Britain’s economy is suffering from a textbook case of stagflation and the symptoms are clear from the latest labor market trends. It looks like a composite image. The number of job seekers increased while the number of job vacancies decreased. Hours worked in the economy fell, while days lost to strikes in 2022 were the highest annually since 1989.
In fact, the diagnosis is simple. There was zero growth in the last quarter of 2022 while annual inflation was over 10%. The Bank of England’s efforts to reduce inflationary pressure through higher interest rates are fueling lower levels of activity – but only slowly. There was no sudden collapse like the one seen during the global financial crisis of 2008.
There are some complications, as the latest figures from the Office for National Statistics show. The legacy of the pandemic has affected labor supply, mainly because workers in older age groups have left work, either by choice or long-term illness. Although the number of vacancies has decreased since last summer, it is still well above pre-pandemic levels.
Businesses and workers are responding to these trends in predictable ways. Businesses are looking beyond the current economic slowdown and wondering whether they will be able to replace workers in the future if they are laid off now. Mainly, they are hoarding staff, hiring part-time employees instead of full-time, and paying their workers more. Annual growth in regular pay – excluding bonuses – was 6.7% in the quarter to December. In the private sector, earnings growth was 7.3%.
Labor shortages have made it easier for some groups of workers to secure higher pay deals. Even so, private sector pay has not kept pace with price increases, and the resulting squeeze on real incomes is a big factor behind the sluggish state of the economy. Public sector workers are hit harder than those in the private sector, leading to widespread industrial action.
However, there are signs that people who were previously inactive – neither working nor actively looking for work – are beginning to return to the labor market. Again, this is only to be expected in light of the problems many people have to deal with. Inactivity fell by 113,000 towards the end of last year as long-term sickness fell and early retirees were put to work.
The government can deal with stagflation with one of two remedies. First, it can try to ease the pressure for higher wages by taking steps to increase labor supply. It could, for example, change pension rules to encourage more early retirees to return to work. It could make childcare less expensive. It could take the advice of the British Chambers of Commerce and reform the shortage occupation list to make it easier for companies to fill vacancies outside the UK when they cannot hire locally. Mel Strid, the work and pensions secretary, is considering whether tighter rules on benefits are needed to move people off welfare and into work.
after the promotion of the newsletter
The alternative is for the Bank of England to keep raising interest rates until higher rates lead to higher unemployment and less upward pressure on wages. In all likelihood, there will be a combination of both approaches. So far, the labor market has proven remarkably resilient, but that won’t last. There are already signs from the latest unemployment and pay data that the labor market is turning. The fact that unemployment has started to rise suggests one thing: this is going to hurt.