Despite the fact that inflation has edged down this year, the Monetary Policy Committee still raised base rates in May and implied there was more to come. The move was widely expected and caused no great surprise in the City, which now accepts that policymakers have moved away from a literal interpretation of their terms of reference. Concerns about house prices and personal borrowing seem to weigh at least as heavily as consumer price prospects in the Committee’s interest rate decisions.
The Bank does have some worries about prices, though. With all the indicators of domestic activity (including manufacturing output) pointing upwards, conventional economic thinking suggests that faster output growth will convert to faster inflation once the spare capacity in the economy has been absorbed. Some MPC members believe that, even when demand was running below trend last year, the amount of capacity available was uncomfortably low and that it would take only a modest increase in activity for price pressures to re-emerge.
A key measure of spare capacity, and a traditional source of inflation, is the labour market. In the past, as the economy expanded and unemployment fell, pay settlements moved up, and higher wages led to higher costs and still faster inflation. Over the past decade, the UK economy has seen a substantial growth in employment and a fall in the jobless total. But could this remarkable success undermine the stability which created it?
That the UK labour market has been transformed since the dark days of the 1970s is beyond doubt. The most commonly quoted measure of unemployment, the number claiming benefit, is now below 900,000. This is the lowest since 1975 and comes just 10 years or so after the low point of the last recession, when the total was pushing up towards three million. As a share of the labour force, unemployment is now down to 2.9%. Using a different European measure, the Labour Force Survey, the UK jobless rate is just under 5%, with France, Germany and Italy all at around the 9% mark.
This trend obviously reflects a surge in employment. The latest figures show there are 28.3 million people in the UK in employment, a jump of almost 200,000 on the previous three months and the highest number since records began. Every year since 1993, when the total stood at 25.4 million, employment has increased and construction has offset a fall in manufacturing.
This rise has been faster than the increase in the population, which reflects the fact that more people, particularly women, have been attracted into the labour force.
All of this is indicative of the recent success of the British economy and it is particularly encouraging that the trends have been national.
The northern areas of the country have seen unemployment fall faster than London and the South East, and the gap between the high and low unemployment regions has been steadily narrowing.
Policymakers worry that any upturn in growth will lead to a rise in demand for labour that cannot be met, thus leading to higher pay settlements, and the early signs are there. After averaging less than 3.5% in 2003, there was a jump in the headline rate of earnings growth in February this year to 4.9% – above the MPC’s 4.5% safety level.
Last year, private sector earnings rose by 3.2%, while the public sector roared ahead at 5.1%. This was almost certainly a consequence of the government’s increased spending on public services at a time when the private sector was more subdued. This trend kept unemployment down. But what will happen when the private sector picks up again? Will those workers who once lost their jobs in the private sector return, leaving the greater security and better pensions of public sector employment?
Since many of the people who could work are on benefits other than unemployment, there is more spare capacity available than the headline figures suggest.
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Low activity rates in the 50 to 64-year-old age group, particularly among men, suggest there are further labour ‘reserves’ to tap into. And, finally, the role of trade unions has changed fundamentally from the 1970s, reducing the risk of a return to the ‘wage-price’ spirals of old.
Given the demographics of the country, this issue will not go away. Politicians once worried about where the jobs would come from, but now they’re more concerned about where they will find the right people to do the work.
If they are not available here, they may have to come from abroad – but that is another subject entirely.