Magazine | January 26, 2015, Issue

The Convalescing Man of Europe

(Ernesto Chieffallo/Eyeem)
A comparison of the U.S. and U.K. labor markets

‘The sick man of Europe” is a moniker that has been applied to every nation of any significance on the Continent in the last 40 years. From the 1970s onward, the United Kingdom, the Netherlands, France, Germany, and Italy have all been deserving of it for a time. At least half a dozen countries could stake a strong claim to it today. These repeated economic crises made the United States in the late 20th century the envy of the developed world. The robust U.S. labor market was an object of desire, and every large European country would have swapped its unemployment rate for that of the U.S. during most of the last 40 years. Most would still take that trade in a heartbeat. But behind a tumbling unemployment rate, the United States’ labor force is walking with a limp. However it’s measured, the share of Americans in work is shrinking.

The United Kingdom is probably the most relevant country to compare with the U.S. A wise decision not to adopt the euro kept Britain’s economy from being stymied by the common currency, and its relatively laissez-faire labor market looks more like that of its American cousin than that of its immediate neighbors. On the face of it, the two labor forces look pretty similar. Since the start of 2012 the benchmark unemployment rates in the U.S. and the U.K. have moved downward in tandem. In January 2012, both were at 8.2 percent, falling to about 6 percent at the end of 2014. But there are major differences beneath the surface. The slumping American labor-force participation rate has become a popular conservative talking point, and a comparison with the U.K. is unflattering. In the U.S., the participation rate is down by three percentage points since 2008 and is hovering at its lowest level since the late 1970s. During the summer of 2014, the U.K.’s participation rate surpassed the United States’ for the first time in three and a half decades.

Despite the popularity of the participation rate as a labor-market thermometer, other measures offer a fuller explanation of what’s happening in the United States. Labor-force participation isn’t a perfect measure because, for one thing, it includes workers who are retiring. The working-age economic-activity rate is a better yardstick: It includes everyone either working or looking for work aged between 15 and 64 for the U.S., and between 16 and 64 in the U.K. In the United Kingdom, the figure ticked up to 78 percent this year, above the January 2008 level. It has been higher in the post-war period by only a fraction of a percentage point. In the U.S., the situation is comparatively bleak. The working-age activity rate is down from 75.4 percent at the start of 2008 to 72.8 percent now. 

That might sound like small beer, just a few percentage points here or there. But with 203 million people in the U.S. in the 15–64 age bracket, raising the U.S. activity rate to current British levels would bring more than 5 million Americans back into the labor force. That’s roughly the size of Colorado’s population. This is not just a post-financial-crisis development, either: The activity rate peaked at 77.5 percent in 1998, and has been sliding or stalling ever since.

One of the more positive explanations for the falling participation rate in the U.S. is that young people who would previously have worked are increasingly staying in full-time education. Increased college enrollment and a decline in the number of high-school dropouts have driven the economic-activity rate in the U.S. for 15- to 24-year-olds from 65 percent in 2000 to around 55 percent today. That may explain a little of the divergence from the U.K., though the U.K.’s young people are also increasingly staying on in full-time education after their compulsory schooling finishes.

The increase in part-time-employment opportunities in the U.K. after the financial crisis seems like a superficially plausible explanation for some of the divergence. Part-time jobs grew to take up about three percentage points more of the total employment share after the recession hit. But the U.S. mirrors that change almost exactly. Severe recessions in both countries drove part-time employment up, as people who would have preferred to work full time or not work at all scrambled to replace lost family incomes. As solid growth began again in both countries (a little later in the U.K.), the part-time-employment share started to tick downward again. This similar-sized movement in both countries doesn’t seem to explain the divergence.

So what’s happening? British leftists have complained for years that New Labour and Conservative administrations have Americanized the U.K.’s labor market. In two ways, those administrations have done so well that U.S. policymakers should now be taking an interest. First, U.K. self-employment, particularly among women, has boomed with falling unemployment, while only formal employment has been rising in the U.S. Second, successive governments of different political stripes have tried to bring down the share of people claiming long-term disability benefits, and the results are now clear.

In 2013, the proportion of working-age Britons who were economically inactive because of long-term sickness dropped to a 20-year low. The proportion of the working-age population claiming disability benefits had begun accelerating in the late 1980s and had peaked in the late 1990s. Disability-benefit reforms beginning in 1995 aimed to slow the flow of workers moving out of the labor force. In the mid 2000s, increased efforts (known as Pathways to Work) were made to return people already in receipt of disability benefits to the labor force if they expressed an interest in working. Junior legislators in the Labour governments between 1997 and 2010 were not enthusiastic about these later reforms, which were largely driven by the party’s leadership. Since 2010, under the Conservative–Liberal Democrat coalition, welfare-reform efforts to move people off benefits have been redoubled. Over the past 30 years in the U.S., the overall trend has been in the opposite direction: Since the Disability Benefit Reform Act of 1984, the proportion of working-age Americans in receipt of Social Security Disability Insurance has more than doubled.

#page#There is a plain correlation between the unemployment rate and the number of people applying for disability benefits, as research by MIT economist David Autor shows, and as Scott Winship discusses elsewhere in this issue. Over the quarter of a century running up to 2010, every rise or fall in unemployment has been tracked closely by a similar rise or fall in claims. As in the U.K. and many other European countries, disability benefits have become an increasingly tempting option for American workers who are pinned in long-term unemployment or who face transfer to lower-paying or lower-status jobs. There is one strange upside to Western Europe’s earlier economic turbulence: Many countries have been through this territory before, and so have already made significant reforms to their long-term-disability-benefits system. The connection between economic factors and disability claims is a reality that is recognized by both academia and European policymakers, but that U.S. policymakers seem more reluctant to acknowledge. In their work on the subject, American economists Richard Burkhauser and Mary Daly stress that many of the forces driving disability claims have little to do with the health of the population. The ease of claiming benefits, the structure of the benefit programs, and the general state of the economy are all major factors too.

The most obvious lesson from Britain’s reforms is that the United States should first look to stem the tide of people applying for such benefits, albeit without doing precisely as the U.K. has. British attempts to reduce the number of people receiving disability benefits have been checkered at best. “Work-capacity assessments” intended to weed out those who are actually able to work have proved to be expensive, controversial, and sometimes cruel. Around a third of the benefit recipients subject to such assessments who were designated fit for work have appealed their removal from the rolls, and a third of those appeals have been successful. Several have died shortly after being pushed into searching for work. Atos, the firm that conducts the assessments, negotiated an early exit from its contract after tremendous criticism. (Britain’s earlier experience with reducing the number of new benefit recipients had been much more positive.)

Self-employment can explain another large portion of the difference between the U.K. and the U.S. From January 2008 to November 2014, the number of self-employed people in the U.K. swelled by 16 percent. There are still 5 percent fewer self-employed workers in the United States than there were before the financial crisis began. All else being equal, a U.K.-like upswing would have brought more than 3 million Americans into work. The entrepreneurial spirit of the United States is dampened, in particular, by difficulty in acquiring health insurance (a subject whose adequate discussion would require a separate article).

Rising female self-employment has also been an important factor in Great Britain. In both the U.S. and U.K., the proportion of men in work has been declining for decades. At the start of the 1980s, the rate of economic activity — defined, again, as working or looking for work — among men in prime employment age (25 to 54) in the U.S. was still at about 94 percent. That figure had dropped to 88 percent by the end of 2013. The female economic-activity rate moved in the opposite direction, climbing from 64 percent in 1980 to 77 percent at the turn of the millennium. But the growth of the female work force stalled and reversed soon afterward. Last year it was back down below 74 percent, and both sexes are now adding to the American work force’s great contraction. In the U.K., things are different. The female economic-activity rate has continued to move upward, due particularly to the astonishing boom in self-employment among women. Between March 2011 and March 2014, a period in which British economic growth was less than stellar, the number of self-employed women grew by a fifth. The U.K.’s entrepreneurial boom is recent and conclusions can only be tentative, but the scale of the expansion has been huge and deserves some attention from Washington.

The United States’ labor market has its strengths. Wage growth, which has been weak in the United States, has been totally absent or negative in real terms in the U.K. A benign explanation for Britain’s weakness is that self-employed workers earn markedly less than employees on average, and people who might otherwise claim disability benefits are unlikely to be going into highly paid work. And those U.S. workers who have fallen out of the labor market entirely and would be happy to return make the wage picture appear somewhat better than it really is: Incomes of zero are not counted in the average.

The U.S. labor market is still worthy of some envy from across the Atlantic, but the U.K. is looking a little less green today, and American policymakers should take note.

– Mr. Bird is a London-based reporter on markets and economics for Business Insider.

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