Economic trends - Why is UK unemployment rising?

During 2006, the UK unemployment rate has drifted upwards, while that across much of Europe has been drifting down. Danny Gabay asks why.

For most of the past decade, the UK economy has been sufficiently strong to keep unemployment stable, at worst, and generally falling. But over the course of 2006, the UK unemployment rate has drifted upwards, while that across much of Europe has been drifting down. At 5.5%, the UK's unemployment rate remains well below the eurozone average of 8%, but it appears to be heading in the wrong direction. Why?

The usual culprit for rising unemployment is a shortfall in economic growth. But UK growth was 2.8% in the year to the third quarter, slightly faster than its long-term trend. This ought to be enough to keep the jobless rate stable, if not falling slightly. Indeed, while unemployment has been drifting up, so too has employment. The number of people in employment for the three months ending in August 2006 was just over 29m, up 120,000 over the quarter and up 255,000 over the year. Total hours worked per week were 929.8m, up 6.2m over the quarter and up 8.5m over the year.

These are the highest figures for employment and hours worked since comparable records began in 1971.

Supply not demand

In other words, the reason unemployment is rising is not deficient demand - the number of jobs being created is high and rising. Instead, to explain why unemployment is rising, we need to look at the supply side of the jobs equation. In short, two factors underpinning the strongest increase in labour supply in a generation: higher net immigration; and falling levels of economic inactivity.

There has been a steady increase in population growth over the past decade or so, but recent rates of growth are strong by historical standards.

Last year Britain's adult population expanded by 0.9%. The last time it grew as quickly was 25 years ago. The explanation for this rests largely with a net inflow of adults from outside the UK, rather than a product of internal demographics. Official figures are sketchy, but suggest that inward migration accounts for around half of the growth in the adult population over the past five years.

Inactivity is the label given to those who are not employed, but who are not counted as unemployed either because they are not actively looking for work or are not available to start work immediately. There are a number of reasons why someone might be economically inactive, including: retirement; illness; or full-time study. The only one of six defined categories of inactivity that saw an increase over the past year was the number of students.

All other categories of inactivity are falling, with the bulk of the decline accounted for by fewer early retirees, a drop in the number of family carers, and a sharp fall in the long-term sick. Today's over-50s are much more likely to stay in work for longer than previous cohorts - either because they find their wealth is not sufficient to fund retirement or because there are now greater opportunities for older workers in the labour market (or both). And as a share of the working population, long-term sickness peaked in 2002 and has since declined.

The chart shows a stylised breakdown of recent labour market flows.

The stacked bar on the left depicts the sources of increased labour supply over the past year. The bulk of this came from a 377,000 rise in the adult population augmented by a 123,000 fall in the ranks of the 'inactive'.

The right-hand stacked bar in the chart shows where the increased labour supply ended up. Employment rose by 276,000 year-on-year, but this was nowhere near enough to soak up the 525,000 increase in the workforce.

As a result unemployment rose by 255,000, taking the rate to 5.5%. Hence, rising unemployment has more to do with a sharp increase in labour supply rather than a shortfall in labour demand.

By and large then, the rise in the unemployment rate over the past 12-18 months, reflects a combination of slightly weaker demand by firms and rapidly rising labour supply - an increase in the rate of population growth due to net migration augmented by declining inactivity. Whatever its cause, the higher jobless rate indicates rising slack in the labour market which, in turn, should bear down on wage increases and hence on consumer price inflation and ultimately, interest rates.


According to surveys of consumer attitudes, the long-dormant German consumer should be highly visible right now. Brightening economic prospects and falling unemployment in particular - German unemployment dipped below 10% for the first time in five years recently - are part of the explanation.

But there is also next January's pre-announced 3% VAT hike to bear in mind. Hence as our chart shows, German consumers think now is the best time to make a major purchase in nearly 30 years. But as for next year?

Not so much. Worryingly, it is still very hard to detect any signs of this accelerated shopping spree in the official data.


The US economic engine appears to be spluttering. In the third quarter, growth slowed to just 1.6% on an annualised basis, from nearly 6% in the first three months of the year. Compared to a year earlier, growth dipped below 3% for the first time since 2003. The proximate cause of this deceleration is the ongoing housing market slowdown - lower housing related spending knocked over 1% from the third quarter figures. US house prices are now falling at their fastest rate for over 35 years. The Federal Reserve thinks the worst is already behind the economy; but the markets are betting on more bad news forcing US rates back down next year.

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