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Mass underemployment

There's much more spare capacity in the labour market than headline figures suggest – which is why wage growth is falling
January 16, 2020

Those of us who were formed in the 1970s and 1980s will find next week’s labour market figures perplexing.

We were trained to believe that if unemployment fell below a certain rate – given the unlovely name of the non-accelerating inflation rate of unemployment or Nairu – then wage inflation would take off. But Tuesday’s numbers will show that this is not the case. They are likely to show that the unemployment rate, at 3.8 per cent, is at its lowest rate since 1974. But wage inflation has fallen. At around 3.1 per cent in the three months to November, it is likely to be at its lowest for over a year.

So, what’s happening?

One thing is that productivity is stagnating. Because we’re not producing more, companies cannot afford to pay us more. In fact, modest as it is, even pay growth of a little over 3 per cent is squeezing profit margins for many companies.

Another is that consumer price index (CPI) inflation has trended down since late 2017. This means workers no longer need big nominal pay rises to cover increases in the cost of living.

But there’s something else. There’s far more excess supply of labour than the official unemployment rate would suggest. There are also 1.8m people out of the labour force who’d like to work – people such as students, home-makers, and the unwell. Theirs are not idle preferences: in the third quarter of last year, 547,000 people moved from economic inactivity into work.

What’s more, the Office for National Statistics also estimates that there are almost 3.3m people in jobs who would like to work longer hours. Although this is below the peak (of 3.9m) reached in 2014, it is far more than we saw before the financial crisis – between 2002 (when data began) and 2007 this underemployment averaged only 2.4m.

This matters, because as David Bell and David Blanchflower have pointed out, underemployment does a lot to suppress wage growth. If an employer can increase output merely by getting existing staff to work longer, he does not have to put up wage rates to the extent that he would if he wanted to hire more workers.

In this sense, the labour market has changed a lot since the 1980s. Back then, people worked either full-time, or part-time, or were unemployed. In our more flexible labour market, however, things are not so fixed, so underemployment is a big problem.

If we add together the unemployed, those out of the labour force wanting a job and the underemployed, we get more than 6.3m people. That’s almost one in six of the working age population. And this is not to mention those who are working the hours they want, but are not fully occupied by their jobs, or those people who are over-qualified for the jobs they are doing.

 And yet Bank of England governor Mark Carney said in November that there is only a “small margin of excess supply” in the economy. He might be wrong. But what should worry us much more would be if he is right.