1.
The Employment Rights Bill is making its way
through the UK Parliament at the moment. There are a lot of details, set out in, for
example, the Impact Assessment, here. Among the provisions quoted there are unfair
dismissal, paternity and sick pay rights from the first day of employment,
repealing laws that require minimum service levels in some industries during
strikes, strengthening union rights etc.
2.
What will the effects be on growth? Since the
government says its entire policy is about growth this is an important
question.
3.
To understand the effect on growth it will be
helpful to understand the effect on investment. The graph below makes dismal
reading. Using the OECD index of employment regulation, there's a negative relationship which is that more employment regulation means less
intangible investment. To the extent that intangible
investment is important for growth, this is bad news for the policy.
4.
This graph might seem obvious. But a moment's
reflection raises a few puzzles. First, if the cost of employing workers goes
up firms would presumably substitute towards capital. That should tell you that
more employment regulation would give you more investment, not
less. Second, the proponents of this bill
argue that it will make workers happier and productivity will go up for that
reason.
5.
So what's going on?
6.
Let's start by thinking about investment. There are
two important effects of costs on investment.
a.
The first is the cost of capital effect. Once
the firm has decided to invest, other things equal, a fall in the cost of
capital, say from a tax break, will make the firm invest more. By this logic, a
rise in the price of labour, due to this bill, lowers the relative cost
of capital relative to labour, thereby potentially raising investment. This
logic gives rise to the first part of the puzzle above.
b.
But there is an important second effect on
investment. The outcome of investment is uncertain. Further, much
investment is sunk, which is to say that it is often difficult to get that
investment back once you have made it. Think
for example about Nokia's investment in software which became Windows Mobile.
When the market for Nokia's mobile phones collapsed, around $5 billion worth of
software investment had to be just written off. This is important because the
cost of capital effect applies once the firm is actually decided to invest.
But the uncertainty effect means that a rise in uncertainty makes the firm
postpone its decision to invest. With uncertainty and sunk capital, there is an
additional cost of investment, which is that investing today costs the firm the
value of waiting. That waiting has value
(formally an option value), since underlying uncertainty might be resolved in
the future.
7.
So the Bill has potentially two effects. The cost
of capital effect is good for investment, because it raises the relative price
of labour. The uncertainty effect is bad for investment, because firms
will postpone investment until the uncertain costs are clearer.
8.
What then will we expect? My best prediction is
that the employment rights bill is a rise in uncertainty for firms. The reason
is that these employment rights are set out in broad outline in the bill, but
then end up being interpreted by the courts.. The backlog of court cases is now
over a year. It will in practise take a long time for the full implications of
these employment rights to become clear to firms. Look for example at the avalanche of cases
around equal pay, the Next case for example ((https://assets.publishing.service.gov.uk/media/66d190b2bdecebe01a183399/Miss_M_Thandi___Others_V__Next_Retail_Limited_-1302019-2018-Resreved_Judgment.pdf). . These cases have taken years, and in the case
of retailers precede retailer by retailer.
9.
In case this might seem a matter of theoretical
curiosity it is worth remembering the effects of Brexit are precisely this uncertainty
effect. As Josh Martin and I showed, after the Brexit referendum investment
literally stopped in its tracks for many years. A significant slowdown in
growth thereby followed.
10. This
uncertainty effect explains why the bill would likely particularly affect
intangible investment. Intangible investment is likely to be more sunk, more company
and market specific than tangible investment: British Airways can always sell
its planes, but much harder to sell its brand name. This in turn is why the
cross country evidence sometimes finds employment market regulation is
negatively correlated with investment and sometimes positively correlated: It
depends upon whether the underlying investment considered is both sunk and if
the regulation is uncertain.
11. Finally,
moving outside investment, some remarks.
12. First,
my baseline model of the labour market is a simple one: there are wage and non-wage
attributes of every job. The non-wage
attributes are, for example, paid tea-breaks, effort on the job and contractual
form (employees v freelancers for example).
13. Second,
the CMA has done
an extensive study of the presence of “monoposony” power in labour markets
(Competition and market power in UK labour markets, CMA Microeconomics Unit 25
January 2024 Report no. 1). This is hard
to do, since we don’t really know what the labour market is, especially in the era
of working from home. Taking the “labour”
market as the Travel to Work Area, they find
a.
87% of workers work in “low-concentration”
labour markets (in 2019, that fell to 80% in the unusual conditions of the
pandemic), see p.104
b.
The effect of moving between concentrations is
not large. (para 5.14, see also the
notes to figure 21), “…an increase in
concentration …by 10% …would be associated with just a 0.1% fall in wages.”. This means that going from medium
concentration, 2,500 to low, 1,500 which is a 51 log point change would change
wages by ½ a percent.
14. Further
work by the CMA, on my reading at least, has not found widespread product
market monopoly power either (except in some cases). It seems unlikely to me then that monopoly and
monoposony power is widespread. Thus the
first-order effect of a rise in costs on firms will be adjustment of wage and
non-wage margins, or, if this is not possible (due to wage floors for example),
adjustment of quantities. Thus the assumption
that workers will be “happier” and so more productive after the passing of the bill seems questionable; we don’t
know what other margins will adjust. For
example, the Next case found that following the minimum wage, Next abolished paid
rest breaks (unpaid rest breaks were the industry norm so this was reverting to the industry standard).
