A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. To subscribe and/or view previous editions just google Deloitte Monday Briefing.

One of the economic puzzles of the last three years has been the shrinking of the UK workforce. Despite labour shortages, record job vacancies and low unemployment, about half a million people of working age have left the UK workforce since late 2019. The latest data show little evidence that either a red-hot labour market or the cost-of-living crisis are tempting people back into work. Earlier this month I gave evidence to the House of Lords Economic Affairs Committee which is looking into labour supply in the UK. This week’s briefing offers some thoughts on what might be going on.

The UK’s experience of a shrinking workforce is unusual. In most other rich countries workforce participation – the proportion of people of working age who are in work or actively seeking it – is rising and in many is higher now than before the pandemic. The UK is also an outlier in having lower levels of employment today than on the eve of the pandemic.

Most of the growth in economic inactivity, or people withdrawing from, or not entering the workforce, appears to be due to increases in the number of people aged 50 to 64 who are long-term sick or disabled. Increasing student numbers have played a lesser, but significant role. Early retirement is another factor.

For the 20 years prior to the pandemic, the number of people classed as long-term sick and disabled had fallen steadily. Long COVID is the obvious culprit for the reversal of this trend. Earlier this year the Office for National Statistics (ONS) reported that almost 400,000 people described their activities as being limited “a lot” by the condition. The fact that other developed countries which suffered from COVID have not seen inactivity rise points to an alternative, UK-specific explanation. Long NHS waiting lists are a plausible candidate. In England waiting lists have hit a record high of 7 million and hospitals are carrying out 12% fewer treatments and operations than before the pandemic. The fact that most of the rise in sickness and disability is among the over-50s would fit with a picture of a health service that is struggling to cope with demand.

Yet maddeningly, what appears to be an open and shut case is anything but. Two important studies of the over-50s, by the ONS and the Institute for Fiscal Studies suggest sickness and disability may not be the decisive factor in rising inactivity.

Both studies suggest that people have left work less because of illness and more because they have the desire, and the financial means, to stop working. The IFS report concluded that – “the rise in economic inactivity among 50- to 69-year-olds does not look to be driven primarily by poor health…it looks more consistent with a lifestyle choice to retire in light of changed preferences or priorities, possibly in combination with changes in the nature of work post-pandemic, in particular more remote work, which reduce the appeal of staying in employment.”

On the issue of economic inactivity, the jury is still out. It’s clear that people have left the UK workforce in scale, but it’s less clear why they have done so.

In one important respect the UK job market is no different from those of the US and Europe. All are running hot, with demand for labour outstripping supply, high levels of job vacancies and low unemployment. Last week the British Chambers of Commerce reported that recruitment difficulties are at record levels. Much the same story holds on the continent. Construction sector skills shortages are far above cyclical peaks seen at the top of previous economic cycles in the EU. In France, manufacturing and service companies are facing record levels of recruitment difficulties.

The Federal Reserve, the European Central Bank and the Bank of England are aiming to cool labour demand by raising interest rates. Tighter monetary policy, together with the dampening effects of high inflation, are starting to feed through to the UK labour market. The latest Deloitte CFO survey shows a marked drop in hiring expectations. Movement between jobs, a classic sign of a strong job market, peaked over the summer and has since eased back. Job vacancies are at high levels but have fallen in each of the last four months. 

It looks as if we are close to a turning point in terms of job opportunities and unemployment. The Bank of England expects the UK unemployment rate, which stands at 3.5% today, to rise to 4.4% in one year’s time, 5.5% in 2 years and 6.3% in 3 years. Since the Bank sets interest rates – and has been clear in its view that the economy is running too hot – these forecasts warrant attention.   

Unemployment is almost always low on the eve of recessions, especially inflation induced ones, and high at the end of them. It would be surprising if this cycle were any different.

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