Britain should learn from the revival of America’s labour force

What is the most efficient way to grow the economy and improve living standards? It’s a question that often triggers a sharp intake of breath from economists. The answer invariably involves capital.

Too little capital has been invested by Britain’s private and public sectors over the past four decades. An average of 17 per cent of national income has been invested in this period. This compares with 20 per cent among other G7 economies.

A difference of three percentage points may not sound like much, but, compounded over 40 years in a £2.5 trillion economy, that’s a lot houses, roads, data centres, power networks and research. Some of the UK’s most eminent economists, including Mariana Mazzucato, the most vocal proponent of a mission-led economy, wrote an open letter to the government last week pleading that the existing fiscal rules don’t lead to a doubling-down on this capital-light UK economic model.

That penny is now dropping. The Treasury is conducting a pension review with an aim to increase in investment in British assets and it is also likely to review how capital spending is treated within the government’s fiscal rules.

The open letter and recent published work by the Office for Budget Responsibility, which identifies an increased economic payback from capital spending, could be coincidental. I tend not to believe in coincidences. This looks like a rolling-of-the-pitch ahead of the budget on October 30.

This increased focus on capital spending is sensible and long overdue, but even its most devoted proponents would acknowledge that delivery and payback from capital-intensive projects takes time. Moreover, a huge body of remedial work is needed to ensure that Britain is an attractive location in which to deploy capital efficiently. Benchmarking the costs and lead-in times for establishing energy connections, building high-speed rail, land promotion schemes and new nuclear power facilities do not make for happy reading.

Therefore, I would return to the initial question of the most efficient way of growing the economy. The answer right now is to look at that other factor of production, labour, and how getting more people into work can be the quicker answer to the nation’s growth challenges. The 9.3 million people of working age who are economically inactive, alongside a further 1.4 million who are unemployed, is a huge reservoir of untapped economic potential.

The most assured way of raising living standards of working-age households is to increase well-paid employment. The first thing to note is that until recently the UK has had a good story to tell in this area. Recent Conservative governments presided over a structural reduction in the unemploymentrate, a sharp reduction of in-work poverty and, until the pandemic hit, a fall in the inactivity rate that had peaked at 24.2 per cent in 1994. At the start of 2020, this rate stood at only 20.5 per cent.

Inactivity was one of the country’s most encouraging economic data points, placing it second behind only Japan among leading advanced economies. What has happened since is less encouraging, though. A 600,000 increase in those reporting long-term sickness as a reason for economic inactivity could become a lost generation if that phenomenon becomes entrenched. This would act as a prolonged drag on the national finances. By contrast, should this group be encouraged back into work this will help to make a mockery of the UK’s subdued growth outlook.

Getting this area of public policy right is of huge importance. Some of this latent workforce potential should begin to return as NHS waiting lists show signs of peaking, as junior doctors’ strike action eases and as occupational health interventions get to grips with conditions acquired or amplified during the pandemic. The latest numbers suggest this is starting to happen.

There is also an important question for the government to answer on how it encourages a much broader basket of potential workers back into the workforce. Here, lessons from the United States may be instructive.

Traditional thinking on “what works” in the British labour market emphasises the role of active labour market interventions. New Labour’s New Deal policies in the late 1990s and early 2000s would be obvious examples. These were tailored support programmes to encourage work-readiness for the disabled, for lone parents and for older workers. The evaluation of these programmes was broadly favourable, but there is no doubt that they involve up-front costs. This is a challenge in what looks set to be a tough backdrop for present spending.

An evaluation of how the American labour market has behaved since the mid-2010s poses the question: is there another way? What was assumed by US economists to be an inevitable structural increase in inactivity has been partly reversed. The Trump and Biden administrations’ economic policies of running economic demand “hot”, first through corporate tax cuts, more recently through post-pandemic subsidies, has had the effect of pulling far more American workers back into the economy than ever had been forecast.

This is also not merely from inward migration. There is higher participation among almost every key US demographic. The result is that millions more Americans are in work and the US economy has grown above its pre-pandemic trend. A labour force participation rate that was expected to fall to below 60 per cent, extending a two-decade decline, has rebounded to its existing rate of 62.7 per cent.This was not supposed to happen.

Stimulating demand is assumed not to have any sustained effects on the supply side of the economy. Indeed, conventional thinking is that it has costly implications for prices inflation. However, the US Federal Reserve has all but claimed victory over its most recent bout of inflation, certainly before theBank of England or the European Central Bank are prepared to claim anything similar.

Labour’s economic thinkers don’t particularly like parallels with the US economy, as it displays levels of inequality that do not conform with their world view. Yet Britain’s self-styled party of workers should consider whether lessons from American policy will support their primary mission for faster economic growth.

Simon French is managing director, chief economist and head of research at Panmure Liberum