World Economic Forum helps shed light on UK jobs puzzle - and vindicates Dr Cable

Having switched radio channels last evening after listening to an arts review of the new big screen version of cop drama The Sweeney, it seemed fitting to hear that yesterday's government reshuffle handed Tory MPs Michael Fallon and Matthew Hancock ministerial roles in the Department for Business and Skills.  The prime minister has clearly decided that this duo, the political equivalents of Regan and Carter, are needed in Vince Cable's manor to put the cerebral Lib Dem Business Secretary on the ideological straight and narrow. Ironically, however, this morning's annual Global Competitiveness Report from the renowned Swiss based think tank the World Economic Forum (WEF) suggests that the newly appointed heavies have more to learn from Dr Cable's evidence based approach to policy making than vice versa.

According to the WEF, the UK has moved up from 10th to 8th place in the league table of global competitiveness, which is good news for the Business Secretary since improving business competitiveness is his principle job. But this improvement is despite the UK having slumped from 85th to 110th when it comes to the 'macroeconomic environment', political responsibility for which is down to the Chancellor of the Exchequer, George Osborne, of whom Messrs Fallon and Hancock are close acolytes. 'Physicians heal thyself' one is tempted to say, yet the more intriguing aspect of the WEF's observation is an apparent structural improvement in the performance of the UK economy during a year that has seen a return to recession, a paradox that is perhaps most evident in the unusual occurrence of a contraction in output alongside falling unemployment.

Significantly, the WEF highlights the relatively good performance of the UK labour market as an economic positive, attributing this to flexibility in the ability of employers to hire and fire staff. This is important since it contrasts with most recent explanations of the 'jobs without growth' paradox, which tend to focus on the GDP side of the equation and thus overlook the structural performance of the labour market itself. But unlike the WEF I think the strength of the UK labour market owes less to hire and fire flexibility than to the ability to match jobseekers to vacancies.

The economy has enjoyed a big increase in (private sector) employment over the past year and a fall in unemployment with hardly any net increase in the level of job vacancies. Indeed, vacancies are still down on mid-2010 levels. In other words, the labour market has been really effective at filling vacancies as they arise - probably related to ever greater pressure on jobless people to find work plus a much greater financial penalty to joblessness than ever before which provides a heightened incentive to work- even though, as a result of weak macroeconomic conditions, the economy isn't creating masses of net extra vacancies. Consequently, the labour market is at least to some extent decoupled from the macro economy, albeit prolonged weak output growth is at some point likely to have a negative impact on jobs if it results in far fewer net vacancies to fill or increased redundancies. If so unemployment will start to rise again, and I still expect this to happen in the coming months.

The combination of a powerful ability to fill vacancies with a still relatively high total rate of unemployment of around 8% also explains why the rise in employment and fall in unemployment has  been accompanied by a sharp fall in the rate of growth of average earnings. This is the opposite of what we saw in the early 1980s when profound skills mismatch and a lack of effective welfare to work measures caused structural unemployment to track upwards in line with total unemployment and thus become entrenched. At that time people in work knew that they could push for higher pay even thiough the jobless rate was around 10% because a large proportion of jobless people were not able or eager to fill vacancies (roughly 40% were long-term jobless compared to roughly a third today).

Putting all this together offers a very good news story since it suggests to me that the economy is capable of a very strong rate of non-inflationary growth and a really big fall in unemployment once we get the demand side of the macro economy fixed. But that won't be achieved by applying strong arm tactics to the Business Secretary, who seems to be pursuing a broadly sensible and rational approach to supply side policy.