by Dr Patrick Nolan, Chief Economist, Reform
The latest labour market statistics presented a bleak picture with unemployment rising by a record 281,000 to 2.38 million in the three months to May. Things are going to get worse before they get better – with some forecasters expecting unemployment to peak at around 3.2 million next year. Indeed, as Theresa May recently warned, “Unemployment is casting a dark cloud over the economy, ruining the lives of millions.”
This increase in unemployment creates a real challenge for government. A strategy of standing back and simply allowing any (eventual) economic growth to absorb the increase in unemployment will be likely to be ineffective. Not only are the future prospects for economic growth subdued but much future growth will be in sectors and regions, and among population groups, that are different from those where unemployment has increased.
But what should any government response involve? And what are the likely advantages and disadvantages of different approaches – and key factors in their success or failure?
It is widely accepted that any government response should include active labour market policies. These policies aim to help unemployed people back into work and include job search assistance, training and job creation subsidies. These different active labour market policies are suited to different environments and have different strengths and weaknesses (summarised below).
But to be truly effective, active labour policies need to be supported by a range of other policies. In a weak labour market welfare reform becomes more not less important. It is especially important to get withdrawal rates for welfare right as the provision of a welfare safety net involves a trade-off with incentives – hence Arthur Okun’s description of welfare as transferring income in a leaky budget.
The role of trade unions (or the industrial relation framework) also requires attention, as unemployment persists when necessary changes in wages and employment conditions are held back. Finally, the minimum wage also require careful consideration – as a higher minimum wage reduces employment but also encourages productivity and interacts with welfare (improving replacement rates).
So how does the current government’s response to unemployment stack up against these points? The first thing that becomes apparent is that there is too great an emphasis on blunt measures such as committing a place in education and training for every 16 and 17-year-old who wants one. Such measures do little to increase the jobs available in the economy and will largely increase expenditure while providing little benefit for the individual participants. Previous Reform research has highlighted that the training already being provided is of questionable quality – which reflects the poor outcomes of an unwieldy education maze.
Rather than emphasising these blunt measures, greater attention should be given to initiatives that make it easier for firms to hire staff. Measures could include allowing employers greater scope for taking staff on for a trial basis. Areas of particular inflexibility in current labour market regulations, including maternity pay and leave, that make employers reluctant to hire certain groups also require reform.
Finally, the central goal of any reform must be to improve productivity in the labour market. For this reason, efforts to encourage firms to hire more staff (strengthen labour demand) must emphasise greater flexibility of employment and working conditions and not inefficient job subsidies.
Strengths and Weaknesses of Active Labour Market Policies
Job search assistance:
• How they work – they may include initial interviews (on exit from the labour market), job search seminars, job matching services and counselling.
• Pros – can reduce the time for which people are employed, relatively low cost.
• Cons – does not directly increase employment (labour demand), requires monitoring to be effective.
• Conclusion – job search assistance is a relatively cost effective intervention for people in short-term unemployment who are work ready, but is much less effective when there are few jobs available.
Training:
• How they work – programmes may range from basic literacy and numeracy, to vocational courses and support for self employment.
• Pros – build workers’ capacity, tend to be effective for adult women, less effective for men and even less for out of school youths.
• Cons – expensive, lock-in effect (participants are largely kept out of labour market, although this may be offset in the long-run).
• Conclusion – to be effective training programmes need to be focussed on the (future) needs of employers, otherwise they represent expensive expenditure that provide little benefit for the individual participants.
Job creation subsidies:
• How they work – government directly subsidises specific jobs.
• Pros – can reduce the time for which people are employed, tend to be more effective for males and for younger workers.
• Cons – large negative effects from displacement (where firms with subsidised labour displace non subsidised firms in the economy), substitution (where firms substitute subsidised labour for unsubsidised labour) and windfall costs (where firms get subsidies for employing people they would have employed anyway).
• Conclusion – subsidies provide poor value for money – for every 10 jobs attributed to subsidies only one is actually a new position. Job subsidies may also prop up employment in declining sectors and slow the development of a more productive economy.
