Recovery may not be enough to fix unemployment

Don’t bust out the champagne yet: not everyone will be able to afford it. Toni Blay

With economic “green shoots” appearing, you might expect to see improvements in the labour market, with higher wages and lower unemployment. But don’t get the champagne out just yet: this crisis isn’t like previous recessions, as a “low-wage bubble” is keeping unemployment down. If a recovery pops the bubble, rising wages could have a damaging impact on employment rates.

According to traditional thinking among economists, lowering unemployment requires growth of around 2.5% or more each year. Even with the recent better news on prospects for the UK economy, we’re unlikely to get that over the medium term.

But one of the saving features of the UK recession has been the relatively modest increase in unemployment. The rate here, around 8%, compares favourably with other European countries. More than a quarter of the Spanish workforce, for instance, are currently unemployed.

Basically, unemployment has been kept under control because of the acceptance of the need for tightening belts. Wages have been held down or even decreased in real terms, allowing employers to keep staff on board and ready for a recovery. In this way, the sheer severity of the downturn - all the gloom and anxiety at what the implications might be, the fear of unemployment - has turned out to be a useful factor in preserving jobs. A more bullish workforce, and trade unions with more teeth, may have led to a different situation.

We have some flickering signs of a potential recovery. For example, the IMF has upgraded its forecast of UK growth this year to 1%. It might be small, but any growth in the recent context is good news.

The real issue now is what renewed confidence will mean for unemployment. Policymakers need to be very aware of the bubble created by years of restraint in pay and other benefits among employees and how its pressure can be deflated without causing further economic problems.

It’s a bubble of unmet demands and expectations that has the potential to burst with a return to growth and a sunnier outlook. People will be saying “we’ve taken the pain, now where’s the gain?” and try to catch up on what’s perceived to be lost income.

So the initial result of recovery could be quite unexpected: a sudden increase in unemployment as organisations look to retain talent but avoid increasing costs. Wage inflation would mean increased prices as costs are passed on - leading to the kind of combination of inflation and rising unemployment seen in the 1970s.

The problem with making forecasts about the UK economy is that so much of what’s happened in the past five years is unprecedented and part of a new global environment and structure. Labour markets are likely to improve in the short-term, but nothing is going to happen quickly and substantial growth would be needed in order to make significant inroads into the unemployment numbers. More significantly, a long-term and successful recovery for the UK will depend upon ongoing restraint in wages.

It’s a global issue, with a need for rebalancing between the older economies, with their traditionally high salaries, and the rapidly-developing economies. In countries such as China, wages have been kept relatively low to promote exports and growth. This in turn has helped other nations (including the UK) to keep their wages high.

As the gap continues to close we will no longer see the same kinds of steep rises in wages as were possible in the past. We now have a situation where pay restraint and levels of unemployment are going to be closely connected.

The challenge for both policy makers and employers themselves will be to keep the workforce motivated and content with their more modest lot, even when there’s a return to good news and growth all around.