Labour market reform

Overview

Labour market flexibility, occupational immobility of labour and geographical immobility of labour.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What is meant by labour market flexibility, and why is it thought to raise productive potential?

   Model answer

   A flexible labour market is one in which wages adjust to changing conditions, workers can move between jobs, occupations and regions without great difficulty, and firms can vary hours and staffing as demand changes. Flexibility allows labour to be reallocated quickly from declining industries to growing ones, so fewer workers are stranded in long-term unemployment and firms can expand when demand appears. The result is a higher sustainable level of employment and output, so long-run aggregate supply shifts right.

2. 2

   How has the reform of trade union law been used as a supply-side measure, and what is the case against it?

   Model answer

   Restricting industrial action, requiring ballots, and ending the closed shop reduce the ability of unions to push wages above the level firms would otherwise pay and to resist changes in working practices, so unit labour costs fall and firms can reorganise production more efficiently. The case against is that unions can raise productivity by giving workers a voice, reducing turnover and supporting training, and that where a single large employer dominates a local labour market a union counterbalances the employer’s wage-setting power. Weakening unions may therefore transfer income from wages to profits without raising output, and can leave low-paid workers with little protection.

3. 3

   What is occupational immobility of labour, and how can policy reduce it?

   Model answer

   Occupational immobility exists when unemployed workers cannot take the vacancies that exist because they lack the necessary skills or qualifications, so vacancies and unemployment persist side by side. Policy can reduce it by funding retraining for workers displaced from declining industries, subsidising employer-led training, supporting adult education and apprenticeships, and improving careers information so people can see which skills are in demand. Reducing it lowers structural unemployment and allows the economy to operate closer to its capacity.

4. 4

   What is geographical immobility of labour, and what measures address it?

   Model answer

   Geographical immobility exists when workers cannot move to where the jobs are, because housing in prosperous areas is unaffordable, because moving means losing family and school support, or because transport links are poor. Measures include increasing the supply of housing in high-demand areas, reducing the transaction costs of moving such as duties on house purchase, improving transport so a wider area is within commuting distance, and providing better information about vacancies elsewhere. Governments may alternatively bring work to the workers, using regional grants and infrastructure to attract firms to areas of high unemployment.

5. 5

   What is the argument for reducing the generosity of unemployment benefits as a supply-side measure, and what is the argument against?

   Model answer

   The argument for is that the gap between benefit income and the pay available in work determines how strong the incentive to accept a job is, so lower benefits or stricter conditions on job search increase the number of people actively seeking and accepting work, which raises the effective supply of labour and lowers the sustainable rate of unemployment. The argument against is that most unemployment arises from a shortage of suitable vacancies rather than from unwillingness to work, so cutting benefits mainly deepens poverty, damages the health and skills of the unemployed and their children, and forces people into jobs poorly matched to their abilities. Raising the reward from working, through higher tax allowances or in-work payments, achieves the same incentive effect without the hardship.

6. 6

   What is the difference between the unemployment trap and the poverty trap?

   Model answer

   The unemployment trap concerns the decision to take a job at all: benefits are withdrawn and tax becomes payable as soon as work begins, so the net gain from moving into low-paid employment can be trivially small. The poverty trap concerns the decision to earn more once in work: as earnings rise, means-tested support is withdrawn while income tax and national insurance are deducted, so a large proportion of each extra pound is lost and the effective marginal rate can exceed that faced by a high earner. Both blunt incentives, and both are addressed by lowering withdrawal rates and raising the point at which tax begins.

Other ways to work this

The same content, four other ways.

What is inside Levo

Six ways to work the same material.