When UK unemployment was at its lowest since the mid-1970s, together with employment at an all-time high, there was concern that a return to above-trend growth, with an associated increase in the demand for labour, could spark a re-run of the old wage-price spiral.

As the economy recovers and unemployment falls back, those concerns could return.

There are those who believe that, following the 1980s reforms to the British economy, the link between unemployment and inflation has been broken.

Others are agnostic on this point, and still fear that the link will be reactivated at some stage, once a number of essentially temporary factors cease to act.

Recent experience suggests that the ‘non-accelerating inflation rate of unemployment’ (NAIRU) has fallen below its 1980s level but is still probably higher than in the 1960s.

If so, unemployment could fall further without igniting pay pressures and price inflation.

Why might the relationship between inflation and unemployment have shifted since the 1980s? Some possible structural factors are listed below:

• A decline in the proportion of workers belonging to a trade union, from around half in 1980 to less than 30% in the late 1990s. There has also been a sea-change in industrial relations, with the number of working days lost to strike action falling sharply since the mid-1980s. In only two years since 1990 has the number of days lost exceeded one million, compared to regular losses of ten million days or more during the 1970s.
• A drop in the proportion of long-term unemployed (i.e. an increase in the supply of workers).
• A reduction in the generosity of, and tighter eligibility criteria for, certain state benefits.
• The de-centralisation of wage bargaining.
• A greater willingness by women to combine work with domestic responsibilities.
• The growth of part-time and temporary contracts.
• New ways of rewarding staff, such as with share option schemes, which aim to align workers’ economic interests more closely with the financial success of their employer.
• Changing demographics including, in particular, a fall of some 1.5 million since the early 1980s in the number of 16-24 year olds.

For firms, meanwhile, increasing competition in product markets has limited the ability of employers to pass on higher costs to their customers. This has imposed a stricter discipline on companies in the conduct of wage negotiations. In particular:

• Globalisation and an increasing degree of import penetration have amplified competitive pressures for many companies. This has long been apparent in manufacturing, and is increasingly an issue in the service sector, thanks to (sic) developments in communications technology. If wage growth is too generous, companies may be priced out of the market, or activity moved overseas.
• Privatisation and deregulation have heightened competitive pressures.
• Low inflation has brought a greater degree of price transparency. In this environment, customers are better able to detect changes in relative prices, and it becomes accordingly more difficult for companies to raise prices surreptitiously.
• Lower inflation, sustained over a period of time, is influencing people’s expectations as regards future inflation, so that that pay claims have been more moderate. This ‘virtuous circle’ is in marked contrast to the situation 20-30 years ago, when workers’ attempts to protect themselves against high inflation helped to fuel rising unemployment.

To ensure that the link between unemployment and inflation remains weak, the Government will need to concentrate on improvements to the supply-side of the labour market.

It is important that those people currently without a job, either unemployed or otherwise ‘inactive’ be allowed back into or persuaded to join the work force.

The ‘New Deal’ and attempts to help the unemployed and inactive to acquire new skills are an integral part of the process of ‘making work pay’.

These types of structural issues, however, are not easily solved and improving the supply side of the labour market is likely to be an ongoing issue.

Central to this process is probably the need to address the training and education needs among the young and among those who have recently lost jobs in declining industries.

Differences in the level of property prices across the country will almost certainly act to impede the degree of regional labour market mobility in the future. This problem is especially critical in London and the South East where, despite the recent weakening in house values, house prices remain much higher than the national average.