Factory bargains and mobile homes: In the third of four articles, Robert Skidelsky advocates pay and housing reforms

OUR wage-setting practices and system of housing tenure are still probably the biggest obstacles to achieving an efficient supply response to increased demand. No two institutions are more likely to abort the present recovery at an early stage; yet the necessary reforms will inevitably take time.

Despite the trade union legislation of the Eighties, wages continue to outstrip productivity. The goal of policy must be to limit the growth of wages to productivity growth. In the Seventies, the favoured device for achieving this was incomes policy. Employers, unions and government were supposed to get together to agree an annual 'norm' for wage increases. Some people want to go back to an incomes policy now. But its record was not good then and it has since tended to break down all over Europe. It restrained wage inflation only temporarily, entrenching in the process such inflexible ideas as 'the going rate for the job' and 'equal pay for equal work'. An incomes policy is even less likely to work now that the era of mass production is drawing to a close.

In the mass production era the slogan was 'Big is Beautiful'. Trade unions were growing in size, unions and employers' organisations gaining in power. Today the reverse is true. The decline of trade union membership and industrial concentration in Britain in the Eighties reflect the fact that the new computer and information technology has made economies of scale less important and brought the benefits of automation within reach of specialists. The growing diversity of consumer taste encourages less-standardised production methods. Small has become beautiful, large ugly. Even the biggest businesses try to behave as though they were small. For the first time since the Industrial Revolution, the gap between mass production and craft production has narrowed.

All of this encourages the setting of wages at plant level rather than nationally. The decentralised approach to wage bargaining is right - for Britain and Europe. Britain has a head start, since most European economies are still wedded to inflexible corporatist models. We need the Maastricht treaty's Social Chapter like a bullet in the head]

But the implications of this transformation go deeper. In the new age, consensus within firms is much more important than consensus in industry as a whole. The new technology requires flexible production. Successful firms need a labour force with adaptable skills built on education and training, and co-operative attitudes built on trust. It is hard to see what old-

fashioned trade unionism, either of the British craft or the German industrial type, has to offer. We need to develop new forms of employer-worker relationship at the plant level, covering pay and decision-making. Here lies the great attraction of profit-related pay as advocated by economists such as Martin Weitzman and James Meade.

At present, when employers have to reduce their wage bill they typically do so by laying off workers rather than paying each worker less. The basic idea behind profit- related pay is to alter this behaviour by linking pay to corporate performance. The variable element in pay can be either a bonus, much used in Japan, or a dividend payable on shares in the company owned by employees. Such schemes not only tend to stabilise a firm's employment, by allowing pay rather than output to vary, but also lock managers and workers in the longterm relationships so important for success in the firms of the future.

As a result of tax incentives offered in 1987 and 1991, one million employees, or about 5 per cent of all workers, are covered by profit-related schemes. Further tax incentives during the present upswing would encourage the acceleration of this trend.

James Meade's more radical aim is to reduce the pressure for wage increases by spreading the profits of capital not just through the labour market, but also through a guaranteed basic income. Under his model the state would use the proceeds of higher taxation to invest in private companies, replacing the national debt with a national asset, and paying out a dividend to all rather than interest to some. Meade believes that a basic income guarantee would allow fuller employment for a given inflation rate. In order to secure higher employment, wage flexibility is required: a basic income from the state contributes to such flexibility by encouraging workers to enter into more risky contracts with employers.

This may be called the left-wing version of a 'social market economy'. Its right-wing counterpart was the much more widely spread private ownership of property and shares brought about during the Eighties. If only the Labour Party were more interested in Meade's ideas, the political divide would start to reflect the emerging, not the dying, world.

Our system of housing tenure is as big an obstacle to labour market efficiency as is our wages system. Economists of all political colours agree on this. Patrick Minford and others have calculated that the immobility of unskilled labour induced by the Rents Act and council house subsidies adds two percentage points to the natural rate of unemployment, say, 500,000 workers.

The Government has been far too timid in its approach to housing deregulation. At present, 30 per cent of households are locked into tenancies, private and public, that cannot be traded - bought and sold. Samuel Brittan and Martin Ricketts have argued that tenants' rights in rent-controlled property - whether owned by local authorities or private landlords - should be specified and then made tradeable. An active market in secondary letting would arise. Leases in regulated private tenancies could be granted for between five and 10 years, with council tenants retaining rights to lifetime occupancy. Decontrol of the private rented sector would take place as the leases ran out, rather than through 'natural wastage', as the Government seems to want.

A country's system of housing tenure has a major impact on the performance of its economy. Low levels of private rented accommodation in the UK not only hinder labour market mobility but also mean young people get locked into mortgages, and are thus less likely to accept the delay in income represented by adequate training than their continental counterparts. While training will address the problem of occupational mobility, the reform of housing tenure will increase geographic mobility. The tax bias in favour of house ownership, making it the favourite form of wealth-holding, gives almost 70 per cent of the population a vested interest in rising house prices, which exerts continual upward pressure on the retail price index. The phasing out of mortgage tax relief should go with the reform of rent controls.

Gearing up our society to the challenge of flexible specialisation requires a revolution in the mind. Co-operation and trust must work upwards from the firm, not downwards from 'the economy'. Governments can play their part by decollectivising and deregulating wage and housing systems wherever possible, but also by encouraging new forms of partnership within firms, as well as the growth of more balanced kinds of income earning and wealth holding.

Tomorrow: short-termism and the capital market.

(Photograph omitted)