How employment can boom without busting the economy

'An accountant who sells burgers is really unemployed, argues Lord Eatwell'

There has been more good news on the unemployment front this week - there is less of it than there was. No matter how fiendishly the Government has fiddled the headline figures, all measures of joblessness show that the economy is growing fast enough to reduce the total.

While this news is genuinely welcome, it raises two questions. First, do further reductions in unemployment depend simply on faster growth and if so how far can this go before the next government has to put the brakes on the economy to prevent inflation rising?

Second, who is getting the new jobs? How the new jobs are shared around is as important for social reasons as how many there are.

The latest two months' worth of official statistics have set the inflation alarms ringing because they suggest that the jobless count has fallen rapidly enough to send wage inflation higher. Underlying growth in average earnings has risen to 5 per cent, which is about the highest consistent with the 2.5 per cent inflation target if the economy's long-term potential growth is about 2.5 per cent. Business surveys suggest that skill shortages have become widespread and, in the service industries in particular, employers are worried about pressure on salaries.

The conventional wisdom is therefore that the booming economy can and will take unemployment lower but it is happening alarmingly fast and stoking the inflationary fires. The economy is breaking the "speed limit" on the rate at which unemployment can safely fall.

Economists and politicians alike stress the need to reduce joblessness - especially among the young and the long-term unemployed - by "supply side" measures such as training, job search support and even the withdrawal of benefits. Few will say instead that they think there is a need to boost demand in the economy even further.

But could this conventional wisdom be wrong? A book of essays published today* challenges it from a variety of left-wing perspectives, some more likely than others to win converts. One of the least likely to sway the orthodoxy comes from Labour peer John Eatwell, who stretches the definition of unemployment to argue that there is plenty of scope for extra demand to reduce it. Following the works of eminent Cambridge economist Joan Robinson in the 1930s, Lord Eatwell argues that there is a great deal of disguised unemployment.

He defines this as all the people doing a job where their productivity is below their potential. If you are a qualified accountant but can only find work selling hamburgers then you are really unemployed, in his view. His estimates make the "real" unemployment rate about 12 rather than 6 per cent.

If you accept this case, there is no inflationary danger in boosting demand in the economy. There are people productive, skilled and efficient enough to meet all the extra demand. They can move out of the less skilled into the more skilled jobs, and their place can be taken by the rest of the unemployed. This argument has something going for it at the depths of a recession but the essay does not address how much disguised unemployment changes over the cycle nor how low it might be now. After five years of economic recovery, it must be far lower.

A more convincing case is made in a separate essay by Peter Robinson from the LSE's Centre for Economic Performance. He points out that the reason everybody thinks falling unemployment will trigger higher pay inflation is that rising unemployment has been accompanied by sharp falls in earnings growth during the two most recent recessions. But the evidence so far is that there is an asymmetry. As the chart shows, moves in the opposite direction have not, during the past two cycles, had as big a pay response. "The fall in unemployment required to produce a given increase in wage inflation was significantly greater than the rise in unemployment required to produce a given reduction in wage inflation."

This is cheering stuff for anybody who thinks it worth boosting the economy by as much as it takes to reduce joblessness even further. But Mr Robinson himself argues in favour of a slow move simply because we cannot be sure how much further it is possible to go without paying the inflationary price. We have already had a long expansion of the economy, and there have been no adverse shocks such as the oil price jumps of the 1970s for nearly two decades. "The new labour market regime in the UK has yet to be really tested," he writes.

So the conventional wisdom comes out on top. Perhaps a more useful thing to focus on, rather than the unemployment total, is the question of how work is shared out.

A report this week from the Employment Policy Institute also concluded that falling unemployment was about to crash into the inflation barrier. But even if it were not, there is a large core of "structural" unemployment that is simply not amenable to higher demand. There is nobody in work in about one in five households in Britain. Nearly two-fifths of job seekers have been out of work for more than a year - twice the size of the long- term unemployment component two decades ago. Middle-aged men's participation rate has fallen sharply since the late 1970s. And there is a lot of evidence that education and training are not fitting many young people for jobs.

The EPI reaches the conclusion that "supply side" policies are exactly what is needed to tackle these unfairnesses which, if allowed to persist, will tend to boost poverty, homelessness and crime. It favours the "welfare to work" philosophy of New Labour and the Liberal Democrats. The catch is that this probably won't work if it is done on the cheap. Director John Philpott charges all the parties with wishful thinking at best, sheer hype at worst. But at least they deserve the credit for going beyond the wishful thought that a bit of a boost for the economy will solve the problem.

*Employment and Economic Performance, ed. Jonathan Michie and John Grieve Smith, Oxford University Press, pounds 15.99 paperback.