Imagine a first year economists’ quiz.  In the market for X, the price for X has been weak.  But the quantity of X transacted at that price has been strong.  Is this

a. A paradox; b. Evidence that the demand for X is strong, but X is not as good as people thought; c. Evidence that the supply of X has been rising, far more than the demand

?

I would have thought it was obvious it was c.  Draw a simple chart.  Demand is downward sloping; people want less of something when it costs more.  Supply is upward sloping; people want to supply more when it gets more expensive.  Now expand supply: shift the Supply curve right.  Price falls, quantity rises. In this chart, a conventional demand curve meets a flat-ish supply curve, which is also shifting out. You move from point 1 to point 3: point 2 is where you would go if the supply curve remained where it was.

ASAD very simple

If this is so obvious, why are people so mystified by the behaviour of the UK labour market? In the last few years, we have seen wages underperform expectations, and levels of employment exceed. (Compare the OBR tables for June 2010, and for March 2014). Maybe few people predicted it.  But it is not as if economics is at a loss to analyse movements like this.

So I am puzzled at how someone as bright as Simon Ward can  say in the face of all this, “The jobless rate is plunging because of strong demand for workers rather than US-style labour force weakness”.  In what world does “strong demand” for X coincide with this sort of behaviour of its price:

Average Wage Growth

There is an explanation for what is going on in the UK.  If you like, it shifts the puzzle onwards. Why has the supply of labour remained so strong? And why has the demand for labour been so anaemic? The latter question is the one I find easiest to solve.  The total envelope of money to pay for labour is something to do with total national income. You can see it in the ONS series breaking down GNI figures.  It used to grow at 4-6%.  Now it grows less.

Total Household Resources Wages

I think this is a straightforward outcome of insufficiently stimulative policy.  When total national income is only growing at 2-4%, so will that portion that goes towards wages and salaries.

What about the supply of labour story? It is impossible to perceive directly what is the UK’s supply-of-labour curve. In particular it is difficult to discern the degree to which a movement comes from shifting along the curve or from the curve itself shifting.  We have to make educated guesses (what blogs are good for, Tony …?)

Here are some sloppy guesses:

– Average wage growth has not shifted very fast in response to demand changes in the last decade or so.  This suggests that the supply of labour curve is pretty elastic;  in particular you don’t suddenly see the UK worker demanding and getting a higher pay rise when things heat up.  It is easy to shed labour and easy to gain it.  Quantities adjust.  So the curve is flattish.  As Rick has exhaustively documented (and as I said tirelessly in government), our labour laws are light and flexible.

In the last five years, most of what has hit the UK economy will have shifted our supply of labour curve out.  This includes:

more old people entering the labour force; since 2010, over 250,000.  They may be less fussed about wage levels.  Abolition of the default age of retirement will have helped.

– A large wealth shock in the form of a once-a-generation credit crunch, giving an extra incentive to rebuild nest eggs. This will also have been an income shock, and the income effect will encourage more work. While aggregate wealth may have rebounded with the London house boom, this makes wealthier those sorts of people not desperate to work in <£25k jobs.

– Improved incentives to work through the tax system.  The income tax threshold is now £3000 higher than it was in May 2010.  For someone earning £15k, say, that means a 4% boost in after-tax incomes. The decision to be in the labour force, and to do more hours (between £7k and £10k) is much higher –

As my friend @ToryTreasury tweeted at me last week, “we’ve cut > £20bn from pre-election welfare system while reforming it to make work pay.”  If this is true (and I don’t see why it shouldn’t be), the benefits system has also shifted the Supply of Labour curve out. All of this is put in much more academic form by the IFS in last autumn’s document.

So is there a “paradox?” I don’t think so.  There will always be people who still say, with the IFS, “In a competitive economy, one would expect individuals’ wages to reflect their marginal productivities”.  I say in return: take a competitive economy. Let it be world-leading in the lightness of employment regulation.  Apply a continuous downward shock to nominal spending. You should expect a suboptimal labour market response. It has often been low employment.  It can also be low wages.

In other words, this is an example of what Krugman echoing Quiggin refers to as micro economics needing macro foundations. If you get the macro economic envelope wrong, the micro economic rules start fraying.

This is a huge topic and I am hitting the word limit.   There is much to say on incentives to invest vs incentives to hire, the tight credit markets, the impact of immigration, the possibility of under reported employment. I would just end with three difficult thoughts:

– The debate about UK employment law is always about making it more flexible. Understandable, given a decade of high unemployment from 1980. But if you want higher wages, too much flexibility is possible.

– When a government says it has “created” a million jobs, it always sounds like it has created the demand for those jobs. It tries to sound like a factory owner who has arrived in a depressed town and created opportunities.   I think that is an incorrect impression. In the last few years, a better description is that the Government has accelerated a steady boost in the supply of labour.  Workers have created the jobs by being willing and able to work at ever cheaper rates.

– Fiscal incentives to boost the supply of labour (income tax cuts, tax credits, and benefits changes) have benefits companies above all, not necessarily workers.

 

UPDATE: here are charts showing the growth in “employable” – crudely, the number employed + number wanting to be employed (the unemployed).  And, its inverse: the declining % of the workforce described under “inactive)

Growth (E + UE)

Declining Inactivity Rate

Little evidence here that the British are lazy!

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4 thoughts on “When the price stays down and the quantity goes up …

  1. There is a difference between price being “weak” and “declining”. In the situation of merely weak price that would suggest supply is large but not growing or that demand is also not merely large but also growing. Do you mean wages are, post inflation, declining and that is why employment is rising or that we are seeing a real rise in demand for workers masked by an increase in supply?

  2. Presumably the employment rate should illustrate some of this? As of March 2014 that was 1.5% points higher for men than 12m earlier and 11.% for women, a big increase, though most of that has come in the very last few months.

  3. Neil: fair question. I think “weak relative to demand” could mean the wage substantially lagging demand growth. Or weaker than is historically normal. I need to work that out.

    Matt: the employment rate should show this, and also the employment+unemployment rate, ie the total number employ-able/claiming to want work. I have a chart for that! will update.

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