The UK Unemployment Mystery

A strange feature of the past two years, has been a largely unexpected fall in UK unemployment. Recently, the ONS said there were 2.49 million people unemployed,  185,000 less than on a year earlier. It is the lowest unemployment rate since spring 2011. Usually, in a recession, you would expect a rise in unemployment because falling demand causes firms to get rid of surplus workers. (see: demand deficient unemployment)

For example, after the much milder 1981 recession, UK unemployment rose to over 3 million (around 11%) and remained high well until the mid 1980s. After the 1991 recession, unemployment again rose sharply, to just over 3 million.

unemployment

Also, in Europe, unemployment has recently risen to record levels. Only in the US, has unemployment shown a similar fall,  but the US has seen much stronger economic recovery than the UK.

In the 2007-13 recession, we have seen UK unemployment rise at a slower rate than previous recessions, and it has also been quicker to fall – even though evidence points to a unique triple dip recession. Why has unemployment been falling, when the economy is so weak?

1. Flexible Labour Markets. Evidence suggests that UK labour markets are more flexible. For example, it is easier to cut hours and keep people employed on shorter working hour contracts.

under-employment

This is illustrated by a rise in under-employment during the long recession. More people are reporting working fewer hours than they would like. However, flexible labour markets can also mean it’s easier to hire and fire workers. You would expect if labour markets were very flexible, firms would be quick to make redundancies, but this doesn’t seem to be occurring. (flexible labour markets)

2. Flexible Pay. Related to flexible labour markets have been the recent trends in pay. We have seen five years of falling living standards, with average pay rates rising at a lower rate than inflation. If unions were powerful, and workers could bargain for higher wages, it is likely that unemployment would be higher. The fact that wage growth has been stagnant has encouraged firms to keep holding onto workers, rather than let them go because they are too expensive. The headline rate of average earnings growth excluding bonuses is 1.4%, meaning that with CPI inflation or around 2.5%, real pay is falling at an annual pace of more than 1%.” (UK wages)

wages-inflation-2007-2012

3. Falling Productivity

uk-labour-productivity-growth-oecd-90-2012

Source: OECD – labour productivity growth | data set: PDYGTH. | 2012 est from ONS

Another feature of this recession has been a record fall in labour productivity. Usually, labour productivity increases by around 2.5% a year, but in the recession, labour productivity has been stagnant. This suggests that faced with falling output, firms have not been so quick to get rid of workers. They have held on to workers, even though their productivity has been lower. This suggests, that there is slack in the labour market, if output increases, firms will be able to meet the increased demand through higher productivity rather than employing more workers.

4. Growth in zero-hour contracts

The number of zero hour contracts have increased from 50,000 (2005) to 200,000 in (2013). This means workers have no guarantee of how many hours they will get paid for. It is a factor in explaining why there is more under-employment.

5. Growth in self-employment

In 2013, there are 367,000 more self-employed people than in 2008. More than 200,000, or 60% of these, became self-employed between 2011 and 2012. This suggests, that in response to deteriorating labour market conditions, more people are seeking to set up as self-employed. It also reflects the fact some firms are trying to promote self-employment.

5. Lagging Indicator

Many labour market analysts suggests, given the weakness of the UK economy, the improved performance is unlikely to be maintained. It is expected output in Q4 2012 will fall. There have also been many high street casualties with HMV, Comet and others going bankrupt. Therefore, in 2013, it is hard to see how unemployment will keep falling. It is suggested that unemployment is a lagging factor. It takes time to respond to past events. So given the fall in output in 2012, unemployment is likely to rise in 2013.

5. Is the Recession so Bad?

Maybe GDP statistics somehow underestimate the state of the economy?
gap

Looking at raw GDP statistics, this is the deepest recession for decades. But, unemployment figures suggest the impact on labour markets has not been so severe. This isn’t so convincing.

Conclusion

There are many reasons to be gloomy about the UK economy. The threat of a triple dip recession, the most protracted drop in GDP on record and a growing trade deficit. But, the unemployment figures are relatively good. However, it has come at the cost of falling real wages and stagnant labour productivity. Also, we shouldn’t under-estimate the fact an unemployment rate of 2.5 million is still a very serious economic and social problem. If recovery had been stronger, the unemployment rate could be much lower, and if we fail to see strong and sustained economic recover, unemployment will continue to be a serious problem. But, it suggests that encouraging labour market flexibility has definite benefits for unemployment, and it is something the Eurozone may also benefit from.

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