Job market must be as flexible on the way up

Unemployment up, wages down, or at least slowing to a record low. It is the story of Britain’s labour market now, and it is likely to be so for some time to come. Within that story, however, there are more silver linings than you might expect.

The latest figures showed the broader jobless total up 210,000 to 2.47m, 7.9% of the workforce, in the May-July period.

The growth in average earnings, meanwhile, slowed from 2.5% to 2.2% excluding bonuses, its lowest since the current series of statistics began in 2001 and, one suspects, for many decades before that. With bonuses, the figure was even lower, 1.7%.

The fact that earnings growth is falling as unemployment is rising will not surprise fans of the Phillips curve. This was what AW “Bill” Phillips, a New Zealander who came to the London School of Economics in the 1940s, would have expected.

In 1958 he published findings showing that, over a century, unemployment and the growth of wages in Britain were inversely related. If unemployment rose, the growth of wages fell, and vice versa.

The Phillips curve was not his only claim to fame. He built the first working models of the British economy, made of hydraulic tubes, some of which survive.

The Phillips curve, however, fell into disrepute in the 1970s, the stagflation era, when sharply rising unemployment did not result in lower wage settlements. So why does it appear to be working now?

One reason is that in the 1970s the job market was distorted by excessive union power. The Trades Union Congress held its conference last week. These days, unions matter in the public sector, where 59% of workers are members, but less in the private sector, where only 16% are.

The latest pay figures either make the case for belonging to a union or demonstrate how unions stand in the way of necessary adjustments in the labour market. Public-sector earnings are rising by 3.6%, twice the rate in the private sector. If bonuses are included, the gap is even bigger.

This cannot last. Vince Cable, the Liberal Democrat Treasury spokesman, has taken himself off the TUC’s Christmas card list by suggesting sensible proposals for cutting the budget deficit, a freeze on the public-sector pay bill and a 25% reduction in the amount paid out to government employees who earn more than £100,000.

The second factor is that people believe they will not be stung by inflation and so do not need big pay rises. Unlike the 1970s, inflation expectations are, in the jargon, “anchored”. The Bank of England’s latest survey shows people expect inflation of 2.4% over the next 12 months.

What is also striking about the labour market is that it has been much less badly affected by the recession than feared. The economy has shrunk by 5.5% over the past year but employment, currently just under 29m, has fallen by only 2%.

This could tell us the growth numbers have exaggerated the recession. Or, taking them at face value, it shows Britain’s job-market flexibility is limiting the unemployment pain of the recession. The experience in America, where the fall in employment matches or exceeds the fall in gross domestic product, has not been as good.

A report last week from the Organisation for Economic Co-operation and Development (OECD) noted that Britain’s jobless rise has been less pronounced than in America, Ireland and Spain.

Nearly a third of UK employees involved in formal settlements have accepted pay freezes, according to Incomes Data Services, the data firm. Others have gone further, agreeing to go on four-day weeks for 80% of salary (though often 100% of the work). Inventive schemes to keep people in work, even on reduced pay, are widespread.

The rise in unemployment, while bad — particularly for the young where the biggest increases have been concentrated — has therefore been less than feared.

The Centre for Economic and Social Inclusion, which digs deep into the figures, took encouragement from improvements in vacancies and a drop in the number of new claims for the jobseeker’s allowance. The claimant count will not fall for a while, but its rise was only 24,400 last month. The worst of the job-market shakeout appears to have come to an end during the early spring.

How quickly will employment pick up and unemployment fall? This is where flexibility gets interesting.

What will employers do as business recovers? Those that have introduced short-time working will start to move people back to normal hours and pay. Firms that imposed pay freezes or cuts will not expect to be able to do so for a second year and normality will be restored there too. Only then, after the slack has been taken up, will new people be taken on. The flexibility that limited the rise in unemployment could make it slower to fall.

Added to this is the risk that the recovery will not be strong enough to generate a net increase in employment. This is the OECD’s fear — it thinks globally there are another 25m jobs to go and UK unemployment will stay high throughout next year.

John Philpott, chief economist at the Chartered Institute of Personnel and Development, also warns that the recovery, if not “jobless”, will be close to it.

“Unless the economy rebounds from recession far more strongly than most economists expect,” he said, “the likelihood is that the recovery will be broadly jobs-light, resulting in a slow grind back towards the pre-recession rate of unemployment.”

It is going to be interesting. After the last recession it took nine months for unemployment to start falling. If repeated, that would see the total begin to fall next March. Sooner than that and flexibility would have proved itself in the upturn as well as the downturn.

PS: Thanks for the many suggestions on who should play the main British characters in a dramatisation of last autumn’s banking crisis. Plenty of good ideas for Gordon Brown and Alistair Darling, some printable. Mervyn King is proving the toughest, so I’ll give it another week.

Talking of the Bank governor, he has been in an unseemly row with Danny Blanchflower, who left the monetary policy committee (MPC) in May and has accused King of ruling it with an iron fist, preventing the rate cuts that could have eased the recession.

Who is right? Let me apply the judgment of Solomon. Blanchflower was right to see through the spike in inflation last year and call for rate cuts. King is correct to argue that earlier rate cuts would have made no material difference when the economy crashed a year ago after the collapse of Lehman Brothers.

Stephen Lewis, chief economist at Monument Securities, and a former classmate of King’s at Wolverhampton, said sometimes central-bank governors have to take accusations of being an “inflation nutter” on the chin. His worry is that King is now so convinced inflation will stay very low he may have flipped too far to the other side. “Deflation nutter might be nearer the truth,” Lewis wrote in a note to clients last week.

That’s enough name-calling. Attention this week will focus on the Bank’s September minutes and whether the governor’s hint about cutting the rate on some commercial bank reserves held at the Bank (to perhaps a negative rate) meant this was discussed by the MPC. The prospect knocked the pound. My sense is that it may have been a shot across the bows at the banks to stop them hoarding reserves rather than a policy that is ready to roll but we’ll see.  (David Smith, The Sunday Times)


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