EMPLOYMENT LAW

Employment Law



Employment Law

Britain has always been a liberal economy when compared with continental Europe. Employment protection legislation has never been very strong and product market regulation, in the form of start-up costs for new businesses and ongoing business regulation, have been weak (except for a large public sector, which was privatised in the 1980s). So two questions need to be answered to establish our claim that the reform of the monetary policy regime was behind the British success story.

First, why was unemployment so low up to the mid 1970s, well before the monetary policy reforms? And second, why did continental Europe, with even stronger anti-inflationary credentials than Britain, not experience a similar success story? The answer to the first question lies in the nature of the shocks that have hit the British economy. In the period before 1974 the shocks that drove output growth were almost entirely productivity shocks and there was hardly any employment growth. When productivity growth slowed down in the 1970s wage demands did not follow suit and inflation became a constraint to maintaining high employment.

The answer to the second question lies in the institutional structure of the labour market. The continental European countries with the anti-inflation credentials have restrictive labour market institutions, which Britain does not have. With the exception of trade union power, where Britain was firmly in the European arena until the second half of the 1980s, British institutions have always been closer to US institutions than to continental European ones. The constraint that stopped Britain short of achieving US-style success in the 1970s and 1980s is the wage pressure and subsequent inflation that each fall in unemployment caused. Once trade unions lost their power and the Bank of England established its anti-inflation credentials, the inflation constraint eased and the British labour market took the transition path from continental Europe to the United States.

Most of the rise in unemployment from the low values of 2 to 3 per cent before 1973 to nearly 12 per cent in 1986 is clearly due to a rise in the smoothed rate. Commentators have concluded from this that the rise in UK unemployment is a rise in the "natural rate," namely, in the underlying unemployment rate that cannot be reduced by expansionary aggregate demand management. Equally, the fall in unemployment since then, to about 5 per cent of the workforce, is a fall in the natural rate.

Currently (2002), aggregate demand policy is neither expansionary nor contractionary, something confirmed by the stability of inflation over the last few years.

Whether the smoothed rate shown in figure 1 is the natural rate and the deviation between the smoothed rate and the actual rate is the cyclical component is open to question.

One thing that we can say is that the deviation between the two rates shown in figure 1 is not the only component of cyclical unemployment. Cyclical shocks can be real and the natural rate as defined in the preceding paragraph is a cyclical ...