The 'conundrum' at the heart of the British economy is getting worse — and economists are baffled

vhines200/Flickr (CC)No one’s really sure what’s going on.
  • UK unemployment fell to a fresh record low this week, but wage growth is still failing to gain momentum.
  • Andrew Goodwin, lead UK economist at Oxford Economics, calls this the “conundrum” at the heart of the British labour market.
  • Sadly, there seems to be no end in sight to stagnant wage growth for British workers.

LONDON – UK’s unemployment rate fell to just 4% this week – it’s lowest level since comparable records began in the early 1970s – and some commentators took it as a sign Britain’s economy is performing solidly despite the uncertainty around Brexit.

The data, however, highlighted a conundrum that has been plaguing the British economy for several years: if unemployment is so low, why aren’t workers getting larger pay rises?

“The drop in unemployment was only one of an array of indicators which suggested that the labour market is becoming increasingly tight,” Andrew Goodwin, lead UK economist at Oxford Economics, wrote on Friday.

A fresh low in the ratio of unemployed people to jobs available is a key sign of this tightness, Goodwin said, as well as record low in the number of people who have changed employment status in the last three months.

That presents a dilemma to employers – how do they attract people to fill vacant roles?

The two standard methods of doing so are to bring people who are inactive into the labour force and to increase the hours of those people already working for them.

“The data shows some evidence of firms pursuing both options. Flows from inactivity to employment have been much higher in recent years, even allowing for the possibility that some of these people may have been temporarily inactive because of universal credit delays,” Goodwin wrote.

“Meanwhile the ONS measure of underemployment fell again in Q2, reaching its lowest level since mid-2008,” he added.

Increasing the number of overall hours worked through these avenues would generally need employers to offer significantly higher wages, designed to tempt people to work more, or come out of inactivity.

Traditional economic theory states that a tight labour market with low unemployment should see wages increase for workers. The logic here is simple: when there are fewer people out of work, there are fewer candidates for jobs, meaning that those in work and those entering the labour market are able to demand higher wages.

In the UK, however, that is simply not happening. Wage growth in the most recent period was just2.7% excluding bonuses, while the inflation rate in Britain is at 2.5%. As a result, real wages are barely rising. Why this is happening remains something of a mystery to economists.

“It is clear that we have not seen the sustained acceleration that would usually be expected,” Goodwin wrote.

Several reasons have been advanced for this disconnect, the rise of gig economy and the fall of the trade union in the UK among them. The Bank of England has consistently maintained that it is merely a blip that will ultimately correct itself.

Goodwin disagrees arguing that there are several compelling reasons to suspect that wage growth won’t accelerate any time soon.

Here’s the key extract:

“It is becoming increasingly difficult to envisage this [wage growth rising as the Bank of England argues] happening, not just because of recent experience but also because the structural factors which have weighed on wage growth – namely low productivity growth, increases in other labour costs caused by factors such as pension auto-enrolment and, as our European colleagues recently found, that rising activity among older cohorts tends to depress pay growth – are not going away.”

NOW WATCH: Money & Markets videos

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.