Risky journey on Clarke's high-wire

The Chancellor's Mais Lecture on 'The Changing World of Work' on 4 May received surprisingly little attention for an important 'think piece' from a potential Prime Minister. In it, Mr Clarke states baldly that 'unemployment must be the main preoccupation of economic policymakers in the 1990s'.

He adds in ringing terms: 'I have devoted a great deal of my political life to strengthening our welfare systems, and I would never support any attempt to dismantle them.' Quite astonishingly for a Conservative finance minister, he never once mentions the need to reduce taxation to improve work incentives, while the need to control public spending gets only the merest mention.

But in case this man should be mistaken for a born-again Butskellite, the Chancellor argues that most of our present unemployment is structural, and he rapidly throws out any suggestion that it can be cured by expanding demand. He lambasts the Social Chapter of the Maastricht treaty, applauds the collapse of trade unions, and says that any attempt to use policy instruments to redistribute income and wealth 'is misguided and needs to be abandoned'.

His central contention is that there is no conflict between the American approach of free enterprise and highly flexible labour markets, and the European commitment to the welfare state. On the contrary, he says that the two should reinforce each other. Policy should promote a free labour market, encouraging as much job-switching as possible, even if this involves repeated periods of unemployment throughout a career. Meanwhile, improvements in the welfare state should be used to 'reduce the fear of change and opposition to it'. Essentially, the idea is that a government- provided safety net would encourage people to travel more quickly across the high-wire of life.

Sounds nice, but does it really square these old circles? One particularly hoary problem is immediately obvious. The welfare state costs money, which requires higher taxation. And that taxation drives a wedge between the amount a worker produces and the amount the worker is paid. At minimum, this must reduce economic efficiency - the allocation of workers to their most productive use - and it can create unemployment.

NOT SO CLEVER

An obvious example. A family earning pounds 400 per week would like to hire a nanny for pounds 100 a week, and could just afford to do so if it paid no tax. In fact the family pays pounds 150 per week in tax, so it cannot afford the nanny. The potential nanny is unemployed, and instead becomes a burden on the welfare state. Meanwhile, one of the parents - say, a production engineer by training - cannot find a job which fits in with looking after the children.

We end up with an unemployed nanny and a non-employed production engineer. Not so clever (and not so trivial either, in view of the staggering fact that there are now more nannies than car workers in Britain's labour market).

The point is that taxation reduces the return to work while the welfare state increases the return to non-work. Perhaps there is some way around this conundrum, but if so, I do not believe that Mr Clarke has found it.

A less obvious, but equally fundamental, problem with the Chancellor's speech is connected to his diagnosis of the unemployment problem.

Although he does not say so explicitly, his thesis seems to rest on the assumption that most of our unemployment is frictional, in the sense that it is caused by a failure of the labour market to adjust rapidly to a changing environment. The speech makes great play of technological change, and the need for workers to shift jobs and develop new skills. Workers who are slow to adjust, he seems to imply, become unemployed.

The trouble with this approach is that, contrary to almost all casual punditry on the subject, there is precious little evidence that the pace of industrial change has increased as unemployment has soared in the past two decades. Professor Richard Layard and his colleagues at the LSE have established this beyond peradventure. Improving the flexibility of the workforce better to fit people to the available jobs will still improve the efficiency of the economy, but it will probably fall some way short of solving the unemployment problem.

In addition to exaggerating the importance of the frictional aspect of flexibility, the Chancellor pays insufficient attention to a larger element in the overall problem - wage adjustment. One recent feature of most industrialised countries is that the demand for skilled labour has hugely increased, while the demand for unskilled labour has fallen.

In the United States, this change in demand has been allowed to have an impact on wage differentials between the skilled and the unskilled, which have widened dramatically. The real wages of unskilled American workers are now at the same levels they reached in the late 1960s - an almost unbelievable outcome for a growing market economy. But as a result of these low wages, many millions of jobs have been created, and the official unemployment rate among male workers has not risen much on trend.

In Europe, the same shift in the demand for labour has occurred, but wage differentials have not reflected this to the same extent. Minimum wage legislation and unionisation have prevented unskilled wages from falling enough to 'price' workers into jobs, so unemployment has risen sharply. Over time, a huge rump of long-term and dissaffected unemployment has been created.

It is usually assumed that the US solution is preferable to the European. But is it? Although there are far fewer people recorded as unemployed in the US, this is in part because so many have dropped out of society. With unskilled wages so low, huge numbers of prime-age, urban males have decided it is not worth working and have turned to crime, or some other form of subsistence in the hidden economy. After allowing for this type of non-employment, it is not obvious that the jobless rate for prime-age males is any lower in the US than in Europe.

This inevitably implies that the unemployment problem is one of income distribution. Technology in the market economy has increasingly shifted rewards in favour of the skilled and against the unskilled. If this is allowed to flow into the wage packet, as in America, it translates into unacceptable income differentials and an urban underclass. If suppressed, as in Europe, it translates into hideous official unemployment figures. Either way, it is disastrous for society.

As many have concluded, the way round this problem in the long term is to reduce the number of unskilled workers by training and education (which Mr Clarke certainly favours). But this will take decades. In the shorter term, the best palliative is probably to encourage American-style wage adjustment combined with a much more active tax policy to redistribute income towards the employed (not the unemployed) poor.

But here we are back to the importance of redistribution, which the Chancellor denies. He should remember a quote from Charles Handy, recently revived by the think tank Demos: ' 'If work were so great', quipped Mark Twain, 'the rich would have hogged it long ago.' They have, Mr Twain, they have.'

(Graphs omitted)