The youth unemployment rate has almost doubled in the last few years and as the government’s Not in Education, Employment, or Training (NEET) report revealed last week, only Romania has a higher NEET rate than the UK when we compare ourselves to the European Union. For reference, the UK was roughly in the middle of this group back in 2015. This will probably only get worse as the Iran war raises firms costs and dampens demand. We can’t know for sure what’s driving this, but we think the main drivers of this are a broad labour market weakening and large rises in employment costs rather than AI displacing workers. Ultimately, the rise in youth unemployment risks pushing up long-term unemployment if young people cannot find work for a prolonged period. That would shrink the supply side of the economy and lead to slower economic growth and higher interest rates.

Youth unemployment driven by economics and policy rather than AI

Since reaching a low point in August 2022, the unemployment rate for 18-24 year olds has risen from 7.6% to 14.7%, the highest since 2014 and now above the EU average. This matters because the longer young people are out of work, the less likely they are to ever enter the workforce and the more likely they are to face lower lifetime earnings.

So, what’s going on?

The most obvious explanation is that the labour market overall has weakened, and when that happens younger workers tend to feel it most. We estimate that a 1 percentage point (ppt) rise in the headline unemployment rate is generally associated with a 2ppt rise in the youth unemployment rate. This is largely because firm’s stop hiring when the economy weakens, putting those entering the workforce at a disadvantage.

For example, based on the official ONS employment data (which we do take with a pinch of salt) employment has risen by 381,000, or about 1%, but the population has risen by 550,000 and vacancies have dropped by 63,000 over the last year. Redundancies have risen, but only slightly. So, it’s not that firms are firing lots of people, it’s more that hiring has dropped. Employment grew by twice as much in the previous year, meaning its young people entering the workforce who can’t find jobs.

That said, there is clearly more going on here, as our chart below shows there has been a much bigger increase in youth unemployment than the overall weakness in the labour market would suggest.

One smoking gun for the larger-than-expected rise in youth unemployment is recent changes to tax and legislation. Young workers are disproportionately employed part-time. Industries with the highest concentrations of part-time workers have seen the strongest wage growth in recent years driven by consecutive large hikes to the minimum wage. Crucially, there has also been a negative, albeit loose, correlation between wage growth over this period and the number of people employed on payrolls, suggesting the minimum wage may be dampening hiring in low-paid sectors. Combine that with the increase in employer National Insurance rate contributions and the lower threshold at which they apply, both of which fell more heavily on the cost of employing low-paid and part-time workers, and there is strong evidence that rising employment costs are leading firms to hire less.

Is AI to blame for high youth unemployment?

There is little hard evidence to suggest that AI-driven job displacement is a meaningful factor behind rising youth unemployment. While anecdotal evidence of AI replacing jobs have circulated as a possible explanation, hiring weakness in IT and professional services, sectors well positioned to benefit from AI adoption, is more likely to reflect over hiring in previous years than any structural shift driven by technology. If the primary reason for rising youth unemployment were the adoption of AI, then we would not expect to see the majority of employment weakness in the hospitality sector. What’s more, if this were an AI phenomenon we would expect to see a similar trend across economies rather than it being a UK issue.

That doesn’t mean that AI won’t have an impact, its effect on employment is likely to grow considerably over the coming decade. But, we think the rise in youth unemployment can be better explained by large rises in employment costs, a broader loosening of the labour market and potentially issues well-documented issues with the data that the unemployment rate is derived from, rather than AI.

Is the UK labour market data reliable?

Of course, as with all the UK labour statistics, there is a chance that data quality issues with the LFS have distorted the official youth unemployment rate. The share of 18-24 year olds contributing to the LFS fell by 1.8ppts between Q1 2019 and Q1 2022, skewing the survey towards older respondents. This may have resulted in youth unemployment was under reported in prior years, meaning elevated levels of youth unemployment may have been an issue for longer than initially thought.

The rising youth unemployment is concerning, if young people spend a prolonged time out of work they may find it even harder to find work later on due to a lack of experience, this could have a scarring effect on the labour market and result in a permanently higher unemployment rate, which would slow growth, but also keep the labour market tighter, requiring interest rates to remain higher to weigh on inflationary pressures from higher wage growth.

It would also depress future tax income and increase state spending, making the fiscal picture even more complicated for whoever is chancellor at the next budget.

UK GDP likely to weaken in April

We expect GDP to contract by -0.1% in April.

Starting with industrial production, we expect a -0.2% drop in output as resilient manufacturing, driven by firms front-running potential supply shortages caused by the war in Iran, is more than offset by a sharp drop in energy demand that will drag on the utility sector. Weak energy demand probably reflects the better weather in April than households cutting back usage, given the lags between household bills and wholesale energy prices. North Sea oil loadings were also weak, which will further drag on output. That said, we see upside risk to industrial production as mining, water and energy supply all fell sharply in March so could rebound despite the signals from loadings and energy demand.

Elsewhere, we expect construction output to remain weak despite the better weather, contracting by around 0.7%. The construction PMI collapsed to 39.7 in April from an already weak 45.6 in March, as sentiment remains chronically weak and leading indicators such as brick deliveries remain subdued. All told, last month’s big 1.5% gain looks too good to be true and will probably unwind in April.

Most importantly, we expect services output to drop by -0.1% in April as the collapse in fuel sales dragged retail sales down 1.3% in April after consumers front-ran price increases in March will lop 8bps from services output in April. The signal from our RSM-CGA hospitality tracker also suggests that hospitality will drop by around 0.5% to round off a weak month for consumer-facing services.

Strikes are also expected to weigh on activity as a tube strike likely weighed on transport activity and a week-long junior doctors’ strike will drag on healthcare. That said, other areas of services activity should remain firm, the Services PMI, which excludes retail and the public sector, actually rose in April so we expect the usual stalwarts such as professional services, real estate and finance all to contribute positively to growth with the latter benefitting from elevated volatility and rebounding equity markets.

All told, we expect GDP to dip slightly in April as big gains in February and March unwind and consumers attempt to front-run higher fuel prices reverse to drag down on growth. The bigger picture is still one of an economy holding up in the first two months of the Iran war with growth running at 0.7% 3m/3m, but we think activity will slow at a quicker pace from May as surveys dropped sharply and are consistent with growth coming in roughly flat in Q2.

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