Tturn the clock back a decade. The economy is about to emerge from its worst recession in living memory. Since early 2008, production has shrunk sharply quarter by quarter. The banks have been saved, but the official unemployment rate has reached 8%, a 12-year high.

Now imagine that you have a crystal ball that could predict what will happen in the next 10 years. It's hard to believe, but your crystal ball tells you there's no real recovery from the burglary. Productivity growth, which averaged 2% a year until 2008, will collapse. The economy in 2019 will be at least 15% smaller than usual if the financial crisis had never occurred.

The crystal ball is defective in one respect. It can not tell you what will happen to unemployment over the next ten years, and lets you guess for yourself. Would you have said that it was: a) much higher; b) slightly higher; c) about the same; or d) much lower.

If you think you have chosen d), you are either the greatest economist who has ever lived, or you are not completely honest. But d) happened. The unemployment rate is now not 8%, but 3.8%, while the employment rate has increased from 70% to 76%. Employment is more than 3 million higher than it was when the banks almost went under.

In every respect, the performance of the labor market was remarkable. The mediocre economic performance in the 2010s would have once met an unemployment rate of 14% and not below 4%. Conversely, in earlier times, an unemployment rate of 4% would be accompanied by strong upward pressure on wages, as a shrinking pool of workers forced employers to offer higher wages. That did not happen. The average income increases by 3.6% per year and the annual inflation rate is 1.5%, which negates the fears of a pay-spiral. No question, something strange has happened.

One explanation is that it all boils down to the flexible UK labor market, with the weakness of the unions, the limited scope of collective bargaining, and the ease with which employers can hire and fire unemployment benefits. The problem with this theory, however, is that Britain had a flexible labor market long before the financial crisis and has not become noticeably more flexible since then.

Another suggestion is that companies use less capital and more labor to decide on the production of their goods and services. Due to the high level of uncertainty, companies were concerned about making new investments. The downward pressure on wages during and after the financial crisis has resulted in relatively lower employment for workers, reducing demand for capital and increasing labor demand.

The problem here is that rising labor demand is usually reflected in higher wages, but after the weakest decade of wage growth in 200 years, inflation-adjusted wages are still below those of 2008.





Unemployment rate in the United Kingdom



Unemployment rate in the UK Photo: ONS

Torsten Bell and Laura Gardiner from Resolution Foundation thinktank found a much simpler explanation: more people work and work longer because as a nation we are much poorer than we expected.

Bell and Gardiner's theory reads as follows: The deep recession of 2008/09 led to a dramatic decline in wages as people either introduced or imposed salary cuts. In contrast to earlier economic cycles, there was no noticeable recovery in wages as production started to recover. Rather, earnings growth slowed. Household income had dropped much further than expected and remained low. A median earner today earns a fifth less than it would have if the trend had been maintained before the real wage crisis.

That's quite a part of the family budget, and the result has been an increase in labor supply. "A rational household response was to protect family finances from such income reductions by increasing the number of employees or by working more hours," say Bell and Gardiner, providing three proofs to support their thesis.

First, the long-term decline in hours worked has come to a standstill. Between 1980 and 2008, the average weekly working time has fallen from 35 to 33 hours and is still at this level. If the pre-crisis trend had continued, it would have fallen by almost another hour. More than one in ten employees would like even longer working hours.

Sign up for the daily Business Today email

Second, employment of women was stable before the crisis, but since 2010 has increased from 65% to just under 72%. This is exactly the answer that would be expected if the main earner (often, if not always, a man) would have suffered wage cuts.

After all, the rise in employment since the financial crisis has not only been a feature of the UK labor market. Workers in many developed countries suffered the same income shock and responded in the same way.

The Resolution Foundation study shows that the UK works 65 million hours more each week than it would if the employment rate remained at the 2008 level and the trend towards a shorter working week continued. This explains why inflation-related increases in the minimum wage have so far been absorbed without any impact on employment levels.

This also explains why wage pressure was so subdued because an increase in labor supply took much longer than expected until wage pressure increased. To a certain extent, the workers have run to stand still.