Employment: the revenge of the Econ101 textbook

Britain used to create jobs, even in bad times. We are now squandering this asset.

Dr. Kristian Niemitz is the Editorial Director and Head of Political Economy at the Institue of Economic Affairs

Sunlight bleaches many things, including people’s hair. Sunlight exposure, if sufficiently strong and sustained, can turn brown hair dark blond, dark blond hair light blond, and ginger hair golden-red. The strength of the effect varies from person to person, but the effect undeniably exists. I’m on the more sunlight-responsive end of the spectrum, which is why, when I see a photo of myself from several years ago and can’t immediately remember when and where it was taken, I can nonetheless tell the season.

But you would not detect that effect by looking at one of those curious hair colour distribution maps. At least in Europe, the regions which have the highest concentration of blond people are all famously cold and sunshine-deprived. Meanwhile, in the sunniest parts of Europe, natural blond hair is rare enough to be considered exotic.

This pattern is, of course, neither surprising, nor confusing, nor contradictory, nor hard to explain. The sunlight bleaching effect exists, but on a population level, it can be overridden by other factors, such as population genetics. That’s why you wouldn’t expect to see it on the map.

Economists deal with competing effects of this nature all the time. Economists may be able to show that doing more X leads to more Y. But this will often not be obvious from macro data, because there will be places that do lots of X and have little Y, and there will be places that have a lot of Y even though they don’t do much X. That is why we are often confronted with counterarguments along the lines of:

“What do you mean, high marginal tax rates discourage work and entrepreneurship? If that is so – why are Sweden and Denmark so rich, while Somalia is so poor?”

“What do you mean, protectionism reduces productivity? If that is so – why did America become the world’s leading economy at a time when they had high tariffs? Why did the ‘Asian Tiger’ economies industrialise so fast when they were heavily protectionist?”

“What do you mean, wealth taxes suppress wealth creation? If that is so – why are Switzerland and Norway, which have wealth taxes, among the wealthiest nations on Earth?”

To me, this all sounds a bit “What do you mean, sunlight bleaches hair? If that is so – why does ice-cold Finland have the world’s highest concentration of blond people? Shouldn’t all the blond people be in Turkey and Greece, according to your theory?”

Photo by Hunters Race on Unsplash

Labour market economics is no different. By and large, it is quite clear that economies with more liberal labour markets (as measured by e.g. the labour market subcategory of the Economic Freedom Index or by the Employment Protection Index) tend to have better labour market outcomes (lower unemployment rates and higher employment rates). But at any given time, there are millions of other things going on, and you would not expect to see a clear and obvious pattern, where a change in labour market policy leads to immediate, observable changes in labour market outcomes.

Except, in Britain, we are seeing something quite like that right now. In recent years, we had a series of government policies that made it costlier and/or riskier to hire people, and we are already seeing the results in the employment statistics. This time, the feedback has been unusually fast, and direct. It is the revenge of the Econ101 textbook.

Last year, the government raised employer National Insurance contribution rates from 13.8% to 15%, effectively an additional tax on employing people.

Then we saw the Employment Rights Act 2025, which the government hailed as “the biggest upgrade to rights at work for a generation”. It will reduce the qualifying period for unfair dismissal claims from two years to half a year, while lifting the cap on the amounts that can be claimed. It has already brought in a raft of new entitlements, such as a right to flexible working, while reducing the qualifying periods for existing rights, such as statutory sick pay and various forms of paid leave, to zero. It is also clamping down on zero-hours contracts, and strengthens union rights. None of these measures are in themselves particularly unusual: individually, they all have their counterparts elsewhere. But it all keeps adding up.

Last but not least, there is the steady increase in the minimum wage, at a time when productivity has been largely stagnant. When the minimum wage was first introduced, its headline rate was less than half of the median wage: it has now reached two thirds of that level. In addition, in recent years, reduced rates for younger workers have been phased out. In the beginning of 2021, you had to be at least 25 years old to qualify for the full rate of the national minimum wage. This has since fallen to 21.

Britain’s current unemployment rate of 5% is not terrible by historic or international standards. But it is about a percentage point and a half higher than it was four years ago, or at the end of the last decade. It is also half a percentage point higher than the G7 average, and it is no longer far below the EU average.

Nobody would look at these figures, and conclude that Britain is uniquely terrible, and must immediately U-turn on everything it does. But then – labour market performance is one of those things that the British economy was supposed to be good at. Over the past fifteen years, nobody would have looked at Britain as a shining example of productivity growth, or affordability, or infrastructure development. But you could have held up Britain as an example of an economy that always creates jobs, even in bad times. That was an underappreciated asset, and now we are squandering it.

The one silver lining is that at least this time, it is relatively easy to identify the culprit policies, because the feedback from the employment statistics has been unusually quick. We do not need to wait until 2035 for the first econometric assessments of the Employment Rights Act and other labour market policies of the mid-2020s to come in. We can already tell that we are on the wrong track, and what we need to do to reverse that.