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Weekly Economic Briefing


Taking the shine off


The headline coming out of the UK labour market seems at first glance to be encouraging. The unemployment rate is sitting at a 40-year low at 4.3%, and has almost halved since its peak in 2011. Our labour market slack indicator, which measures the gap between current unemployment at its equilibrium rate, provides another way of observing this progress (see Chart 4). The recovery has been driven by strong job creation, and this has continued of late, with fears that uncertainty might hold back hiring not materialising. Employment growth is currently running around a healthy 1% in year-on-year terms, with the majority of this representing full-time, private sector jobs. This has been outpacing the still-solid growth we are seeing in labour supply. The labour force has been boosted by both a rise in the working age population and the participation rate to a record high. Interestingly, we have already seen a slowdown in the growth rate of EU nationals employed in the UK since the referendum last year. However, it is too early to draw any strong conclusions around what Brexit might mean for future EU migration flows at this stage, with even the details around current resident rights after the Article 50 deadline and beyond not yet agreed upon.

Running out of room Doing less with more

The good news story starts to falter when we take a step back to look at the broader economic environment. A clearly tightening labour market has come in spite of a slowdown in economic activity over the course of 2017. The upshot of this unusual dynamic has been further disappointments on the productivity side. The Office for National Statistics this week released updated figures which underline productivity challenges. Labour productivity (output per hour worked) fell in both Q1 and Q2 of this year, with much of the weakness concentrated in the production industries. While this may have been exacerbated by cyclical factors, the longer-term trend is alarming. Indeed, when we look across its peers the UK fares very poorly in comparisons of labour productivity (see Chart 5). The concern is that a seeming reluctance of businesses to invest amid current uncertainty over EU membership could be exacerbating this underperformance. Therefore, while it is positive that employment is rising as people get jobs, the weak productivity backdrop takes the shine off these dynamics.

There are a number of reasons why the UK’s productivity woes matter so much. Productivity growth is critical for raising real per capita incomes in an economy. Indeed, a good portion in the weakness in pay growth over recent years reflects productivity struggles. Bank of England Governor Carney has flagged that monetary policy can do little to alleviate this problem. Instead, weak productivity and potential growth are likely to mean that the Bank is forced to raise rates sooner rather than later, with spare capacity seemingly eliminated. The chancellor will also be contemplating these data with a degree of trepidation. If the Office for Budget Responsibility marks down its expectations for potential growth in response to these latest setbacks, fiscal policy will need to be tighter to hit deficit targets. At least the government can do something about the productivity challenge. More aggressive action is needed to boost growth and we would advocate a rewriting of overly restrictive fiscal rules in order to create room for targeted investment in infrastructure and skills.   

James McCann, Senior Global Economist