Stephen King: Anarchy in the UK gives way to wonderful world

The MPC may find that low unemployment alone is not a major threat to price stability
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In the days of flares and platform shoes, when floral shirts and big collars were all the rage, economic policy began to fall apart. It wasn't so much that our policymakers were distracted by the sounds of T-Rex or the Osmonds. Rather, they discovered that they had lost their ability to control the macro economy. Unemployment was too high so they tried to get rid of it. The net result was an increase in inflation. Then they tried to get rid of inflation and unemployment promptly went up. Then they tried to control both by imposing price and incomes policies, leaving the supply side of the economy up the proverbial creek without a policy paddle. No wonder the happy songs of the Bay City Rollers gave way to the Sex Pistols and "Anarchy in the UK".

Suddenly it seemed that the old choices did not exist. Radical solutions were required. No longer was it possible to boost demand to bring unemployment down. Monetarism was brought in in 1976 to defeat inflation. As for unemployment, supply-side reforms and wage moderation became the key components of a strategy designed to get people back to work. For a long time, this medicine was pretty unpleasant, but eventually a new harmony began to come through. The punks gave way to the new romantics and we lived through the 1980s boom to the sounds of Spandau Ballet and Duran Duran. Ah, happy days!

Since then, of course, there have been some fairly major ups and downs, both in the economy and in the world of popular music. As time goes by, however, the challenges don't go away. In the pop world, all sorts of odd things keep happening. Who would have expected a couple of complete nobodies to suddenly become the most popular singers in the country with songs like "Evergreen" and "Unchained Melody"?

Equally, who would have expected the economy to have lived through a major global downswing with scarcely a rise in unemployment? And isn't it a bit odd that the first signs of global recovery have been accompanied not just by a fall in unemployment but also by a slowdown in wage growth? Could it be that the old trade-off between unemployment and wages – feeding through to inflation – is beginning to break down? Could it be that we can now achieve full employment without having to worry too much about a return to the inflationary story of the 1970s?

This week's charts show the oddity of the situation. Here we are, with the unemployment rate at remarkably low levels by the standards of the 1970s and the 1980s, yet with wage growth – as reflected in average earnings – coming in at an extraordinarily low rate. Admittedly, a lot of the slowdown in overall wage growth is the result of a collapse in city bonuses – which, for the lucky, had been dropping like manna from investment banking heaven in recent years. So this is not a story that provides a true reflection of the country as a whole. Yet, even if the bonus effect is chopped out, there has still been a significant slowdown in underlying wage growth.

For economists at the end of the 19th century and at the beginning of the 20th century, this result would come as no real surprise. In their eyes, workers were paid according to their marginal product. A company is likely to employ decent people first of all but, as business expands, it's forced to take on less-qualified workers. These people are paid less and, as a result, the average wage bill falls as more and more people are employed. Meanwhile, the average quality of work is likely to come down as these people are taken on (anyone who's tried to check into an American hotel over the last few years and been met with an absolutely vacant stare will know what I'm talking about). In this model, workers will only get jobs if they set their price at a level which equates to the marginal product that they are likely to offer.

There are many different views as to why this model broke down in the 1970s and 1980s. It's pretty clear, however, that a move back to this kind of model would be helped along by a reduction in the bargaining power of unions, a move towards greater global competition, a greater mobility of capital – and of labour – both within economies and across economies, a removal of government guarantees of full employment and a reduction in the generosity of the social safety net. Throw these things into the melting pot and suddenly a labour market emerges that provides job opportunities for the vast majority, even if wage levels are likely to vary a lot more.

Within the UK labour market, there is some evidence of the greater flexibility that follows from these changes. Young people have done rather badly. Employment in the 18-34 age group has fallen over the last 12 months. Yet those in the 35-plus category have done rather well, with an overall gain over the last year or so of 320,000. Meanwhile, job losses in manufacturing and financial services have been fairly unpleasant but there have been sizeable job gains in construction and public services.

Generally speaking, job quality seems to have gone down. This is not so much a jibe at the public sector rather than the private sector. Instead, it's simply a reflection of an increase in part-time jobs offsetting a decline in full-time jobs. But every potential cloud has a silver lining. Fewer people appear to be genuinely long-term unemployed. Of the total number currently without a job, there has been a significant fall in those out of work for more than 12 months and an increase in those unemployed for six months or less. Of course, if this second category can't find jobs, they're eventually going to increase the ranks of those unemployed for a year or more. Nevertheless, the fall in the average duration of unemployment, accompanied by the slowdown in wage growth, does point to a much more flexible labour market where people genuinely are pricing themselves back in at a "market-clearing" wage and are perhaps more open to the idea of taking on a part-time job.

These changes suggest that low unemployment does not directly provide a threat to inflation. Instead, it suggests that the "supply-side" performance of the UK labour market is a lot better than it used to be. This ought to have some influence on thinking at the Bank of England. The Monetary Policy Committee (MPC) has every right to worry about tight labour markets, but it may find that low unemployment alone is not a major threat to price stability. If that's true, the MPC's members can forget their pogo moves to the Sex Pistols and their disco steps to the Bee Gees and settle back instead to the soothing sounds of Louis Armstrong and "What a Wonderful World".

Stephen King is managing director of economics at HSBC.