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Economics: Soft Labour

A key measure of the success of the UK economy in recent years has been the
astonishing turn round in the labour market. Unemployment, which stood at three
million as recently as 1993, fell to less than 815,000 last year. At around 3%
of the labour force, it compared very favourably with the double-digit rates in
France and Germany. And the million jobs lost in manufacturing since New Labour
came to office were more than offset by employment growth in services and
construction. By last summer there were 28.8 million people in a job, more than
two million up on 1997 and an all-time high for the UK.

Clearly, employment growth has contributed to high levels of consumer
confidence, and the willingness of households to spend and borrow. This, in
turn, underpinned economic growth in the UK, which has been consistently faster
than in the major eurozone countries. Now, however, there are signs that the
jobs market is turning. Not only will the deteriorating employment outlook
damage prospects for consumer activity and GDP growth, but it will also
highlight some of the weaknesses of the UK economy that a focus on the
high-level numbers tends to mask.

In December, the number of people claiming benefit jumped by 7,200. It was
the tenth consecutive monthly rise and took the total to 909,100, more than
95,000 higher than at the start of 2005. The government’s preferred measure of
unemployment, the Labour Force Survey (which takes into account those available
for work, but not claiming benefit) rose by 111,000 during the three months to
November, to 1.53 million. This was the biggest increase since February 1993 and
the jobless rate climbed to 5% for the first time in almost three years.

As worrying was the fact that the number employed has also started to fall
(particularly among young people and women) as have the number of unfilled
vacancies. Although weaker earnings growth was good news for inflation, it was
not encouraging for spending prospects, and it is further evidence of the
softening labour market. Just to rub it in, the UK’s employment rate will fall
below Germany’s this year, while the number of “economically inactive” is now at
its highest since records began in 1971.

Aside from the short-term macroeconomic implications of these numbers (which
make base rate cuts during 2006 more likely), they raise important longer-term
questions about the strength of the economy and the timing of some government
policy initiatives. A look below the surface suggests that we are probably not
quite in as good shape as we like to think.

The first point is that the growth in jobs has relied heavily on the public
sector. Employment by central and local government has increased by 637,000
since Gordon Brown accelerated spending on public sector services, this at a
time when private sector job creation has roughly halved. It is not just the
rising cost of the public sector that is important. The consequences for
pensions, productivity and labour mobility have to be taken into account.

There have long been suspicions that the unemployment numbers are
artificially low, with the real jobless count masked by the sharp rise in people
classified as sick and disabled. The government wants to reduce the 2.67 million
claiming disability benefit, now renamed Employment and Support Allowance, by
getting them back to work. Since nearly half of the current claimants are over
50, the total will shrink, over the next ten years anyway, assuming the new
claimants figure does not rise. But the assumption underlying the proposed
benefit reform is that the current system has been abused and many of the “sick
and disabled” could work. If this is true, the claimants really belong on the
unemployment register and, worthwhile as the changes are in principle, the
timing is questionable.

In the past, a tight labour market would have led to upward pressure on
wages. Over the past couple of years, wage inflation was the dog that didn’t
bark. Earnings growth stayed within the MPC’s comfort zone of around 4.5%,
despite above-trend GDP growth. A significant contributory factor to this is
generally held to be the influx of labour, particularly from the new East
European members of the EU. Widely admired for their work ethic and skills,
these workers travelled to the UK for jobs, and helped keep a cap on wages. Now
that employment growth is slowing, what will happen to them? Will they move on
elsewhere, will they be eligible for benefits or will it be the British workers
who lose their jobs?

For all the carping, this has nevertheless been the UK’s most buoyant labour
market for a generation. Whether it has been the most productive is another
question. In terms of output per worker, the UK does not look too bad against
our major competitors. But in terms of output per hour worked we compare much
less favourably, which suggests we are working longer rather than smarter. With
an ageing population, the issues going forward will be what we do and how we do
it rather than how many people are working.

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