Time to unshackle the labour market

It may seem like a tale from a bygone age, but not that long ago the UK was envied by many of its neighbours for its impressive labour market performance. In the decade from 1998 to 2008, while the large European economies were struggling with widespread joblessness, the UK was not too far away from full employment. The unemployment rate averaged 5.3%, of which only a quarter (1.3%) represented long-term unemployment.

Unemployment figures 1998-2008, harmonised Eurostat measures

 

Unemployment
1998-2008
(average rate)

Long-term
unemployment
as a fraction of
total unemployment

UK

5.3%

¼

EU-27

8.4%

⅖   

Italy

8.5%

½

Germany

8.9%

½

France

9.1%

⅖  

These results occurred because the British labour market, albeit never in the same league as the US or Australia, had become one of the freest in the world. State interference with the buying and selling of labour services had receded, and as a result, labour services were being bought and sold more frequently.

Few people would have favoured a return to the union-dominated, sclerotic labour market of previous decades, and yet, regulation crept back. For a while, adverse effects on employment were cancelled out by favourable macroeconomic conditions. In the 2005/3 edition of Economic Affairs, J. R. Shackleton explained:

‘So far, changes in employment protection in a generally buoyant UK labour market have not produced problems, but the position may look different should the economy face a downturn.’

Quite so. The economy has now faced a downturn, and the position looks very different indeed. Much of the recent surge of unemployment is cyclical. But whether we will be able to return to pre-crisis employment levels with the present set of labour market institutions is far from certain. Labour market freedom has declined further in recent years:

Graph: Labour Freedom 2005-2011

(Sub-index of the Heritage Foundation’s Index of Economic Freedom)

      

To get an idea of what this means on the ground, one could use the activities of employment tribunals as a barometer. During the first half of the 2000s, employment tribunals were dealing with an annual caseload of around 120,000 claims. Since then, this figure has doubled to 240,000 claims. Hiring has become an increasingly risky activity.

About a third of these claims are related to breaches of the employment agreement, for example employers refusing to pay the full wage. Enforcing agreements is the proper role of tribunals, and there is an easy way for employers to avoid this problem: sticking to the contracts they have signed.

However, another fifth of claims are about various kinds of unequal treatment. In these cases, establishing the question of fault is much less straightforward. Essentially, they require employers to ‘prove’ that they do not hold (or act upon) politically incorrect preferences. The unpredictability of outcomes might explain why the compensations awarded in these areas follow such a skewed distribution. Mean awards are around £20,000, while medians are closer to £5,000. The remaining cases are about regulations which attempt to prevent long working hours and dismissals, so they are essentially about moving labour market outcomes away from the outcomes that would result from free negotiations.

Could the number of tribunal cases, or at least the uncertainty about their outcomes, be reduced through procedural changes? Possibly. But the most obvious way is to cut back on the underlying regulation itself. Of course we want groups with weak bargaining power to be protected. But what better protection could there be than the availability of a range of employment opportunities in a booming labour market? 

Sometimes people with weak bargaining power have little of value to offer. I don't quite see why we should want them to be specially protected. But, as always, Kristian hits the nail on the head. A healthy labour market implies plenty of coming and going -- not people stuck in jobs for which they may no longer be suitable (if they ever were) or employers unhappy with some of their workers, but unwilling to take the risk of sacking them, even for what may commercially seem like good cause, but with the spectre of political correctness in the background.

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