The economic consequences of cheap labour deserve more attention

This morning’s business news bulletins contained items on the adverse consequences of both falling oil and milk prices on UK producers in these respective sectors. What I find intriguing, however, is the relative lack of attention given to the long-term effect on business behaviour of the currently very low price of labour.

Although the big squeeze on real wages in the past five years has often hit the headlines, the implications of this for business have generally been considered in relation either to aggregate consumer spending or to change in patterns of spending, such as that which has benefited emerging low price supermarket chains. But surely of far greater significance is how businesses have adjusted to what is evidently a new era of cheap labour.

Few would disagree that the fall in real wages – which has now come to an end on some if not all measures of earnings – is preferable to the even sharper rise in unemployment that several years of economic slump and stagnation would otherwise have caused. Yet while this highlights the obvious merit of a flexible labour market during periods of relatively weak demand, the continued weakness of real wage growth as the economy has mounted a strong recovery suggests that one can have too much of a good thing.

The kind of flexibility that dominates the British economic model – founded on a deregulated labour market, a tough welfare to work regime and reasonably open borders to migrants – is operationally conducive to maintaining a high rate of employment but has signally failed to deliver strong growth in labour productivity. Successive supply side reforms introduced since the 1980s have been far more successful at weakening the bargaining power of workers, thereby pricing record numbers of people into jobs, than at triggering businesses to invest in new technology and skills.

Indeed, the acute degree of deregulation that underpins the British model is inimical to investment since it provides businesses with a constant drip feed of highly addictive and easily absorbed cheap labour. Moreover, with real wages in recent years falling by an amount not seen since the mid-19^th century, the level of addiction has soared.

As a result of this I think it naïve in the extreme to expect a sudden change in business behaviour to give an early strong boost to growth in productivity and pay. The best hope is that our economic recovery will be sustained long enough to enable unemployment to fall to such a low rate that labour becomes more expensive – i.e. a case of higher pay providing a spur to higher productivity. But the question then will be whether British businesses weaned and reliant on cheap labour, especially the least well managed, will be able to raise their game.