Working to Rule – The Damaging Economics of UK Employment Regulation


Monetary Policy

SMPC votes seven / two to raise Bank Rate in May

Economic Affairs

Political consensus to increase employment regulation risks undermining the economy

  • Legal restrictions on the terms and conditions under which employment takes place have a long history in the UK. Since the mid 1960s, however, regulation has substantially increased and now permeates all aspects of work. The costs of this are huge. Just one element relates to the direct burden on firms. For example, the direct cost of running human resources departments is now likely to be over £15 billion per year: much of this relates to compliance with employment law. Most of the costs of regulation are, however, much more subtle and not easy to calculate.

  • The European Union has regulated many aspects of labour markets including: restrictions on working hours; holiday leave; parental leave; pro-rata payments for part-time workers; information and consultation requirements (including European Works Councils for large multinationals); consultation over collective redundancies; equal conditions for permanent and agency workers; maintaining conditions for workers transferred between undertakings; and the outlawing of discrimination not just between men and women, but also on grounds of ethnic origin, religion, sexual orientation, disability and age. Some estimates have suggested that the repatriation of powers, especially in relation to the Temporary Agency Workers Directive and the Working Time Directive, could lead to the creation of at least 60,000 jobs. However, in practice, Brexit is unlikely to make a great difference to the regulatory impulse of UK politicians and interest groups: recent UK
    governments have been responsible for large extensions of employment laws going far beyond those ordained by the EU.

  • Increasing the minimum wage through the implementation of the National Living Wage will have considerable effects on labour markets. By the government’s own estimates it will costs tens of thousands of jobs and 4 million working hours in the next few years. It is likely to lead to over 20 per cent of all private sector workers having their pay set directly or indirectly by the government – in addition to those on public sector pay scales. The academic literature suggests that minimum wage laws have a small but significant negative effect on overall employment levels, with the effect being greater for young adults, greater in recessions and greater in the long term. Given that 60 per cent of those who are believed to earn less than a ‘living wage’ work part time and 44 per cent are in the top half of the household income distribution, any benefits from the National Living Wage as an anti-poverty measure are questionable.

  • There is much concern over high pay as well as low pay, and new restrictions are being contemplated. Although the earnings distribution has not become more unequal in general over the last thirty years, those at the very top have seen large increases in their earnings. However, the evidence suggests that (despite assertions to the contrary) high pay is linked to performance. Artificial restrictions on top pay may lead to knock-on effects which end up penalising poorer workers.

  • A stronger case needs to be made to emphasise the benefits of free labour markets in generating employment, growth, productivity and higher living standards. Furthermore, it is important that it becomes more widely understood that the effects of employment regulation and mandated benefits ultimately fall on employees, consumers, the unemployed and taxpayers, not on employers. The new

  • Apprenticeship Levy is an example of regulation which will almost certainly reduce pay levels in the long run without any obvious corresponding benefit. And some elements of regulation raise significant issues about personal freedoms and opportunity in addition to narrowly economic concerns.

  • Well-meaning employment regulation often has significant and perverse downsides: anti-discrimination laws, for example, may lead to falling job opportunities for some protected groups. Employment protection laws lead to less hiring, more temporary contracts and worsened employment prospects for young workers and other disadvantaged groups. Middle-aged male workers benefit most from such laws.

  • There have been moves to extend employment protection laws still further by restricting or even banning outright ‘zero-hours’ contracts. This would be a great mistake. Many people on such contracts are both well-off and have good job security. Many others find it suits their lifestyle and other obligations. Indeed, evidence suggests that those on zero-hours arrangements are happier with their employment conditions than those who are not. It is easy to be sanguine about the effects of yet more employment regulation because of the low level of unemployment in the UK. However, youth unemployment remains worryingly high and it is often the most vulnerable groups who lose out from restrictive legislation.

  • There are strong vested interests against reform. Employers see labour market regulation as a sunk cost and a useful barrier to potential competitors with different business models. Employees suffer from the ‘endowment effect’, well-known from behavioural economics, which leads them to value the benefits regulation brings more highly than the potentially bigger benefits of reform. Regulators and human resource managers benefit from regulatory complexity, which increases the demand for their services.

  • A case can be made for greater regulatory competition: apart from repatriation of regulation to the UK from the EU, there is an argument for devolution within the UK – for instance, allowing Scotland to set its own minimum wage. More fundamental reforms should involve adding a ‘sunset’ clause to a large body of existing employment legislation, followed by a major review of regulation with the default of scrapping laws which can no longer be justified. This could lead to a dramatic reduction in the categories of employment regulation from around 100 currently to perhaps just 5. • Some have argued for less reliance on legislation but more emphasis on ‘voluntary’ measures such as the promotion of the Living Wage, or setting targets for women members on boards. These measures, however, are not an improvement on compulsion if the policy itself is damaging. Such pressures blur the boundaries of legitimate state power: businesses and individuals should not be cajoled into changing their priorities in line with often transient government objectives.

This report featured in City AM.

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Editorial and Research Fellow

Len Shackleton is an Editorial and Research Fellow at the IEA and Professor of Economics at the University of Buckingham. He was previously Dean of the Royal Docks Business School at the University of East London and prior to that was Dean of the Westminster Business School. He has also taught at Queen Mary, University of London and worked as an economist in the Civil Service. His research interests are primarily in the economics of labour markets. He has worked with many think tanks, most closely with the Institute of Economic Affairs, where he is an Economics Fellow. He edits the journal Economic Affairs, which is co-published by the IEA and the University of Buckingham.