Now is the time to change our economic model
The budget may not reverse our shrinking workforce but higher wages could just be the spur firms need to innovate
It was billed as the “back to work” budget. Jeremy Hunt promised to solve one of the most pressing problems holding back growth: “labour supply”.
There is a good reason why Hunt is worried about Britain’s shortage of workers. Wages are on the rise as employers struggle to fill a million vacancies. All else equal, wage rises exacerbate inflation, prompting consumers to bid up the cost of everything, which in turn raises pressure to increase wages. What results is the dreaded wage-price spiral, last seen in the 1970s.
So the government is right to worry about inflation, which erodes living standards and savings. But is it right to think the solution is to expand the workforce to strangle wage growth? I’m not so sure.
The conventional view is that rising wages caused by labour shortages are a very bad thing. Workers are one of the main costs employers face (the others being capital and raw materials). If these costs go up, the argument goes, innovation is harder and productivity suffers.
Economists point to the 1970s and successful modern economies to argue that keeping a lid on wage rises — as Germany or China have done encourages investment so wages can rise sustainably. “Good” wage rises, they’ll tell you, come only after you’ve put in the hard work of efficiency improvements.
If this model is universally true, it’s bad news for the world, not just the UK. Across the OECD, the share of the population that is working age has been falling since 2011. These market economies are also having fewer and fewer babies, so this trend will accelerate. High levels of immigration have not offset either trend despite generating political backlashes that make more immigration a hard sell.
The UK has an additional problem not seen in most other countries: a cohort who simply stopped working during Covid and haven’t come back. Hunt unveiled a plethora of measures designed to lure these people back into the workforce: removing the pension savings cap, changing the disability system so the disabled do not lose benefits if they work, toughening benefit requirements for the non-disabled and offering free childcare for babies (from next year). These measures will address “the two biggest barriers that stop business growing: investment incentives and labour supply”, he said.
In truth, although these measures may help to slow the workforce shrinkage, they will not reverse a trend decades in the making. In financial circles, it is easy to find pessimists who believe wage inflation is the new norm and that taxes on the working-age population will inexorably rise to meet the growing needs of the elderly.
What if this analysis has it all backwards, though? Wage inflation, rather than being a harbinger of decline, could just as easily be the incentive businesses finally need to invest in labour-saving technology. For years, our economy has been saddled with a long tail of firms that have failed to adopt basic productivity improvements, from new housebuilding techniques to bookkeeping software or automated seed-sowing devices. Many of these improvements do not require huge outlays or unimaginable new advances in technology. So why haven’t they happened? The likeliest explanation is surely that, with wages stagnant and the demographic cliff-edge yet to hit, companies simply have not bothered to upgrade their equipment or lay on training to improve workforce productivity.
Now, after a decade of ignoring the inevitable workforce crunch, employers have a pressing need they cannot fill in the usual way. This is a very different backdrop to the wage inflation of the 1970s, which forms the basis of the modern economist’s dread of high pay. Back then, the industries leading the charge to put up salaries were state-run and beholden to overwhelming union power. The working-age population was growing strongly and Britain was saddled with a whole backlog of useless capital stock, which had not been written down to its proper value. It could not have been innovated into profitability, even if the government had been the right vehicle to do it.
The situation now is different. The workforce is shrinking and will continue to do so even if the budget has its intended effect. This is happening in rival economies too. And the demand for new technology and workers who can deploy it is high, whether it’s heat pump installers, administrators or engineers.
What’s more, until the last year or so, the fear haunting many Davos panels and business-school essays was that automation would lead to mass unemployment. The solicitous intellectuals fretted: what were all those laid-off workers going to do?
Now, automation looks like the solution to our woes and high wages the trigger to spur investment in it. Those jobs that cannot be automated, such as social care, can soak up the workers whose jobs have been replaced by more efficient technology. There may be a mismatch between the skills required in our economy and the skills available, but that is not the same thing as a high wage problem. It is an education problem rather than a labour shortage.
Instead of asking how we bring wages down and fill the worker shortage, we should ask how we unleash the economy to fix this problem. If energy costs, poor access to training, shoddy infrastructure and planning regulations get in the way, the process of innovation could easily get stuck, replicating the barriers to progress that fed the 1970s wage-price inflation spiral. But that is not an inevitable.
In the mid 18th century, English and French glassmakers engaged in a competitive fight for market dominance. Delaunay Deslandes, the director of a French firm, thought his position secure because the English “could never make [glass] that would enter into competition with ours for the price. Our Frenchmen eat soup with a little butter and vegetables . . . Your Englishmen eat meat and a great deal of it and they drink beer continually.” English labour, in short, was just too expensive.
Deslandes was wrong. England’s high labour costs and cheap energy (coal) created the perfect incentive structure for innovation. Within a decade or so, English glassmaking was operating at a sixth of the cost of the French, despite paying workers more. What seemed to be our Achilles heel instead formed part of the formula for success. There is no reason why it should not be the case again today. If this government is serious about changing Britain’s economic model, now is its chance.
