, but most people do not come here if there are no jobs for them. The relative success of foreign nationals in the job market fits in with that.

But it also suggests that income per head may not have risen as much as we might expect. If revisions to the GDP data suggest the economy is larger than we thought, revisions to population estimates suggest that per head we may not be that much richer.

That leads to a final point. If you are interested in living standards, it is GDP per head that matters most. If you are interested in whether we can service the national debt, overall GDP and a growing workforce matter more.