Why messing with pay is not the best way to end living cost squeeze

Kristian Niemietz
UNEMPLOYMENT and underemployment in the UK are still far too high. But given the circumstances, the UK’s labour market is in a far better shape than we might have expected. In much of Europe, five years of stagnation have sent jobless figures through the roof. Yet the UK got away with a black eye. A new report, released by the Resolution Foundation yesterday, highlights the downsides to this. But we must not take the upside too easily for granted.

In inflexible labour markets, as in most Mediterranean countries, outsiders and insiders are separated by a solid wall. The impact of downturns is thus highly asymmetric: some lose their jobs or never find one in the first place, while well-established insiders are insulated from the downturn.

In more flexible labour markets, the barrier between insiders and outsiders is permeable. Those at risk of being left out will try to squeeze in, and that squeeze will also be felt by those who are already inside. When an economy is in trouble, this will manifest itself in a rise in temporary contracts, part time positions, short-term work, unstable work patterns like zero hours contracts, and pay cuts. As Resolution’s report shows, the latter description is close to what has happened in the UK over the past five years.

This is not too surprising. On the Fraser Institute’s index of hiring and firing regulations, which ranges from 0 (most regulated) to 10 (least regulated), the UK scores 5.7 – somewhat closer to the lightly regulated labour markets of Denmark (8.5) and Switzerland (7.9) than to tightly regulated France (2.8) and Italy (3.3).

Resolution is clearly uneasy with the direction the UK has taken. But when the alternative is an escalation in long-term unemployment, a wage squeeze combined with a rise in precarious employment is by far the lesser evil. The latter is temporary, while the former can leave long-term scars.

The recession of the early 1980s is a good illustration. It was not as deep and not as protracted as Britain’s most recent stagnation, and was followed by a period of rapid growth with falling unemployment. Yet the employment rate of low-skilled men never fully recovered to pre-recession levels. Too many had been out of work for too long, and struggled to find their way back in – even as the economy recovered. This was a recession amid a labour market dominated by closed shops and unions. For all the problems that Resolution rightfully points out, today’s freer labour market is an asset.

Of course, policymakers should do their utmost to avert the squeeze in living standards – but not by messing with wages and employment contracts. Instead, they should address the many supply-side distortions that send the cost of living (housing, childcare, energy) in Britain to stratospheric levels. Resolution itself has found that, for a couple on average wages, full time childcare for two children amounts to 40 per cent of household income after housing costs. Reducing the number of fiddly rules that make these figures possible would help the poor more than anything else. It would also make perfect economic sense.

Kristian Niemietz is senior research fellow at the Institute of Economic Affairs, and author of Redefining the Poverty Debate.