Explaining the rise in employment

After yesterday's unemployment figures I was looking for reasons for the continued rise in employment when the economy is basically flat. I found the article below from October.

In past recessions firms have shed labour and, because the least productive have been allowed to go first, average productivity has risen. This has not happened since 2008.

Because of the much more flexible labour market real wages have fallen for those in work and so firms have not had to reduce their labour force as much as in previous recessions. Therefore the productivity 'jump' has not materialised.

Is that really enough to explain the flat productivity levels reported? Well probably not, but add to this low morale of the workforce given the falling real and nominal incomes and maybe this is enough.

Because of falling wages and no productivity increases firms have had to take on more labour to raise output. They can do this because they can offer lower wages for the higher output levels.

The article compares previous recessions and offers some thoughts.

The BBC article is here

Energy prices - a reason to reconsider?

Five of the six big energy companies has announced very high price rises, up to 11%. This is going to have a very large impact on household budgets.

There are two areas I'd like to think about, one fairly obvious and the other more reflective.

1. Fuel Poverty

Fuel Poverty is a relatively new term that refers to a situation where households spend more than 10% of their income on keeping warm. (The definition is vague on gross or disposable income, but only the latter makes sense.)

Clearly an 11% price rise will cause more households to fall into this category. If we taxed energy then people would explain that this was a 'regressive tax'. It would fall more heavily on the poorest households as it takes up a greater proportion of their income.

Therefore we should be worried about these energy price rises on the grounds of equity and income distribution. The Sunday Mirror article below looks at the effect on Fuel Poverty which may now affect one in four households.

2. The privatised energy market

In the 1980's the energy market was privatised. The aim was to introduce competition and force prices down and so making everyone better off.

The effectiveness of this policy should now be reassessed. Has it led to lower prices? Is there actually competition? Was it, in retrospect, a good idea?

Supply side policies take a long time to yield their results. It took two attempts to get the gas market right as well.

Is there really competition in this market? All the big companies are going to raise their prices by about the same amount. This is to be expected as their raw material costs are changing in exactly the same way.

If government still controlled this market then they could moderate the price rises, allow special tariffs to vulnerable groups etc. But the energy companies are private, profit making, firms and they work in the interests of their shareholders.

The Government has proposed forcing all energy companies to make sure customers are on the lowest possible tariff. This implies one tariff per company, probably all pretty identical. A major blow to competition and without any price controls. Politically popular but hardly market economics.

The Daily Mirror article is here

Employment at a record high

If there is something to celebrate it is that there are more people in work in the UK than ever before. In addition unemployment has fallen from 8.1% to 7.9%, a significantly larger drop than was expected.

This is good news for the economy because more people in work implies higher Real GDP and so an improvement in the standard of living. The Government will be pleased because tax revenues should rise leading to a smaller deficit.

The question of why employment is so high in a recession is one we must visit again. It is almost certainly due in part to a demographic anomaly. The size of the workforce must have risen. Fewer people leaving the workforce (for example not retiring at the previous normal age) and more people gaining jobs would explain this. While a substantial number of people remain unemployed there are more jobs.In other periods unemployment would have fallen substantially already.

There are particular concerns. The young are finding it increasingly difficult to get work and the difference between geographical areas is also widening. Scotland saw a rise in unemployment as did Northern Ireland. Cambridge has the lowest jobless rate overall in the country. Horsham has 1.6% unemployment, Birmingham Ladywood 12.2%. These are big differences showing the costs of unemployment are not evenly distributed.

Good news has to be welcomed. It will help boost confidence in both households and firms, but we really have to start asking about how youth and long term unemployment will be solved over the next few years.

The Telegraph report the figures here with numerous links to related stories.

France pays the price for not reforming

There is one consolation for the UK in the recession. It is worse in France.

The French government have just issued their latest budget proposals. This is against a background of three quarters of recession and unemployment of 10.2%. Also the French government budget deficit is significantly higher than it needs to be to meet Euro area rules.

So the French are proposing a 75% tax rate for the really high earners. There is also a new 45% tax rate for those earning more than £120k.

This has an obvious effect on income distribution and that suits the new socialist administration (the LibDem's have similar ideas in the UK). But many say that the French have again missed the point.

The French have resisted making the supply-side reforms which have helped other economies, like the UK, adjust working conditions in the face of the crisis. French employment law continues to discourage firms from employing staff on a permanent basis and raises the cost of employment further beyond the wage rate making employing staff expensive.

The rise in profit taxes makes the prospects for employment worse not better.

The French are caught in a difficult situation. They want to help ease the recession and help the poor and unemployed, but they are finding it hard to make the tough decisions.

The Independent covers the new French budget here

A new initiative on an admission of failure

The political conference season always brings some populist policy announcements. So Vince Cable has provided the embattled LibDem's with one to try and cheer them up (they currently lag UKIP in the polls).

The idea is unusual in the sense that it is the fourth of its type and two of previous ones were also announced this year. Essentially it is another attempt to help businesses borrow funds and so grow.

Leaving aside the previous, presumably inadequate, measures this one involves a new government owned bank. It will have £1bn of public money and some private sector money. It hopes to help small and medium sized businesses to borrow long term (around 10 years).

The problem, as before, is that the high street banks (such as Lloyd's and HSBC) are short of cash and risk averse. They are reluctant to lend to small and medium size businesses long term and so these firms cannot undertake new projects that take years to repay their investment.

The aim is to provide greater certainty.

Certainty for the high street banks - they can pass loans on to this new 'CableBank' and remove the risk from their balance sheets. In this case they will be much happier to agree long term loans as they remove the risk of default.

Certainty for small and medium sized businesses as they can borrow at an agreed rate for a period that makes investing safer. No firm wants to have the risk of losing their funding or seeing a hike in interest rates part way through an expansion.

So overall this will help? Like all supply-side policies it will take time to work. It will be 18 months before this bank can start operating and then more time before enough loans can be made to really make a difference. If the economy isn't growing by then nothing may help!

The BBC report the scheme here and there is a link to Robert Peston's blog where he doubts its effectiveness

A supply-side reverse?

Today some details emerged about the scrapping of GCSE's and their replacement by a new exam.

The aim is to make the exam 'tougher' by which I presume they mean that the material examined will be more advanced. Some believe that it just means the exam will offer fewer pass grades and the format, a single three hour paper, is less user friendly.  (Languages and science subjects will have some interesting problems with that format.)

The question for economists is, will this raise educational standards and so make the workforce more capable? If the answer is yes then the capacity of the economy will increase and the prospect of a more competitive and faster growing economy is in prospect (in about twenty years time it should really kick in!)

But for most educators it is a huge step backwards which will exclude the less able and those not so good at three hour exams which would include many of the most able.

Further there is a huge missed opportunity. Everyone will  be compelled to stay in education until 18 when the new exams begin in 2015. So why is there a 16 year olds exam at all? Why not concentrate on education rather than hoop-jumping and have exams at 17 and 18.

Some will say that the Education Secretary has no grasp of modern education and is a throwback to an earlier age. Neanderthal.

The BBC cover the story here 

Does easier hiring and firing mean a better economy?

A major improvement in the UK economy since 1980 has been the improved supply side performance of the economy.

The main aim of the supply side reforms has been to make the market work better. That includes reducing regulations that makes it more costly for businesses to operate. By reducing costs not only do profits and so investments rise, but firms are more confident in their chances of success and so expand more quickly.

One area of concern has always been the ease with which firms can get rid of staff. If it is easy to fire staff then, so runs the argument, firms will be more willing to hire staff. If it is difficult to shed staff then firms will hold back on recruitment just in case they don't need the staff for long.

A classic example is the French who provide employment protection after just three months. As  a result many French workers find themselves on a series of short contracts making it impossible to borrow money long term.

Now the government is proposing making the cost of losing staff less by altering the rules on compensation for unfair dismissal. The Business Secretary, the very sensible and wise economist Vince Cable, (no political bias here) has rejected the idea of 'no fault dismissal' which would allow hiring and firing at will. But he has supported the idea of reduced compensation.

Will this accelerate the rate at which firms hire labour and help reduce unemployment? That is the acid test.

The BBC reports the proposals here

Is it really going to work?

Despite a lot of talk about boosting growth the government has announced only a modest scheme to help and much of it is only an extension of previous measures.

The scheme will underwrite construction projects, allowing lower borrowing rates because the government will guarantee repayment. A third runway at Heathrow is to get another hearing.

The main measure is a promised relaxation in planning laws. At present it is very difficult to get approval in some areas for new building, partly because of objections from those protecting their own vested interest. This simply holds up projects and so delays growth.

These are supply-side measures that will not necessarily act very quickly, although they will help in time. Some people call for tax cuts.  For households, cuts in VAT or Income tax, to boost Consumption and so AD. For firms tax write-offs to cut the costs of new investment and so boost AD.

The argument about whether further boosts to AD or AS are most appropriate will continue. However both sides cannot escape the fact that confidence is so low and uncertainty over so many variables is so high, that governments are almost powerless to influence growth rates by more than a fraction of one percent.

The BBC report the 'new' initiatives here

Permanent damage to supply side - NIESR

A regular report by the National Institute for Economic and Social Research (A bit like the IFS without the political posturing) has said they expect unemployment to reach 9% and not decline until the end of 2013.

This continued economic weakness will do long-run damage to the supply side of the economy. This will include the loss of motivation and skills of many workers who find themselves in long term unemployment. It will also lead to the loss of productive capacity, which had initially fallen into disuse but is eventually derelict and scrapped.

Interestingly the NIESR suggest, as I have, that there is a need for a moderate and targeted fiscal boost. They say:

It remains our view that fiscal policy could be used to raise aggregate demand in the economy with little to no loss of fiscal credibility. We have never and do not now advocate scaling back the government’s medium- to longer-term policy of fiscal consolidation. However, the UK also suffers from a lack of demand in the short term. As we noted in our January Review, a 1 per cent of GDP increase in government investment this year would boost GDP by around 0.7 per cent, assuming no reaction by the MPC. A temporary boost to net investment, which has been cut extremely sharply, would have no direct effect on the government’s primary fiscal target of balancing the cyclically-adjusted current budget in 2016–17. 


Interestingly there is a one year estimate of the multiplier effect in that paragraph. Suggesting that governments are not really that powerful when it come to demand management.

The BBC covers the story here

Just getting supply side labour market policies in perspective

This week the government changed the law on how long an employee has to work before they can claim unfair dismissal. It rises from one to two years.

This restores the situation to the pre-1997 situation and is another move that has seen the period vary between six months and two years. The argument is about getting the balance right between protecting workers from being used by employers and then discarded, and encouraging employers to take on new staff.

If employers feel that there is a financial risk in taking on staff they may not do so. If they can terminate employment without cost then they might take the risk. Under the current situation the point might be welcomed by prospective employees, but many feel it just transfers uncertainty from employer to employee and is unfair.

The aim of UK policy is a flexible labour market. Making the UK capable of responding quickly to world events and keeping the economy competitive. Contrast this with the Australian view, where even moderate reforms are seen as unacceptable, and the legislation is loaded massively in favour of employees.

This makes the Australian economy quite staggeringly uncompetitive. There are high wages for shifts, young people can't work short shifts preventing them competing in the labour market and add on costs for staff are very high. The article from The Age is a typical response to any attempt to bring supply side reform to Australia, but for us its main use is to contrast the UK and a 1970's style labour market.

You may conclude Australia is doomed once the mineral prices fall.

The Age article is here

Red tape - a legitimate target for supply side policy?

Today the new Planning regulations for England are published. They are to be 50 pages, not 1000, pages long.

What prompts this move is the desire to speed up development plans. At present it can take two years to get permission for even a moderate development and while the planners and councils consider their opinions and check against the regulations labour stays idle and growth is stalled.

Good supply side policy allows the Long Run AS curve shift to the right more quickly. This cutting of red tape seems to fit that bill. It should give a one-off boost to growth, at least in construction, but also in the faster building of private and public infrastructure and may allow improved growth in the future.

However it is worth asking why there were 1000 pages in the first place? Often it is to prevent environmental damage and to protect the sustainability of development. Do we really want no gaps between urban areas?

In reality 1000 pages was certainly too much. Petty rules to preserve old fashioned and outdated ideas, but 50 may be far too few and we may have endless appeals as planners have to make personal judgements.

The Independent covers the story here

So the Budget.....

As Budget's go this one had a lot of different things in it. You might not agree with the direction but you have to admire the width. There were both demand side and supply side measures.

Demand side measures

Included raising the income tax allowance to £9,205 from next April. This is effectively cutting income tax and so increasing AD by raising consumption.

Indirect taxes have risen on tobacco and alcohol. This will reduce AD by raising prices, but there is a clear justification on this on the grounds of market failure.

The Budget deficit will continue to fall over the rest of the parliament reaching just £21bn bu 2017. This is a contractionary stance and will push AD down.

Corporation tax will fall from 26% to 24% from this April. This should boost profitability and so raise the incentive to invest, so raising AD.

Higher stamp duty and the closing of 'loopholes' means that really high earners are not as well off as tax cuts appear.

On the supply side there were a number of measures.

There is help in gaining finance for small businesses with a loan guarantee scheme.

The top rate of tax will fall from 50% to 45% from NEXT year. It is argued that this will increase incentives to work and will therefore increase output and benefit the economy. Combine this with the cut in Corporation tax and this can be seen as a clear attempt to make Britain appear a better place to locate your business than other countries.

Faster broadband speeds in the major cities to improve infrastructure.

The income tax and corporation tax measures listed in Demand side also have a supply side incentive effect.

Overall

There are a lot of measures! I have listed only a few and you should read the papers on this, but looking at them in a list does not really do them justice. Is there an overall philosophy behind the budget and does it make economic sense?

I think the Budget can be summarised as a mixture of short term details and long term vision:

In the short term the economy is growing, but slowly, and can manage with less fiscal support in the future. Some people are really struggling and the higher tax allowances and concessions of child benefit are designed at help them a little. Some people are too generously dealt with and they must pay more.

In the long term there is a need to re-balance the economy by reducing the deficit and encourage growth. The Chancellor has avoided short-term popular measures in favour of a long term view.  The supply side measures really stand out here.

Of course some policy objectives are so low down the list they have pretty much dropped off. Can you order the priorities?

As usual the BBC provide excellent coverage with plenty of interactive bits

Do governments get more money by cutting tax?

You could be forgiven for thinking that raising tax rates is a way of reducing government revenue. So far various groups have asked for:

* The 50% income tax rate to be scrapped
* The duty of fuel to be reduced
* The VAT on tourism to be cut to 5%
* The passenger duty on flights to be dropped

All four have claimed that as a result:

* The government will receive higher revenue
* Jobs will be created

What are the reasons for these arguments? And does this not imply we should simply cut taxes and solve the economic crisis?

Well on one level these groups are arguing for an old fashioned fiscal stimulus. Lower taxes and raise consumption and so Aggregate Demand. On the other hand they are relying of incentives to change behaviour.

For those advocating the cutting of the 50% income tax rate they suggest people will work harder if they keep more of their wages. This is a supply side measure.

For the other measures its just the law of demand and the proponents are really assuming a lot about the elasticity of demand. More jobs may result, but it seems optimistic to suggest that the government will get more tax revenue due to increased output and sales.

Of course the other interpretation is that the proponents of these tax cuts are all vested interest groups who want a boost to their incomes or their business.

The linked article relates to the latest calls for lower VAT on tourist services.

Call for 5% VAT on tourism

Unemployment - an insight

David Blanchflower is an expert on the labour market. He was once on the Monetary Policy Committee and constantly worried about the effect of monetary policy on the jobs market, which annoyed the government as it was inflation he was meant to be worrying about.

In the piece below he looks at the current state of the UK labour market, considers why it has performed in the way it has and what schemes might work to improve it. This is a must read article.

You will notice that he too refers to the film 'The Full Monty', so its not just me!

Blanchflower's article is here

Numeracy skills hold back UK economy

For those who have already encountered supply side policy it may seem odd that much remains to be done on the basics.

A report suggests up to 50% of the UK adult population has numeracy skills no better than an 11 year old. This is a significant handicap to the economy.

Improving the supply side of the economy requires, among other things, improving the capabilities of the working population. If the workforce cannot perform simple calculations then they have little chance of performing the complex tasks required of a competitive, skills based, economy.

So what is the solution? We could attempt to improve the numeracy skills of the existing adult workforce. This is unlikely to meet with much success and could absorb a great many resources. The alternative is to improve the numeracy skills of school leavers.

Currently only 15% of UK students study mathematics after GCSE. That makes the UK unusual among developed nations (where the figures range from 50% to 100%) and we may have to consider sacrificing some higher skill development post GCSE to allow further training in mathematics. However it would seem that it is more likely that the numeracy figures represent a massive failure of mathematics teaching to age 16. Surely any successful programme would ensure a competent level of numeracy?

The solution, whatever it is, will take two generations to put things right. A frightening prospect, but an essential one if the UK workforce is to be fit for purpose.

The BBC covers the story here

Incentive to work vs revenue from a higher rate

The last government introduced a 50% income tax rate on taxable earnings over £150,000. The aim was to raise more tax revenue by making the rich pay more.

This is a well established principle of progressive taxation. However the trend has been to reduce direct tax rates because of the disincentive effect this has on workers.

The 'Laffer curve' describes how as tax rates rise the government gains a higher tax revenue. As tax raises, however, some people begin to think that working is no longer worthwhile and start to reduce their working hours. Eventually this effect becomes so strong that raising the tax rate even more leads to lower government revenue. The increased tax rates add less to government revenue, due to the higher proportion of income being paid tax, than the loss of revenue due to people opting to work less.

It is very difficult to find the tax rate where the government maximises its revenue but also keeps the labour supply sufficiently high for the economy to grow.

Many people are making a lot a of noise about the "temporary" 50% tax rate and saying that it is already holding back growth. Their argument is basically that the disincentive effect has already kicked in.

The counter argument is, of course, equity. The less well off would have to pay an unfair proportion of the cost of the collapse of the banks and the resulting deficit. Further many might say that having the chance to pay 50% tax is quite a good position to be in!

The Guardian covers the story here

Neet's to be helped

Click on image to enlarge

NEET's are  young people Not in Employment, Education or Training. There are a worryingly large number of them.

The problem is that a 16 or 17 year old, with no GCSE's above C grade, is really quite low down the list when it comes to picking amongst job applicants. The very poor job market means that many of the people in this category are not getting that first job they need to gain experience.

The problem is that if a 16/17 year old does not get a first job until then when will they? The possibility of a lifetime of short term, casual jobs is quite likely and this equates to a lifetime of poor living standards.

So giving these people a start is important and a new scheme has been announced. Essentially employers will be given a subsidy to employ 16 and 17 year olds who qualify. Hopefully the skills they gain will allow their continued employment.

This is a supply-side policy. It is targeted, it affects the costs of firms and it is expanding the productive potential of the economy. Like many supply side policies the effects will take some time to come through and are far from certain to work. Maybe the firms will take the money, employ the young workers for a short time and then release them having benefited from cheap labour. Of course those people do now have work experience, so some good comes of it.

The budget, £126 million, is small but as each employer will only get around £2000 per employee the measure could benefit a lot of NEET's. But is it enough? That remains to be seen.

The Guardian has some NEET's data here

Increasing competition or normal oligopolist behaviour?

In October it was reported that the big six energy companies had increased profits from £15 to £125 per customer per year. This drew the attention of the regulator Ofgem.

When the nationalised industries were privatised the idea was to move from state monopoly to a competitive market where the consumer got a better deal. What we got in a lot of cases was either private monopolies or strong oligopolies with high barriers to entry.

Ofgem are trying to improve the situation by forcing the 'big six' energy companies to auction off some of the electricity they generate to allow new entrants into the market.

However this week a number of the big six announced price cuts. Does this mean the fear of new entrants is forcing them to act (a contestable market)? Ofgem would be delighted if this were true. But this behaviour is consistent with oligopolist's profit maximising behaviour.

The warmish winter means spot market prices for energy are lower this year than the last two years. With lower than expected costs one firm moves price down to gain market share. The others lower prices to match them to protect their market share. The kinked demand curve model and game theory would both predict this move.

The Telegraph report the story here

Immigration - good or bad?

Some people are fond of telling us that the problems of Britain are down to the many immigrants that arrive here, for example The Daily Fascist (aka The Daily Mail and The Daily Express).

Recently 'Migration Watch' blamed youth unemployment on migrants. And the Migration Advisory Committee, the governments own advisers, have today claimed that for every 100 non-EU immigrants 23 jobs are lost to UK residents. But can such views be justified?

Increasing the labour force by migration raises the capacity of the economy (the PPF/Long Run AS curve shifts right). Skilled migration will also improve productivity. Of course if the migrants are not of working age these advantages are not gained.

The National Institute of Economic and Social Research (NIESR) have simultaneously declared that there is no harm to jobs from immigration. Personally I am with them on this issue. The need to expand the supply side of the economy is most important and good immigrants provide a skilled workforce far faster than the education and training system.

Politically this one will not go away while unemployment remains high.

The BBC report the Migration Advisory Committee here

The Independent reports the conflicting NIESR report here

Chinese have been reading the Development textbooks

One of the pieces of advice given to Less Developed Countries (LDC's) by the 'First World' in the 1960's was to invest in 'leading sectors'. This was based on the view that certain sectors have high second round effects and so a high multiplier value.

While this advice was largely ineffective, and in many cases disastrous, the idea of government intervention and 'unbalanced growth' to kick start under developed economies has remained in the literature. Clearly the Chinese have read about it as they now wish to invest in British infrastructure in order to help boost economic growth.

The Chinese are, of course, acting in their own best interests. They need Europe to grow so they can buy more Chinese goods. They also need somewhere to invest their considerable wealth. They have established 'sovereign wealth funds' to do this, a very sensible move as China cannot possibly use all the profits currently earned by their exports.

There are several ideas to explore here. Will there really be a big multiplier effect as a result of the proposed new investment? Is this the golden goose the Public Private Partnership programme has been looking for (it has totally failed to attract significant private funds for nearly ten years)? Are sovereign wealth funds a good idea? And of course how long has China considered the UK an LDC?

Whatever the answers it is clear that old copies of Todaro have a ready market in China.

The BBC cover the story here