U.K. Unemployment Rate Lowest In 45 Years - Wage Growth Has Gone Missing Though

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Includes: DBUK, EWU, FKU, FLGB, HEWU, QGBR
by: Tim Worstall
Summary

It's a general assumption that low unemployment means high wage growth - not unreasonably.

The UK has generationally high employment ratio and generationally low unemployment rate; where's the wage growth?

The answer is in Bucharest, Brno and Bialystok; that's where the unemployed are.

It's a general belief about wages - one so simple that even Karl Marx managed to get this one right - that low to zero unemployment will mean rapid wage growth. The reason being that if there is that reserve army of the unemployed, then the capitalists don't have to raise wages to get more workers. But if there's no unemployment, then the only way you can hire more people is by tempting them away from their current job. You tempt by offering higher wages - and everyone else has to raise wages to prevent the temptation.

So, the Office for National Statistics announces that Britain's unemployment rate is the lowest it has been since 1974 - 45 years now.

uk unemployment We also have the employment to population numbers today:

uk employment That's actually the highest it's been since we started measuring it. And given the likelihood of stay-at-home mothers before that starting date as high as it's ever been.

This means that we can't say that the low unemployment rate is because many people have dropped out of the labour force entirely. That's just obviously not what is happening.

So, given that this is all true, then where the heck is that wage growth? Well, the answer is that the reserve army of the unemployed, to use Marx's phrase, have all gone home. Or, if you prefer, they're still out there and available, just not being counted as being in the UK because they're not at present.

This is an effect of the freedom of movement of labour within the European Union. Well, that and Wizz Air and the like offering £50 return fares from Eastern Europe to the UK. That's what is causing this:

Wage growth has slowed in the UK to put a squeeze on living standards despite unemployment falling to its lowest level for more than 40 years.

The fall in pay growth to 3.3% on the year in the three months to March, from 3.5% in the three months to February, also came as the buoyant labour market recorded a rise in employment to a new high of 32.7 million.

The Office for National Statistics said the growing number of vacancies, together with the falling level of unemployment, indicated the jobs market was continuing to tighten. The jobless rate fell from 3.9% to a record 3.8%, the lowest since 1974.

However, analysts said this trend had not driven employers to increase wages to levels seen before the financial crisis.

If we're expecting to see a surge in consumer spending, or a similar rise in wage led inflation - the two sides of the same coin - then that's going to be dependent upon the terms of Brexit. Assuming it finally happens that is. For that reserve army is out there in Eastern Europe. When employers need more labour, they can simply call one of the myriad employment agencies specialising in recruiting in Slovakia, Romania, and Poland.

That's how we get record employment, record unemployment, among people in the UK without significant wage rises.

For us as investors, this means that the terms of Brexit matter. If it continues to include the free movement of labour, then there's some way to go before we can expect the Bank of England to raise interest rates to forestall inflation.

This is all, obviously, akin to the Federal Reserve's decision tree:

When might this process stop? An indicator at least is when we do indeed have better employment numbers but these are accompanied by a lower unemployment rate. That would mean that we weren't continuing to pull people in from outside the formal labor market. We really are at full employment and thus further increases in labor demand will just feed through into wages and thus inflation. At which point the Fed really does think about choking off the expansion.

The difference in the British situation is that we can pull people in from outside the UK to adding to that labour force. When we can't, then we are, as with the US, going to be at about the limits of the economic expansion.

So, a good predictor of future interest rate changes - of how far an economic expansion can go before inflation arrives - is the terms of Brexit. Free movement persists, the UK economy will not experience significant wage inflation. Free movement disappears - as certain forms of Brexit would have happen - and we'll get wage inflation much earlier.

Any form of Brexit that doesn't include the free movement of labour is a sign of higher interest rates earlier.

To emphasise this point, new figures:

Number of EU workers in the UK hits record high as unemployment falls to lowest in 44 years.

We're pulling people from outside the native workforce rather than labour limitations leading to higher wages.

The number of EU nationals working in the UK hit a record high in the three months to March as the jobs market ignored political turmoil to create more positions.

It came as unemployment fell to 3.8pc, the lowest level since the end of 1974.

Almost 2.4m citizens of other EU nations now work in the country, a rise of more than 100,000 compared to the final three months of 2018.

A Brexit which ends freedom of movement will end this process.

There are those who have argued for some time now that leaving the European Union will cause economic pain, even economic disaster. Hey, they might even be right. But it's not true that there are only bad effects likely. The situation is much more nuanced. Brexit will likely raise UK wages at the expense of the length of the economic expansion. This is not a political point, either pro- or anti-Brexit, just a fact. As investors we have to be alive to that nuance.

A Brexit which ended freedom of movement of labour would likely boost UK wages, thus making consumer spending oriented stocks relatively more appealing.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.