The UK’s labour market needs to be allowed to work

There may not be many reasons for optimism about the economic outlook, but one is the relative flexibility of the UK labour market. This should help unemployment to fall back and activity to recover more quickly – provided the government gets out of the way.

There is no doubt that many jobs are being lost as a result of the coronavirus crisis. The data over the next few months will look horrible. My own guesstimate is that the unemployment rate will jump to around 8%. That would be bad enough, but others are even more pessimistic. The OBR’s first attempt at a ‘coronavirus reference scenario’, published in April, predicted a surge to 10% – an increase of more than 2 million in the number of people without work.

However, the labour market did at least enter the crisis in good shape. The employment rate was a record high of 76.6% in the three months to February, with over 33 million in work. The unemployment rate was only 4%, compared to more than 7% in the euro area.

At this point, someone always gleefully notes that a person only needs to do a minimum of one hour’s paid work per week to count as ’employed’ in the official data. But this is a standard, internationally recognised definition. In practice, the proportion of those in employment working less than 6 hours per week is tiny (1.5%) and has actually fallen slightly since the 1990s (when it was about 2%). In contrast, the proportion who are usually working what might be called ‘full-time’, that is between 31 and 45 hours, is close to its record high of about 55%.

There are still some more valid concerns about the quality of some jobs and about productivity in general. Real wage growth has been weaker than might have been expected if the UK were indeed close to full employment. Nonetheless, even measures of under-employment (such as those calculated by Bell and Blanchflower) have also fallen sharply since the global financial crisis and were relatively low before coronavirus struck.

Above all, there is ample evidence that the UK labour market is good at creating jobs to replace any that might be lost, and at filling vacancies when people drop out. This flexibility can be measured in different ways, but about 4 million people move into employment every year having previously been either unemployed or economically inactive.

So, what should the government be doing? Like most people, I was a strong supporter of the Coronavirus Job Retention Scheme (CJRS) when it was first introduced, despite concerns about its fiscal costs. The grants covering 80% of the wages of millions of furloughed employees have clearly helped to limit job losses and protect incomes. The CJRS has also allowed fundamentally sound businesses to avoid the costs and uncertainty of having to fire workers during the lockdown and then rehire them when the economy reboots.

However, the longer the CJRS remains in place, the greater the risk that it actually becomes a drag on the recovery. For a start, the fiscal costs are mounting. The OBR originally put the bill at £42 billion, but it will be substantially higher now that the scheme is being extended and many more people are being covered.

Of course, some would argue (as I have) that even £60 billion would be a price worth paying, to prevent mass unemployment and all the additional economic and social costs that would bring. But it is also important to take account of the distortions and perverse incentives that the CJRS is creating. These will become an even bigger issue once the lockdown is eased.

For example, the CJRS reduces the incentive for people who can safely return to work to do so, or to find alternative employment. It also protects businesses that should actually be allowed to fail, not just those that can continue to thrive in the ‘new normal’ (whatever that may be). It feels brutal to talk in terms of ‘creative destruction’ and the elimination of ‘zombie businesses’, but this is the right way to think about supporting the recovery.

The government should therefore resist pressure to keep rolling over the CJRS and instead look to scale it back, sooner rather than later (as the Chancellor appears to recognise). This need not mean ending the scheme all in one go. The economy could be weaned off the emergency support by first reducing the subsidy from a relatively generous 80% of normal wages to, say, 60%. There may also be simple changes that can be made to rules so that employees are still able to do some work for their employer (though this could be administratively complicated and even more open to fraud).

Elsewhere, the government should resist pressure to saddle businesses and employers with additional costs and regulations, especially at a time when firms are already (and understandably) showing an abundance of caution. Indeed, the latest Deloitte survey suggests that 76% of CFOs are prioritising cost cutting and only 7% are planning to increase hiring.

In particular, the government should be wary of demands for the enforcement of new working practices to protect returning employees that are, at best, disproportionately costly and, at worst, completely unrealistic.

It should resist calls for large increases in public sector pay, which would inevitably put upward pressure on labour costs in the private sector too, and for a permanent increase in public spending generally, which would add to the tax burden. And there needs to be a fundamental rethink of planned increases in the National Living Wage.

However, provided the labour market is allowed to work properly, we may still be relieved at how quickly employment can bounce back. Job creation has been one of the success stories of the last decade, and it can be again.

This piece was first published by CapX

You can also follow me on Twitter @julianhjessop

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