If macroeconomic and crisis resolution policies have been more favourable to recovery in the UK than in the eurozone, to what extent has the eurozone’s very mixed record on liberalizing labour and product markets made a difference to its growth outlook? Another potential factor to consider is the interaction of both economies with the rest of the world, namely the extent to which each has been able to draw on the import of human and financial capital to kick-start and sustain its recovery. This is of particular importance to the UK, not least in the light of the ‘Brexit’ vote, which may make it more difficult to rely on external sources of potential growth in future.
The responsiveness of the labour market
If the recovery in the UK has been brisker than in the eurozone, the question arises as to how the supply side has been able to accommodate this smoothly. We have already seen that investment in the UK has been one of the drivers of the recovery, and this has helped the capital stock – machinery, tools, etc. – to adjust to the rebound in activity. As regards the labour market, we have already mentioned the greater flexibility of labour supply in the UK than in the eurozone. This both helps the economy to respond to increased demand for labour and enhances consumer confidence, which in turn feeds back into more buoyant demand.
As Figure 7 shows, unemployment in the UK is structurally lower than in the eurozone. Perhaps more importantly, so is the share of long-duration unemployment relative to total unemployment. Put another way, there are proportionately more long-term unemployed people in the eurozone than in the UK. It is well documented that long-duration unemployment erodes skills (and human capital more broadly), and as such jeopardizes the re-employability of the jobless.14 UK labour laws provide for greater contractual flexibility, and so the country has proportionately fewer people who remain unemployed for more than 12 months, than the eurozone. That said, the UK’s long-term rate of unemployment has risen since 2008 (see Figure 7), notwithstanding some improvement in the past two years.
Greater labour flexibility meant that the UK’s unemployment rate fell faster than the eurozone rate after the 2008–09 crisis.15 In the eurozone the ‘stickier’ labour market, which makes it harder to shed workers, has constrained job creation. Amid weak business confidence and sluggish economic growth, firms have been careful about hiring too rapidly in order to avoid being saddled with excess workers should the European economy not fully recover.
Figure 7: Unemployment rates in the UK and eurozone
Figure 7: Unemployment rates in the UK and eurozone
Comparatively higher rates of economic growth in the UK before the crisis – averaging 2.9 per cent a year in 1999–2007, versus 2.3 per cent in the eurozone – were associated with comparatively rapid growth in labour productivity (1.9 per cent a year in the UK, versus 0.9 per cent a year in the eurozone).16 The economy’s success also coincided with increased labour market participation during this period: the working-age population grew by an average of 0.8 per cent a year in the UK, compared with 0.4 per cent a year in the eurozone.17 The differences in both indicators reflect the UK’s more dynamic demographics, including high net immigration. Higher productivity in the workforce may directly reflect migration inflows if these raise the quality as well as the quantity of available labour.
Yet the durability of the UK’s productivity advantage vis-à-vis Europe is by no means clear. During the global financial crisis, the loss in employment and output per worker was quite similar for both the UK and the eurozone.18 However, the initial rebound in output in 2010–11 relied heavily on a surge in output per worker in the latter, whereas in the UK the recovery was more a reflection simply of greater numbers of people taking up work. Moreover, labour productivity growth in the UK has not reverted to the rates that were normal pre-crisis; in 2015 productivity grew by only a tenth more than in the eurozone.
If stronger fiscal consolidation and a weaker monetary policy response in the eurozone had been offset by structural reform, the outcome could have been positive for growth. Unfortunately, progress has been limited, as illustrated by the charts in Figure 8. These two charts display indexes of labour- and product-market rigidity in different policy fields in 1998, 2007 and the most recent post-crisis observations (depending on the indicator, 2012, 2013 or 2014) obtained from the OECD.19 In all areas, the UK is characterized by the highest market flexibility and, despite progress towards flexible markets in the eurozone, the UK has preserved this advantage over time. The eurozone has taken major strides in liberalizing product market regulation (PMR) and early-retirement pensions. But there has been no progress on reforming unemployment insurance (UI), easing employment protection legislation (EPL), or reducing the tax ‘wedge’ so that low wage earners are less costly to employ – all policy areas that are particularly important for job-creation incentives. Again, had the eurozone achieved more progress in these policy domains, employment growth could have been stronger.
A further problem for the eurozone is that market rigidity tends to be most severe in the southern European economies such as Greece, Spain, Portugal and Italy. So even though austerity was not uniform across the currency union – Figure 5 shows averages for the eurozone as whole, but there were distinct differences between countries – those economies most in need of stimulus were also generally weak on policy reform. This paradox inhibited economic convergence inside the monetary union, and it continues to complicate convergence to this day. This is especially the case in France and Italy, which are the most reluctant to embark on structural reform and currently act as a drag on economic growth in the eurozone as a whole.20 As long as unemployment in France and Italy is persistent or increasing, household and corporate spending will remain tepid. This also complicates the political environment for policymaking. Sluggish economic growth and limited job opportunities, particularly for young people, have become a major source of discontent that anti-euro parties and movements have been quick to exploit.
If private consumption and investment remain suppressed, other drivers of GDP growth, such as exports or government spending, must pick up the slack. Boosting export growth was the approach successfully taken by Germany, while France took the route of increasing government spending, albeit with less success. Not surprisingly, the ECB keeps stressing that there is only so much it can do to stimulate growth, and that structural reforms to reduce market rigidities need to be strengthened as well.
Figure 8: Structural reform indicators
Source: OECD.
Figure 8: Structural reform indicators
Source: OECD.
Immigration and demographics
The differences in growth rates between the UK and eurozone economies are significant, but to what extent is this explained by demographic developments? Figure 9 tells us the following story: (i) the divergence in economic growth between the two economies since the financial crisis has coincided with a sudden drop in population growth in the eurozone that has not been replicated in the UK; and (ii) in per capita terms real GDP growth has diverged much less than real GDP growth per se since the onset of the financial crisis (indeed whatever divergence there may have been occurred basically in 2014 and 2015). To complete the analysis, however, we need to look at the sources of faster population growth in the UK, as reported in Table 3. This table shows that the more dynamic demographics in the UK since the onset of the financial crisis can be traced not only to a higher natural rate of population growth (i.e. births and deaths) – on this measure Britain was in any case more dynamic than the eurozone before the crisis – but also to a considerably larger contribution from net migration.
Our interpretation of this phenomenon is that, to a considerable extent, faster output growth in the UK relative to the eurozone post-crisis has been possible owing to substantial imports of human capital. It seems that immigration has been one of the major factors that allowed the UK to recover more quickly from the Great Recession than the eurozone. This is not only because proportionately greater numbers of workers have entered the country, but also because more of them are of working age and because their employment rates tend to be higher than those of the indigenous workforce.21 Moreover, in the eurozone the spikes in migration inflows in 2013 and 2015 were mostly associated with arrivals of refugees who could hardly be expected (or in many cases were not legally allowed) to enter the active labour force in large numbers quickly.
Figure 9: Demographics and economic growth
Figure 9: Demographics and economic growth
Table 3: Sources of population growth
|
1999–2007 |
2008–12 |
2013 |
2014 |
2015 |
||||||
|---|---|---|---|---|---|---|---|---|---|---|
|
’000s |
% of pop. |
’000s |
% of pop. |
’000s |
% of pop. |
’000s |
% of pop. |
’000s |
% of pop. |
|
|
United Kingdom |
||||||||||
|
Natural |
111 |
0.2 |
238 |
0.4 |
203 |
0.3 |
207 |
0.3 |
174 |
0.3 |
|
Net migration |
221 |
0.4 |
229 |
0.4 |
242 |
0.4 |
209 |
0.3 |
400 |
0.6 |
|
of which EU |
72 |
0.1 |
123 |
0.2 |
174 |
0.3 |
184 |
0.3 |
||
|
Total |
332 |
0.6 |
467 |
0.7 |
446 |
0.7 |
416 |
0.6 |
574 |
0.9 |
|
Eurozone |
||||||||||
|
Natural |
299 |
0.1 |
268 |
0.1 |
22 |
0.0 |
96 |
0.0 |
-137 |
0.0 |
|
Net migration |
1,228 |
0.4 |
618 |
0.2 |
1,403 |
0.4 |
681 |
0.2 |
1,416 |
0.4 |
|
Total |
1,526 |
0.5 |
886 |
0.3 |
1,425 |
0.4 |
777 |
0.2 |
1,279 |
0.4 |
Sources: Eurostat and Office for National Statistics, annual averages.
Obviously the migration of workers into the UK has further consequences, not least for real wages and labour productivity. Figure 10 shows that as the UK recovered from the financial crisis, the average real wage fell. While labour productivity growth has also slowed, on balance the real unit labour cost – a measure of profitability and international cost competiveness – has fallen, to the benefit of businesses. It is plausible, although hard to prove empirically, that the large inflow of workers from the EU played a role in creating this dynamic by increasing competition in the UK labour market. By stark contrast, average real wages continued to grow after the financial crisis in the eurozone – albeit more slowly than before. As labour productivity growth slowed roughly as much as real wage growth, real unit labour costs levelled off.
Figure 10: Labour cost and labour productivity (cumulative changes since 1999, %)
Figure 10: Labour cost and labour productivity (cumulative changes since 1999, %)
Capital movements
Financial capital flows into the UK have been another factor enabling the comparatively brisk recovery. Table 4 shows the net inflows of foreign direct and portfolio investment against the current-account balances of the UK and the eurozone respectively.
What we observed in the aftermath of the crisis was FDI flowing out of both economies and portfolio investments flowing in. On balance capital inflows during this period were positive, broadly matching the UK’s and eurozone’s current-account deficits. This turned around completely in 2012–14, when the eurozone started to run a current-account surplus, with the offsetting financial outflow not invested in securities or channelled into FDI, but rather placed into bank deposits abroad – i.e. deposit flight. The UK, meanwhile, saw a large net financial inflow (other than FDI and portfolio investment) in this period – presumably from the eurozone to a large extent – well exceeding its current-account deficit. In 2015 these patterns diverged again, with massive portfolio investment and FDI flowing into the UK, well in excess of its current-account deficit, so its basic balance turned positive. (The basic balance is the difference between the current-account position and the net outflow of portfolio investment and FDI.) The eurozone situation was a mirror image of that in the UK, with net portfolio investment and FDI flowing out massively.
Table 4: Current and financial account (annual averages)
|
2009–11 |
2012–14 |
2015 |
|
|---|---|---|---|
|
United Kingdom (US$ bn) |
|||
|
Net FDI inflow |
-36 |
-2 |
183 |
|
Net portfolio inflow |
144 |
-91 |
194 |
|
Basic balance |
41 |
-216 |
220 |
|
Current account |
-67 |
-123 |
-156 |
|
Eurozone (US$ bn) |
|||
|
Net FDI inflow |
-147 |
-6 |
-132 |
|
Net portfolio inflow |
303 |
15 |
-245 |
|
Basic balance |
76 |
280 |
23 |
|
Current account |
-80 |
271 |
401 |
Note: The basic balance is defined as the sum of the current-account balance and the net inflow of capital.
Sources: European Central Bank, UK Office for National Statistics.
Table 4 clearly shows that the UK is a much more popular investment destination than the eurozone. This has helped the UK to finance its current-account deficit – currently over 5 per cent of GDP22 (see Figure 6) – on favourable terms. As to the reasons why this has happened, we can only speculate, but two potential factors stand out: (i) in the eurozone, growing concerns over the viability of the single currency (in the face of the refugees crisis, growing populism, and conflicts between creditor and debtor countries in the wake of the debt crisis) have resulted in capital outflows; and (ii) in the UK, the more flexible economy (see the structural reform discussion above) and the more mature macroeconomic policy framework have driven inflows. In the absence of these two factors, the UK’s economic growth would likely have been weaker and the eurozone’s stronger.
14 Blanchard, O. and Summers L. H. (1986), ‘Hysteresis and the European Unemployment Problem’, in Fischer, S. (ed.) (1986), NBER Macroeconomics Annual, Vol. 1, Cambridge: MIT Press, pp. 15–78.
15 OECD (2016), ‘Unemployment rate (indicator)’, doi: 10.1787/997c8750-en (accessed 8 Sep. 2016).
16 OECD.Stat (2016), ‘Gross domestic product (GDP)’, https://stats.oecd.org/index.aspx?queryid=60702 (accessed 6 Oct. 2016); and Eurostat (2016), ‘Real Labour Productivity’, http://ec.europa.eu/eurostat/ (accessed 6 Oct. 2016).
17 European Commission, AMECO.
18 OECD.Stat (2016), ‘Unemployment rate’ and ‘Level of GDP per capita and productivity’, https://stat.oecd.org/(accessed 6 Oct. 2016).
19 OECD (2016), ‘Chapter 4: Structural Policy Indicators’, in Economic Policy Reforms 2016: Going for Growth Interim Report, Paris: OECD Publishing, http://dx.doi.org/10.1787/growth-2016-en (accessed 8 Sep. 2016).
20 In Italy the Job Act, the labour market reform, was implemented in 2014.
21 Migration Advisory Committee (2014), Migrants in low-skilled work: The growth of EU and non-EU labour in low-skilled jobs and its impact on the UK, London: Home Office, p. 73, https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/333083/MAC-Migrants_in_low-skilled_work__Full_report_2014.pdf (accessed 10 Oct. 2016).
22 Ecowin (see Figure 6).