Promising job creation figures look like a symptom of the low wages and falling investment of an imbalanced economy
Recessions are usually job killers, so the way in which the UK economy has created new jobs at a time when growth has been so weak has baffled the experts. Employment is up even though national output has been flat over the past year.
Economists have been searching high and low for an explanation. Is Britain actually doing a lot better than the official data suggests? If so, the double-dip recession will be revised away in due course. Has the UK become less efficient, with more people needed to provide the same quantity of goods and services?
It could be the expansion of part-time work – people working 20 hours week when they would actually like to be working 40. Official data last week showed underemployment in the economy has risen by 1 million since the recession began.
Robin Chater, the secretary-general of the Federation of European Employers has a different explanation: labour is dirt cheap in Britain and that encourages firms to boost output by hiring or retaining workers rather than by investing in new plant and machinery.
Since 2005, Chater says, capital replacement has been falling faster in Britain than in any European country. This is confirmed by official figures for investment as a share of national output, which at 13.9% is the lowest since records began in 1955.
"The UK is turning into an old-style third world country with low pay growth for most workers below managerial level, widening pay differentials and poor levels of capital investment," Chater says.
"This has been partly encouraged by the influx of workers from eastern Europe since 2004 – who have been willing to perform many functions at low wage rates that would have been otherwise automated."
Governments of both left and right have said their aim is to turn Britain into a high-wage, high-productivity economy that competes with countries such as China and India on the basis of quality and technological expertise rather than cost. The opposite appears to be happening. Some might argue that an economy that is creating low-wage employment is preferable to one that is creating no jobs at all.
So what's happened? The first thing to note is that this is not a new phenomenon. Life has been getting tougher for labour for decades, with the real break coming in the 1980s. Over the past 35 years there has been a marked shift from wages to profits in the UK economy, with labour's share of national income falling from 59% in 1977 to 53% in 2008 and the share of profits up from 25% to 29% over the same period.
Over the same period, median earnings failed to keep pace with growth in the economy as measured by gross domestic product. Had they done so, median earnings for full-time workers would be £7,000 a year higher than they are.
Two separate factors are involved here: labour has got a smaller share of the national cake, and the distribution of earnings has become more unequal.
These figures are contained in a paper by Howard Reed and Jacob Mohun Himmelweit, which will be published soon by the TUC as part of its Touchstone Extra series.
In the past explanations for the falling share of wages in national income has been attributed to a combination of technological change, globalisation and the reduced bargaining power of trade unions. Reed and Himmelweit say there is a fourth factor: the increased financialisation of the economy.
Their analysis shows that over the past three decades the whole of the increase in the profit share can been attributed to the increased profitability of the financial sector.
"Firms are increasingly able to invest in financial assets as an alternative to direct investment in productive capital (ie, plant and machinery) and they are also able to invest abroad instead of at home," the paper says. It adds that financialisation has also empowered shareholders to put constraints on companies designed to make life tougher for labour. This has been especially marked in the case of private equity deals where companies are loaded with debt and under pressure to cut costs aggressively.
The rationale for a rising profit share is that it leads to higher investment, which in turn leads to stronger growth and rising employment. Workers gain in the end because companies expand and become more productive. The supply-side reforms of the 1980s were in part based on the theory that the wage share in the 1970s was too high, leading to low levels of investment.
There is, however, no evidence that the squeeze on labour's share of national income has led to higher investment. While the profit share rose from 25% to 30% of GDP between 1980 and 2010, investment fell from 20% to 15% and is still falling. It is a similar picture for spending on business research development, which has been dropping steadily since the mid-1980s.
What appears to have happened is that the rising profit share went to the financial sector and has been used to boost City pay and bonuses rather than used for new investment. In the bracing climate, few groups of workers are able to garner the full fruits of their labour: Premier League footballers are one, investment bankers another.
A number of conclusions can be drawn from this analysis. The first is that the task of rebalancing the economy may be even more daunting than first thought. If the financial sector is responsible for the entire increase in the profit share over the past three decades, that shows how dependent the economy has become on the City as a source of growth.
The second conclusion is that the 30-year experiment with supply-side economics has failed to deliver the results in terms of higher investment. That supports those who argue that the UK – if it is serious about rebalancing – needs a national investment bank to provide the sort of support provided for business in other developed nations.
Finally, investment might be higher if the wage share started to increase. At present, there is little real incentive for businesses to invest. Labour is cheap, finance is difficult and expensive to obtain from the banks, and demand is weak.
A rising share of wages in national income would lead to stronger demand. Reed and Himmelweit say this could be achieved either by reform of the financial sector so it has a less pivotal role in the economy, a full-blooded campaign to raise skill levels or reforms to wage bargaining. A rising share of wages in national income would require either a prolonged period of full employment or a rethink of UK economic policy making over the past 30 years. Neither looks remotely probable.