David Blanchflower: Don’t be misled - the fall in unemployment has nothing to do with the Coalition’s welfare reforms

There are no credible empirical studies that show joblessness is being reduced by welfare changes

I have to admit, the employment performance of the UK economy under the Coalition has been much better than I had expected. Yet the downward flexibility of wages has taken the strain much more than anyone, including me, could possibly have anticipated.

There was nothing in the wage curve data, which looks at how wages respond to changes in unemployment, to suggest this was going to be the case. Moreover, there was little in the data to suggest that wages would be more flexible downwards in the UK than they are in the US. Who would have believed our labour market was more flexible than that in the land of the free?

All the estimates suggested that wage flexibility was broadly the same in both countries, with their highly flexible labour markets and low levels of job protection and union bargaining power. The OECD, for example, ranks the US second and the UK fourth in its index of countries with the lowest levels of job protection, after New Zealand in first place and Canada in third.

Here are three UK labour market facts since May 2010. First, employment is up on a seasonally adjusted basis by 1,669,000 (5.8 per cent), of whom 288,000 are 65 and over (17 per cent of the total). Second, the unemployment rate has fallen from  7.9 per cent to 6.5 per cent. Third, real weekly earnings in the private sector are down 7.4 per cent using the retail prices index measure of inflation, and 4.9 per cent using the consumer prices index.

Now here are three labour market facts from the US over roughly the same period. First, employment is up 7.1 million  (5.1 per cent), of whom 1.5 million are 65 and over (21 per cent of the total). Second, the unemployment rate is down from  9.6 per cent to 6.2 per cent. Third, private sector real wage growth is unchanged.

There are, then, broad similarities between the US and UK. The jobless rate has fallen faster in the US but employment has grown a little more quickly in the UK. The decline in the US participation rate, against a small rise in the UK, is another difference – as is the rise in under-employment in the UK, which has not been observed across the Atlantic. However, the disparity in real wages is especially pronounced, so what has changed over time and why are the UK and US so different?

Answer: the UK took in a large influx of migrants, who have pushed down on wages, and older workers were forced back to work after the collapse of their pensions, increasing the labour supply.

Since the start of 2004, the number of non-UK born workers is up by two million, including a rise of 880,000 from the 10 Eastern European accession countries of Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovenia and Slovakia (the A10). Since May 2010 there has been a rise of 715,000 in foreign-born workers, including 315,000 from the A10. This increase in migrant employment presumably also has zero to do with welfare reforms.

One issue worth addressing is that the number of workers from the A10 was probably hugely underestimated in the years before the recession. According to the Office for National Statistics (ONS), there were 563,000 highly skilled, mostly English-speaking, migrants from the A10 working in the UK at the start of 2008.

However, there were probably at least as many as that again in temporary jobs, who were not picked up in the ONS surveys.

Workers from these 10 countries had to register for national insurance, and these numbers are much larger. In 2002 and 2003 41,000 registered. This rose to 975,000 between 2004 and 2007. A further 565,000 were recorded between the start of 2008 and May 2010, when the Coalition took office, and 846,000 have registered since then – making a total of 2.4 million, compared with the 940,000 who the ONS says are here. Any burst of real wage growth would be matched by an increase in the flow of workers, perhaps a further 1.5 million or more, and/or the amount of work done by those already here. All of these workers buy stuff, boosting labour demand.

Unemployment is both a stock and a flow – equivalent to water in the bath where the tap is running and the plug is leaking. Indeed, flows into and from unemployment are large relative to the net change in unemployment that results. For example, in the latest data we have, for January to March this year, 817,000 moved into unemployment while 966,000 left unemployment.

The chart above plots the inflows and the outflows. It is clear that the rise in unemployment in 2008 and 2009 was largely driven by greater inflows. During 2010 and 2011 the level of unemployment stabilised, as outflows increased to offset the rising numbers of workers who moved to unemployment. Since mid-2013 the falls in unemployment are primarily the result of sharper inflows rather than because of greater outflows.

Some commentators, including Ben Broadbent, deputy governor at the Bank of England, have recently guessed that many of the improvements in the labour market are attributable to the Coalition’s welfare reforms. There are no credible empirical studies that show this. I recall similar claims being made for the Coalition’s Work Programme, which studies have subsequently shown to have had negative rates of return, worsening participants’ labour market prospects rather than improving them.

It is most improbable that the rise in the number of working people who are aged 65 and over has much, if anything, to do with welfare reforms. It appears mostly to do with unexpectedly low pension incomes. Indeed, there is evidence that these older workers would prefer to reduce their hours of work. Similarly, migration flows, especially from Eastern Europe, are clearly unrelated to Iain Duncan Smith’s reforms at the Department for Work and Pensions.

Recent reductions in unemployment also appear to be a function of reduced inflows rather than higher outflows. The latter would be seen if welfare reforms were the main driver.

The bottom line is that demand, finally, picked up and it’s still cheaper to hire people rather than invest.

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