The UK’s flexible labour market needs to be allowed to do its job

The Treasury is right to begin to wind down the furlough scheme – and not a moment too soon. The UK economy is springing back to life and the labour market is not far behind.

It will take a while for this to be confirmed in the official data. We still only have the headline numbers for unemployment in April and some early estimates of payroll employment in May. But these show that the unemployment rate has levelled out below 5% (some had feared it could be as high as 10%), and that the economy is rapidly regaining the jobs lost last year.

The more timely business surveys and ‘faster indicators’ are even more encouraging. For example, the KPMG and REC Report on Jobs showed that recruitment surged again in June, with other sources confirming that vacancies and online job ads are hitting new highs.

Indeed, many sectors are now reporting labour shortages. The British Chambers of Commerce has found that 70% of firms are facing difficulties in recruiting staff, notably in construction (82%) and hotels and catering (76%).

One result of this is that wage pressures are building. Again, we do not have much official data to go on. We do know that average weekly earnings grew by 5.6% in the three months to April compared to the same period a year earlier, while early estimates for May suggest that median monthly pay increased by 9.1%. But these figures are distorted by many factors, including a rebound in the number of hours worked.

Underlying pay growth is probably much lower. The Bank of England’s regional Agents have suggested that average settlements were still in the range of 1.5% to 2.5% in the second quarter of the year. However, other surveys are more bullish, with reports of large increases in starting pay and bonuses in many sectors.

This is both good news and bad. On the plus side, this is the free market operating as it should. Higher wages will attract people back to work in the businesses where they are now needed most. And few would begrudge a boost for those doing what have traditionally been low-paid jobs in industries such as hospitality or social care.

There are also two downsides. One is that labour shortages could hamper the economic recovery. Indeed, there is already some evidence that supply bottlenecks, including shortages of parts and raw materials, are holding back the construction and manufacturing sectors.

The other downside is the impact on inflation. In normal times, average hourly pay growth of 3% to 4% might still be consistent with price inflation of 2%, assuming labour productivity increases by 1% to 2% to cover the difference. But very little is ‘normal’ about the economy at the moment. There is a significant risk that higher wages will be passed on in higher prices as businesses try to make up ground.

What, then, to do about this? Some have pinned a lot of the blame for labour shortages on Brexit. The evidence for this is actually pretty weak. More than 6 million EU citizens have applied for ‘settled’ or ‘pre-settled’ status, which is many more than actually live here. This would allow them to work in the UK with few limitations, other than international travel restrictions due to Covid.

The latest labour force estimates from the Office for National Statistics (ONS) also suggest that far fewer EU citizens have left the UK during the pandemic than previously thought, while the number of workers from the rest of the world is higher.

Nonetheless, maintaining a flexible approach to migration would help to address labour shortages in critical sectors.

The furlough scheme has also got to go. The number of people on the scheme has already fallen sharply. The latest hard data from HMRC report that the number of jobs furloughed as of 31 May was down to 2.4 million. The ONS survey suggests that the proportion of the UK workforce on furlough had fallen further in late June, to about 5%, which would be less than 1.5 million.

That is still a large number, of course. The Resolution Foundation is right to say that the labour market is recovering, but has not yet fully recovered.

It is also inevitable that the winding down of the furlough scheme will lead to some job losses. For example, the Bank of England’s Decision Makers Panel suggests that firms expect around 2% of employees still to be on full furlough in the third quarter, which could be half a million people.

If (and this is a big if) they then all lose their jobs when the furlough scheme ends, unemployment could jump from 1.6 million to 2.1 million, or from 4.8% to 6.3%. But this would be a worst case. In practice, a continued strong economic recovery and buoyant labour market should mean that most either keep their existing jobs, or find new ones.

Put another way, there is a race between the pick-up in the economy and the winding down of the furlough scheme. Despite Friday’s slightly disappointing GDP data for May, my money is still on the economy winning this race, with GDP set to return to pre-Covid levels by the autumn.

It is therefore increasingly likely that the furlough scheme will simply contribute to staff shortages. With most of the economy open again and ‘Freedom Day’ just around the corner, people should be encouraged to find new jobs, not be locked into their old ones.

Above all, policy flexibility must work in both directions. Economic growth and inflation have both been stronger – and unemployment lower – than either the Treasury or the Bank of England expected. This means that policy-makers should be thinking of scaling back their support sooner rather than later, instead of adding even more.

This article was first published in the Sunday Telegraph on 11th July 2021

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