Suppose that by the
mid-2000s, immigration from the EU (and the potential for additional
immigration) had led to an important shift in the UK labour market.
The possibility of bringing labour from overseas meant that old
relationships between the tightness of labour market and wage
increases no longer held.
You might think that
was bad for workers, but that is not so. It would mean what
economists call the natural rate of unemployment (or NAIRU) has
fallen. Unemployment can be lower without leading to wage increases
that threaten the inflation target, because workers fear that the
employer can resort to finding much cheaper overseas labour. It
reduces the power of workers in the labour market, but also leads to
overall benefits. (This is just an example of the standard result
that reducing monopoly power is socially beneficial.)
But it is only good
news if the Bank of England recognises the change. If they do not, we
get stagnant wage growth and unemployment higher than it need be. The
obvious response is that the Bank will know there has been a change
because wages will start falling faster than they would expect based
on previous relationships. However that effect may be masked by the
well documented employee and employer reluctance
to actually cut nominal wages. Add in the shock of the financial
crisis, and this change in the way the labour market works might well
be missed.
Here is the big
leap. Suppose the above had happened, and the Bank of England did not
miss the change. Monetary policy would have been much more
expansionary, bringing unemployment well below the 5% mark. Nominal
wage growth would have been stronger, and a buoyant labour market
would have generated a feel good factor among workers. With more
vacancies and less unemployment, concerns about immigration would
have begun to fade. The Brexit vote would still have been close, but
would have gone the other way.
You may say how
could monetary policy be more expansionary given how close we are to
the Zero Lower Bound? If that was the case the Bank should have said
they were out of ammunition, and placed responsibility with the
government and austerity. But for the last two years at least, the
Bank could
have cut interest rates and has not. You could blame the relentless
expectation
in the media and financial sector that rates would increase, but the
Bank should be able to rise above that.
Of course the Brexit
blame game is easy to play when the vote was so tight. The most
speculative aspect of this chain of thought is the initial premise
about a shift in the NAIRU created by immigration potential. While
the possibility makes sense, whether the data backs it up is much
less clear.
Yet there is some evidence of a structural shift in the UK labour
market in the mid-2000s, as Paul Gregg and Steve Machin report.
