Chifley Research Centre

Chifley Research Centre
Wednesday, 3 December 2008

Hard Labour: Jobs, Unemployment and the Global Recession

David Coats on the Global Financial Crisis and the local and global responses

Chifley Research Centre – Firstly, how is the global financial crisis now impacting on the British economy?

David Coats – The most obvious effect is that the UK’s banking system is in serious crisis. Many of the country’s major institutions are burdened with “assets” that are now worthless. A combination of inadequate supervision and a willingness to tolerate excessive risk have brought the system close to collapse. Despite the government’s efforts to recapitalise the banking system the UK still has a liquidity problem. Banks are not willing to lend to each other (LIBOR, the inter-bank interest rate is much higher than bank rate), are cutting back on loans to businesses and have curtailed mortgage lending. All this is happening in an environment of falling housing prices and very volatile securities markets.


So far the impact on the real economy has been limited and the worst is yet to come. Unemployment is rising and growth has fallen. Manufacturing order books are weak and manufacturing output is falling. Consumer confidence is low. This is not a happy position, but the government has taken fairly swift action and has offered a modest fiscal stimulus. The Work Foundation has predicted that unemployment will peak at 2.5 million in 2009. Others have been more pessimistic forecasting more than 3 million and the doom mongers have placed no upper limit on their pessimism. We believe that our assessment is prudent, but it is based on the assumption that some of the recent policy interventions have the desired effect. If unemployment rises beyond our expectations then we could be on the brink of a prolonged slump.


CRC – How has the government responded and how has this helped the situation?

DC – Policy responses that were off the agenda for twenty years are now firmly on the menu of policy instruments to be deployed. The government has nationalised three banks (Northern Rock, Bradford and Bingley and Royal Bank of Scotland) and more may follow if weak balance sheets put the solvency of other institutions in question. There can be little doubt that this has prevented a wider collapse in the banking system. If the government had not acted to nationalise Northern Rock then the run on that bank (which had begun before nationalisation) would almost certainly have continued. The first domino would have fallen and others would have inevitably followed. It has been suggested that the government was slow to take action – the “N” word was thought to be politically toxic. Nonetheless action was finally taken and policymakers have begun to understand that the state remains the guarantor of the system.


The Chancellor’s pre-Budget report (PBR) contained a fiscal stimulus of 1% of GDP. Much of this was used to fund a cut in Value Added Tax (the UK’s equivalent of GST) from 17.5 to 15 per cent. The reduction will run for one year. Additional resources were pumped into JobCentre Plus and the New Deal (the UK’s active labour market programme), Train to Gain (support for skills development for those in employment, including those facing imminent redundancy) and more support for the early intervention service to support those at risk of losing their jobs. Extra money was also put into the pockets of pensioners and child benefit was increased. A programme of public works has been brought forward (although the scale is modest) with a focus on the construction of social housing.


The measures to recapitalise the banks have been welcomed and, while the PBR was a step in the right direction, there is a real question whether the cut in VAT was the most effective way to deliver an immediate stimulus. Our preference would have been to target the help on low income families (through a one-off tax credit) and the unemployed (through higher benefits). We have had a lively internal discussion at The Work Foundation about this. Will believes that the VAT cut will prove effective whereas I am more sceptical – in this instance I would be pleased to be proved wrong.


CRC – As the crisis continues to unfold, what are some of the new policy levers that you think should be employed by government as part of its response?

DC – Even though decisive action has been taken so far there is a strong argument that the banking system remains blocked. The monetary policy transmission mechanism is not working – cuts in interest rates by the Bank of England have not been reflected in reduced interest rates for consumers. Government needs to do more to get the system moving again. This is partly about the fiscal stimulus, but also about the need for more radical action. We have argued that the Bank of England’s special liquidity scheme should be relaxed so that banks can more easily swap commercial paper for cash and Treasury bills. In addition, we have made proposals (consistent with the government’s own review) that there should be a government backed scheme for insuring the nominal value of residential mortgage-backed securities.


Small and medium sized firms are under real pressure and we have called for the expansion of the Small Business Loans Guarantee Scheme. And there is something to be said too for Barack Obama’s proposal for an infrastructure bank to get major projects moving – all developed countries could learn from the US experience in this respect.


One measure worth considering is government support for short-time working, where employers and workers agree a working hours reduction and the government offers a payment to cover either all or part of the lost earnings. This enables employers to retain human capital during the downturn and ensures that organisations are ready to respond to the upturn when it comes. We have been clear that these measures should be temporary because they might inhibit necessary structural change when the economy is growing strongly. A similar scheme in Germany ensured that their manufacturing sector weathered the 1990s recession with rather less disruption (and fewer job losses) than we experienced in the UK


CRC – World leaders have identified executive salaries and the culture of risk taking as contributors to the current crisis. What do you think has been the role of this culture in the crisis?

DC – In this case world leaders are half right. It’s more a matter of annual bonuses than salaries that have caused the problem. This is why investment bakers and others in the financial sector adopted short-term horizons and developed a tolerance for risk. If all you have to worry about is the year end results it may not really concern you that a supposed AAA security may in fact be worthless in two years time. Perhaps we have all conspired in this culture where Gordon Gecko’s maxim became an article of faith – greed is good. Indeed, at the extreme, greed was seen to be an appropriate manifestation of the efficient markets hypothesis (the incentives were appropriate because the market would not offer anything but appropriate incentives) and as the lubricant that kept the system working. To some extent this was more of an Anglo-American than a global phenomenon, exemplified by the greater tolerance of income inequality in the UK and the USA. Moral constraints on excessive rewards had been eroding from the 1980s onwards and the tax system, by becoming less redistributive, compounded the problem. That the phenomenon is not universal is confirmed by the fact that the top 0.1% of earners have not seen their share of GDP increase in either France or Japan since 1975. National policy choices and ethical standards make a real difference here.


The Work Foundation has suggested that a 75% marginal rate of tax on annual bonuses would lead to a rethink – we propose that the marginal rate should be progressively tapered to the normal income tax regime for bonuses paid over five years. This should create a powerful incentive for longer term thinking. A high marginal rate may concentrate the minds of already chastened investment bankers


CRC – One of the interesting points that you make is around the need for practical and immediate policies involving skills-updating. You’ve proposed subsidies for travel to training courses as well a greater role for public/private sector cooperation. Can you describe how you see this working?

DC – The real issue here is building the capacity of JobCentre Plus (the UK’s public employment service) to cope with the increased flow of the unemployed in to the benefits system. We already have a system of mixed provision of ALMPs – parts of the New Deal are delivered by the public sector (through local colleges for example) but voluntary and private sector providers are also involved. This system is about to be expanded with the private and voluntary sector providers offering tailored help to those in “hard to reach” groups (lone parents and the disabled). In our view the most effective route to rapid expansion of the core functions of JobCentre Plus will be through developing the capacities of public, private and voluntary sectors.


Offering job seekers subsidised travel to training courses and interviews has already been used successfully following the closure of the MG Rover car plant in Birmingham. Simple measures like this can make it easier to access training and reduce the financial burden of job search. If we apply the principle “what matters is what works” then experience tells us that these policies work


CRC – Tax credits are now an important part of the British taxation system. How do you see these being used as a policy response to the crisis?

DC – We would have placed a great deal more emphasis on tax credits to deliver the fiscal boost – and our one off proposal would have helped the government to meet its 210 target for the reduction of child poverty. For the time being tax credits are not being used specifically to raise effective demand, although they continue to play an important role in making work pay


CRC – You’ve drawn attention to the connection between ‘welfare to work’ policies and the unemployment problem in the UK. While recognising the ongoing virtue in getting the long-term unemployed into work, how has the current global crisis impacted on the real ability to do this? What can be done in the interim, until the British economy recovers sufficiently?

DC – The government’s welfare reform programme continues to cause great controversy, with the critics suggesting that the policy goal is to coerce lone parents or those with work limiting disabilities into rotten and unrewarding jobs – leaving those unwilling to participate to see their benefits cut or withdrawn. This is not the Work Foundation’s assessment. We believe that the government’s intentions are good. Most importantly perhaps we know that work is good for us – unemployment exposes people to a much higher risk of mental illness or coronary heart disease. And access to work is the best route out of poverty.


The question of course is whether the government should press ahead with more intensive help and tighter job search conditions for lone parents and the unemployed? Our answer is an unequivocal yes. It is simply wrong to say to people that they will be neglected for the duration of the recession, that they have to wait for the recovery before anything can be done for them. On the other hand, government must recognise that the attempt to reach an 80% employment rate by 2010 is unlikely to succeed. More investment will be needed in the core functions of JobCentre Plus, alongside more help for lone parent s and the disabled. Maintaining the focus on activation policies is more likely to keep the long-term unemployed in touch with the labour market – and healthier or more motivated – than leaving them with the rather dispiriting option of watching daytime TV.


CRC – As part of the downturn, we’ve seen employers in some countries reduce work hours. You propose extending the right to request reduced hours to employees as a valuable source of flexibility for employers and employees. This would also benefit the government’s agenda on balancing work and family life. How would this benefit Britain’s real economy right now?

DC – We have already suggested that the UK government should consider a short-time working scheme to encourage employers to retain valuable human capital. The right to request reduced hours of work could play a rather similar role during the downturn – although in this case the employee would be taking a voluntary pay and hours cut with no wage compensation. Far from being a burden on business this seems to us to be a valuable route to flexibility when employers are faced with reduced demand. Moreover, we have suggested that now would be a good time to think about working time reform more generally so that the UK can be weaned off its addiction to overtime – whether paid or unpaid. Other countries have adopted a similar approach with innovative working time policies being developed in both France and Germany during previous recessions, with a view to achieving greater flexibility and a better work-life balance as the economy recovers. Our goal would be to achieve flexibility through an annualised hours system where no employee would work more than 48 hours a week measured over a 12 month reference period.


CRC – The economic downturn will effect different sectors of the economy in different ways. You have suggested market interventions by government based on demographic, industrial and occupational structure, and skills level. What form should these strategies take in regions which are exposed on these indices?

DC – What we have called for is a devolution of budgets to region and city-region level, bearing in mid that the UK is still largely a unitary state – Australia already has a devolved form of governance. Essentially, our argument is that authorities at this level will have the economic and labour market intelligence to make judgements about how they get the most bang for their buck through public works programmes. We have also suggested that spatial policy (urban regeneration and community development) needs to be linked to employment policy (the new flexible New Deal) if the worst consequences of the downturn are to be avoided. This means that employment, skills and regeneration budgets should be integrated at region or city-region level and administered by partnerships between all the relevant players with either the Regional Development Agency (RDA) or the major city concerned in the lead. There are some examples of this in place already. For example, there is a proposal for a Greater Manchester Flexible New deal, jointly funded and managed by the Department of Work and Pensions, but with a leading role for Manchester City Council and other institutions.


Other areas for intervention include offering small businesses access to capital – for example, the West Midlands RDA recently established a 4 million pound transitional loan scheme for SMEs – and using the power of public procurement to sustain local businesses. This is not a matter of deliberately seeking inefficiency and value for money criteria should continue to apply, but even within this constraint there is no doubt that more sophisticated purchasing by public sector clients can help to sustain the local economy.


CRC – In your paper you’ve proposed more infrastructure investment as a form of job creation, which also has a positive benefit on the productivity front. Others have proposed a greater emphasis on ‘green-collar jobs’ and a large investment in the renewable energy industry as another important area for investment. Where do you stand on the issue?

DC – This is essentially a practical matter. The immediate public works programmes will get the construction sector moving – hence the emphasis on social housing. We endorse the idea that moving to a lower carbon economy will create more green collar jobs and that the UK is well positioned to make the most of this opportunity. But these are medium term objectives. We will not see hundreds of thousands of these jobs being created tomorrow, whereas there are construction workers looking for work today. Certainly the government should incentivise investment in environmental technologies and should ensure that the economy has an appropriate supply of skills. Furthermore, the regulatory environment (tougher emissions limits, the carbon trading scheme) can, over time, encourage the development of a green manufacturing sector – but these are challenges for recovery perhaps rather than immediate solutions for the downturn.


CRC – Finally, your paper proudly puts forward the case for maintaining full employment as the goal of government economic policy. You’ve cited health and social impacts of unemployment in your report, how important is it that social-democratic governments continue to prioritise this objective?

DC – For The Work Foundation full employment remains a fundamental principle of policy. Our argument is that unemployment is bad for individuals and bad for the economy. We know that worklessness is a waste of human potential, leaving the unemployed with cramped, poor and unhealthy lives. Without work we lack some of the essential capabilities to choose lives that we value. In this sense unemployment can only be seen as a serious constraint on individual freedom. Moreover, there is something wrong with an economy that allows high levels of unemployment to continue. This is economically inefficient, a cause of economic as well as social instability and a reflection of the brutal fact that the needs of some citizens are simply not being met. Social democrats, if they are concerned about expanding life chances, cannot be relaxed about such a situation. They would be abandoning some citizens to diminished opportunities in communities detached from the mainstream of society, which is fertile ground for the political forces of the extreme right.

About Chifley Research Centre:

The Chifley Research Centre is the Labor Party’s official think tank, committed to the advancement of public policy debate and progressive thinking in Australia.