The riddle of the labour market

ECONOMIC VIEW

Britain's labour market has become a riddle. Once it could be relied on to behave reliably but poorly. Now it is behaving unreliably. But can it still be depended on to to perform poorly, as the increase in unemployment in July suggests? Or has there been an underlying improvement, as the Government maintains?

Something has certainly changed. Unemployment may now be rising but it defied precedent by starting to fall a year after the trough in economic activity in 1992. By contrast, it took five years for unemployment to respond to the upswing after the similar trough in 1981.

Still more extraordinary, wage inflation has been barely rising above retail price inflation in recent months. Indeed, underlying earnings, stuck at 3.5 per cent, will fall below inflation if it rises to 3.7 per cent today as the market expects. At the similar point in the recovery of the 1980s, they were running well.

But if the labour market is now behaving unreliably, is it still behaving poorly? With unemployment now rising again, the first instinct is naturally to say that it is not just performing poorly but is actually doing worse. For the jobless total to start rising at this point in a recovery that still feels anaemic to most people must be worrying.

All the more so, given the modest gain in employment that has been achieved. According to the Labour Force Survey, employment has increased by just under half a million since the spring of 1993, when unemployment peaked. Yet this palls by comparison with the increase of well over a million in the two years after the jobs cycle turned in the 1980s.

Indeed the early decline in unemployment that started in 1993 can largely be attributed to a surprise reduction in participation in the labour market at a time of recovery. As economic conditions pick up, more people who are not counted as unemployed - generally married women - join the labour force. The inactivity rate, defined as the percentage of people aged 16 and over who are neither employed nor actively seeking work, declines.

As the chart shows, the fall in unemployment in the mid to late 1980s was accompanied by a fall in inactivity. By contrast the fall in unemployment in the 1990s went hand in hand with a surprise rise in inactivity until the start of this year.

One factor behind this increase, the big increase in school-leavers going into higher education, may pay long-term dividends for the labour market. The others - large increases in the number of people claiming invalidity benefits and a rise in the proportion of men taking early retirement - amount in large measure to disguised unemployment.

The case for the pessimists does not stop there. The main reason why overall earnings are going up so slowly is that they are only rising at 2.75 per cent in the service sector. However, this very low rate of increase is largely because of the behaviour of two sub-components, the retail and the public sectors. Other areas of the service sectors have been growing in the first half of the year at more familiar rate of 4 per cent plus.

If consumer spending picks up as real personal disposable income increases, then the pressure on earnings in the retail sector will be alleviated. And in the run-up to an election, it is unrealistic to expect the clamp on public sector pay settlements to remain as tight as in the past couple of years.

Yet it is possible to take a more optimistic view of the labour market. For all the caveats, the behaviour of pay has been much more muted than in the past. And the recent rise in unemployment may not necessarily herald a decisive turning point to further sustained increases.

One reason is that the jobless count is now being pushed up by increased participation in the labour market. The inactivity rate is now at last coming down. This may reflect increasing confidence about jobs prospects: vacancies remain high.

It can also be seen as an unwinding of some of the factors pushing inactivity up in 1993 and 1994. The July claimant total, for example, was affected by students now leaving higher education. They should be better equipped to find jobs.

Another reason for more confidence is that in today's flexible labour market, employers are much quicker to adjust their workforce to the state of the economy.

According to David Mackie, economist at JP Morgan, the lag between employment and output may have narrowed to just six months. Provided that the economic slowdown proves to be a pause in growth, employment should start to pick up again.

The jury is still out on the labour market of the 1990s. With endemic job insecurity, it is undoubtedly a much harsher environment than it used to be. But it is too early to say that it will not deliver a better deal for those without jobs - and do so without the persistent excess pay pressure that has ultimately led to severe recessions in the past.