1.We launched this inquiry on 28 July 2022 with a call for evidence on the causes of the reduction in the size of the UK labour force. This report seeks to explain the recent reduction in labour supply in the UK, the types of people who have left the labour market and their reasons for leaving. A thorough examination of policy solutions to the rise in inactivity was outside the inquiry’s remit. We are grateful to all our witnesses and to our Specialist Adviser, Robert Joyce.
2.Falls in labour supply can impact inflation, economic growth, and public finances. They can add to inflationary pressures—as employers compete for scarce employees by raising wages, adding to the cost of producing goods and services. 5 By constraining the level of output that can be produced, or by leading to increases in the costs of producing it, labour shortages can limit economic growth. Falls in labour supply will worsen the public finances, through lower tax receipts and, depending on who is withdrawing from the labour force and why, could result in increases in benefits payments.
3.In the UK, changes in the labour market (higher vacancies and rising economic inactivity) have occurred against the backdrop of the economic shock caused by COVID-19, and then the energy price shock exacerbated by Russia’s invasion of Ukraine. The Bank of England factors labour market tightness into its decisions on interest rate changes because a tight labour market can lead to inflation.6 Labour market tightness means that labour supply is low relative to demand. Huw Pill, Chief Economist and Executive Director for Monetary Analysis at Bank of England, said:
“Two shocks in particular stand out … The impact of higher gas prices interacts with developments in the labour market. Even as economic activity in the UK has weakened as higher gas prices weighed on household spending power, the labour market has remained tight. The unemployment rate recently reached its lowest level since the mid-1970s. Recruitment difficulties in a tight labour market have supported stronger underlying wage growth. Taken together with the supply chain disruptions that accord firms pricing power in supply chains, this tightness creates conditions conducive to the emergence of the second-round effects we fear.”7
4.The August Monetary Policy Committee report said:
“How labour market tightness evolves will be a key factor determining wage growth and domestic inflationary pressure over the medium term. This is because inflationary pressure stemming from the labour market has tended to be more persistent in the past than that caused by factors such as the cost of energy.”8
5.The adverse supply shock caused by a reduction in labour supply “adds to the difficult shorter-term trade-offs facing monetary policy.”9 The Bank of England’s Monetary Policy Committee has projected that the UK economy will probably be in recession throughout 2023 and until the middle of 2024.10 The Office for Budget Responsibility has forecast a somewhat shallower recession and also forecast that the budget deficit in 2022/23 is £177 billion (7.1% of GDP), rising from £133 billion (5.7% of GDP) last year.11 The Recruitment and Employment Confederation told us that labour shortages could cost up to £39 billion a year in GDP.12
6.Trends in benefit payments to those suffering from ill health and potentially unable to work also highlight one of the fiscal impacts linked to increasing economic inactivity: it will worsen the public finances; health- and disability-related benefit claim increases are forecast to cost an additional £8.2 billion in 2026/27.
7.In addition to the macro-economic impact, there are crucial questions to be asked about what has caused people to withdraw from the labour force, and whether this signals vulnerability or hardship that should elicit concern not simply for the wider economy but also for those individuals and their households.
8.Policy makers are unclear about the balance of factors causing reductions in labour supply and labour shortages. The Autumn Statement 2022 said “The Department for Work and Pensions will thoroughly review workforce participation. This work will conclude in early 2023.”13 Bank of England officials have said publicly that they do not understand the reasons for reduced labour supply. Andrew Bailey, Governor of the Bank of England, told the Treasury Committee on 16 May 2022 that the Bank of England were uncertain about what has been causing persistently high levels of long-term sickness. He said:
“The scale and persistence of the fall [in the workforce] has been very unusual. If you go back to the period after the global financial crisis, there was a much smaller fall in the labour force, but it recovered much more quickly after that. The notable difference this time … is that we have got this quite large long-term sickness element in there.
I have to be honest: we don’t know much, really, about what is behind that. We have discussed it with health experts. We have asked: is it long COVID-19? Is it, as some health economists have suggested to me, people with other pre-existing conditions who feel insecure about going to work in the COVID-19 era? It is possible.”14
9.Dave Ramsden, Deputy Governor, Markets and Banking said, “it’s not clear what is driving this participation puzzle”.15 Huw Pill told us, “The short answer is that it is difficult. I do not have an easy answer.”16 Trying to answer this question is the focus of this report.
10.The rise in economic inactivity and changes in the labour market appear to have contributed to inflationary pressures in the economy. A smaller workforce will hinder the UK’s recovery, while rising long term sickness among the economically inactive will increase welfare costs. This underscores the importance of understanding what is happening in the workforce and why inactivity is rising.
|
6 Bank of England, ‘Monetary Policy Committee Report’ (August 2022): https://www.bankofengland.co.uk/monetary-policy-report/2022/august-2022 [accessed 9 December 2022]
7 Bank of England, ‘Monetary policy and central bank asset purchases: Substitutes and complements: speech by Huw Pill’ (23 November 2022): https://www.bankofengland.co.uk/speech/2022/november/huw-pill-speech-at-the-beesley-lecture-series [accessed 9 December 2022]
8 Bank of England, ‘Monetary Policy Committee Report’ (August 2022): https://www.bankofengland.co.uk/monetary-policy-report/2022/august-2022 [accessed 9 December 2022]
9 Bank of England, ‘Monetary policy and central bank asset purchases: Substitutes and complements: speech by Huw Pill’ (23 November 2022): https://www.bankofengland.co.uk/speech/2022/november/huw-pill-speech-at-the-beesley-lecture-series [accessed 9 December 2022]
10 Bank of England, ‘Monetary Policy Committee Report’ (August 2022): https://www.bankofengland.co.uk/monetary-policy-report/2022/august-2022 [accessed 9 December 2022]
11 Office for Budget Responsibility, ‘Economic and Fiscal Outlook’ (November 2022): https://obr.uk/overview-of-the-november-2022-economic-and-fiscal-outlook/ [accessed 9 December 2022]
13 HM Treasury, Autumn Statement 2022, CP 751 (November 2022): https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1118417/CCS1022065440–001_SECURE_HMT_Autumn_Statement_November_2022_Web_accessible__1_.pdf [accessed 9 December 2022]
14 Oral evidence taken before the Treasury Committee, 16 May 2022, (Session 2022–23), Q 423 (Andrew Bailey)
15 Bank of England, ‘Shocks, inflation, and the policy response: speech by Dave Ramsden’ (7 October 2022): https://www.bankofengland.co.uk/-/media/boe/files/speech/2022/october/dave-ramsden-securities-industry-conference.pdf [accessed 9 December 2022]
17 Office for National Statistics, ‘A guide to labour market statistics’ (June 2020): https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/employmentandemployeetypes/methodologies/aguidetolabourmarketstatistics [accessed 9 December 2022]