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«Economic policy in the UK under new Labour: the end of boom and bust? Malcolm Sawyer University of Leeds June 2006 Abstract: The paper first ...»

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Figure 3 near here Calculated from Treasury, 2005a, Table B25 The inflation record can be seen from Table 1 and also from Figure 3. The immediate impression could be that the policy has been successful in the sense that inflation has remained within the target range throughout the period (in contrast, for example, with the record of the ECB where inflation in the euro area has persistently exceeded, albeit by a relatively small margin, the inflation target range). But two further features stand out from Figure 3. First, inflation over the period since 1997 has been rather similar to inflation after

1992. This conforms to a more general finding that the inflation record of countries adopting inflation targeting (which the UK policy since 1997 has been) is rather similar to those, which do not adopt inflation targeting (see Arestis and Sawyer 2005). Second, one significant feature of the post-1997 situation is the fall in the expectations of inflation (as compared with 1992-1997)4. The achievement of lower inflation is then much enhanced by these lower inflationary expectations.

A quick look at Table 3 suggests that within a general climate of low inflation, the UK’s inflation record since 1997 (on the HICP measure) has been similar to, and perhaps a little better than, inflation in USA and euro area. However, Table 4 suggests that nominal interest rates in the UK have been consistently higher than in the USA and euro area over that period (and real interest rates even more so).

Tables 4 and 5 near here Figure 4 near here A major reason for doubting that monetary policy and how it is conducted has much impact on the rate of inflation (and more generally on the macroeconomy) comes from the results of simulation exercises undertaken on macroeconometric models. A recent illustration of this comes from the Bank of England’s new macroeconometric model. Figure 4 is reproduced from Bank of England (2005) and illustrates the effects of a 1 per cent increase in nominal interest rates held for a year (and then with interest rate policy following a simple Taylor’s rule). The small effect on inflation (maximum decline in inflation of 0.3 per cent) is evident.

This result is in line with other finding, which we have surveyed in Arestis and Sawyer (2004). This conclusion may be modified by the reflection that ‘The simulation shown in Figure [4] is based on the assumption that the unexpected change in interest rates does not affect agents’ long-run inflation expectations. But the response of the economy to a change in It can be observed from the inflationary expectations survey conducted by Barclays Capital that the inflationary expectations of the public have not declined to the same degree. For example, in the first quarter of 2005, the average expected rate of inflation of the public was 3.7 per cent.

interest rates depends on the credibility of the inflation target. In particular, as inflation expectations become more firmly anchored around the inflation target – the target becomes more credible – a change in the short-term interest rate is likely to have less impact.’ (Bank of England, 2005, p.131). This can be linked with the argument that the success of monetary policy with an ‘independent’ Central Bank comes from the creditability in the achievement of low inflation, the belief that the authorities will and do act to restrain inflation and the favourable impact which these have on inflationary expectations. Figures along the lines of Figure 4 can be produced to support this argument.

At one level, monetary policy over the past nine years could be judged a success in that it was set a single objective in terms of a target rate of inflation, and the actual rate of inflation has been within the permitted +/- 1 per cent of the target throughout the period. In this regard, the Bank of England’s track record is clearly superior to that of the ECB where inflation in the eurozone has often been above the 2 per cent upper limit set for inflation. Clearly the question is whether the conduct of monetary policy and its institutional framework can take the credit for that achievement, and to answer that question would require the setting of some counter-factual episode of what would have happened under some other form of policy. We are not able to construct that counter-factual but offer the following comments. The inflationary climate (as illustrated in Table 4) has been favourable, particularly when compared with the climate in the 1970s and 1980s. Most countries have experienced low inflation, and this does not appear to be related to the institutional arrangements (and specifically when a country has adopted inflation targeting, see Arestis and Sawyer, 2005).

The effects of interest rates on inflation, as discussed above, appear small, and the effects of say a ¼ per cent change in interest rates (which has been the typical change) would be miniscule. The policy regime change in 1997 inherited a benign inflationary climate (cf.

Table 4), and it may have helped to consolidate low inflationary expectations, which in turn fostered lower inflation.

5. The (un)employment record Table 1 has indicated the continuous fall in unemployment from 1991 to 2005. The rate of unemployment on the basis of the unemployment benefit claimant count in 2004 at 2 ¾ per cent was lower than at anytime since 1974. The figures on unemployment on the ILO definition of those actively seeking work were not quite so impressive, but had fallen below 5 per cent in 2004 though with a subsequent rise. In their report on the UK, the OECD wrote that ‘[i]n international comparison labour utilisation rates are high, with activity rates only clearly exceeded by a small number of Nordic countries where female participation is particularly high. However, while the unemployment rate has fallen to its lowest level in three decades and by nearly 7 percentage points from a peak in the mid-1980s, there has been little fall in the inactivity rate (Figure [5]). Indeed, while the activity rate of women has risen substantially, the male inactivity rate has shown a consistent upward trend accompanied by a similar rise in men reporting long-term sickness or disability as the main reason for inactivity.

In 1980 the number claiming disability-related benefits was less than the number claiming unemployment benefit, whereas currently the former are three and half times as great. While increasing numbers on disability-related benefits is common in many OECD countries, the United Kingdom stands out as having a relatively high concentration of disability among prime-age males.’ (OECD 2005, p.39) Figure 5 near here Table 6 near here ‘Seven per cent of the 25-54-year-old men are now inactive outside the labour market, many more than three decades ago. Solid growth since the late 1990s has brought down unemployment but not inactivity, with 2½ million currently claiming incapacity benefit.’ (OECD 2005, p. 99). Table 6 indicates recent trends in the number of recipients of incapacity benefits. The significance of the numbers receiving incapacity benefits arises from the general perception that one method used during the 1980s to keep down the figures on unemployment (based on the benefit claimant count) had been the encouragement of placing some of those without employment and with poor prospects of securing employment on the then form of incapacity benefits. It has also been argued that the proportion of people receiving incapacity benefits is higher in regions of higher unemployment. Both of these suggest that incapacity benefits can to some degree take the role of unemployment benefits, and that many (but by no means all) of those on incapacity benefits could be considered as ‘hidden unemployed’.

The record on unemployment appears laudable. We would argue that full consideration does though need to be given to the measurement of unemployment, and that there is at least a case for considering perhaps half of those receiving incapacity benefits as ‘hidden unemployed’.

The doubling of those receiving incapacity benefits since the mid 1980s is unlikely to reflect a worsening health situation in the UK, though it clearly could reflect a more relaxed approach to the award of such benefits (e.g. application of less stringent medical tests).

Particularly when regard is given to the inactivity rate (as mentioned above) the record on unemployment is not quite so good.

A particular important question is why did unemployment (as recorded) fall continuously from 1993 to 2004 (with some upward movement in the past 15 months). The two competing explanations would be the aggregate demand one and labour market ‘reforms’ and increased ‘flexibility’. We could first note the lack of cross-country correlation between labour market ‘flexibility’ and unemployment (see, e.g. Baker et al., 2004). Indeed, we may generalize the argument by referring to more recent evidence on the degree of labour market flexibility in Europe and economic performance. A recent OECD study (Brandt, Burniaux, and Duval, 2005), makes the point vividly. In Table 7 we cite the degree of labour market reforms (score) and the ranking in view of the score, in a number of European countries. Given the UK’s economic success, perhaps at the top of this group of countries, its 11th position in so far as labour market reforms does not sit comfortably with the argument that the two are so strongly correlated if at all! Moreover, Germany and Italy, to take another obvious example, with their relatively high position in Table 7 cannot claim much of an economic performance recently. We can also note that the decline in unemployment is consistent with what was happening to demand in that there were no marked changes in productivity growth. There are also specific episodes, notably in the recent years, when the rise in employment can be clearly linked with expansion in public sector demand for labour.

Table 7 near here

6. Income distribution and poverty The policy towards the redistribution of income has sometimes been described as the ‘policy, which dare not speak its name’. The previous Labour government had emphasised the redistribution of income, reflected in ‘squeezing the rich until the pips squeak’ (Denis Healey), the establishment of a standing Royal Commission on the Distribution of Income and Wealth and the manner in which incomes policies were constructed and the introduction of the Equal Pay Acts. In the intervening period, the inequality of the distributions of income, of earnings and of wealth as well as the extent of poverty had increased substantially, particularly during the period the Thatcher government 1979 to 1990. Although it has not been a policy which has been trumpeted by the Labour government, there have been two sets of measures which have been specifically targeted to the redistribution of income. First, the introduction of a minimum wage. Second, the adoption of a target for the reduction of poverty, specifically amongst children, and the pursuit of a range of fiscal measures such as raising child benefits, introduction of working families tax credits. ‘Reducing poverty amongst pensioners and families with children has formed an important part of the Labour government’s agenda, particularly during its second term in office.’ (Brewer, Goodman, Shaw and Shephard 2005, p.14).

The national minimum wage (NMW) was brought into effect in April 1999, and the rates for the minimum wage are given in Table 8. The adult NMW has tended to be around 85 per cent of the earnings of the lowest decile. It is estimated that ‘since April 2004, 1.1 million jobs have directly benefited from the 2004 upratings but crucially many more may have received the benefit of an anticipatory wage increase before April’ (Low Pay Commission, 2005, p.15). The NMW has been fairly effective with ‘ONS data show[ing] that some workers are being paid below the minimum wage. The Annual Survey of Hours and Earnings (ASHE) estimates for April 2004 show that 272,000 jobs were held by people aged 18 or over with hourly pay below the appropriate National Minimum Wage. This represents 1.1 per cent of the total number of UK jobs.’ But ‘the figures should not be used to calculate the number of workers being denied their legal right to the minimum wage. Some workers may legitimately be paid below the minimum wage and it is not possible to tell from the data whether an individual is entitled to the minimum wage.’ (Low Pay Commission, 2005, p.13). It is widely accepted that any effects on employment have been minimal. ‘Overall, employment has increased among the groups of workers and in the sectors most affected by the National Minimum Wage. The main exceptions to this have been agriculture and the textiles, clothing and footwear sectors (the decline is a long-term trend attributable mainly to external factors) and young workers. … But commissioned independent research found minimal negative impact of the minimum wage on employment.’ (Low Pay Commission, 2005, p.xii).

Table 8 near here The recent trend in the distribution of earnings is summarised in Table 9. The only detectable change in that distribution is the increase in the earnings of the top 10 per cent (relative to the median). The minimum wage at best raised the earnings of the bottom 10 per cent by 1 percentage point relative to the median with a relative wage increase for the bottom 10 per cent of the order of 2 per cent.

Table 9 near here The recent trend in overall poverty is illustrated in Table 10. The increase in poverty under the Thatcher government is indicated, but of more concern here is that the extent of poverty has basically not moved since 1996/97, and as with the distribution of earnings, there has been no over turning of the increases in inequality under the Thatcher government. This fits with the conclusion that ‘despite a large package of redistributive measures, the net effect after seven years of Labour government is to leave inequality effectively unchanged.’ (Brewer, Goodman, Shaw and Shephard, 2005, p.1) Table 10 near here However, ‘relative poverty has fallen amongst pensioners and children under Labour. In 2003–04, there were 700,000 fewer children in poverty than in 1996–97 on one of the government’s most commonly used poverty measures, cutting the proportion of children in poverty from 33% to 28%. On the same measure, there were also about 800,000 fewer poor pensioners in 2003–04 than in 1996–97, cutting the proportion in poverty from 28% to 20%.

By contrast, poverty has risen slightly amongst working-age adults without children.

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