Shocks and Structural Breaks - Labor Market Reforms in the United Kingdom

WP/94/152-EA
Shocks and Structural Breaks: Labor Market Reforms in the United Kingdom
by Ramana Ramaswamy and Eswar Prasad

Radical labor market reforms were initiated in the United Kingdom in
the early 1980s. These reforms included legislation to curb industrial
disputes and measures to decentralize wage bargaining. This paper evaluates
the impact of these reforms on the growth of labor productivity, the
responsiveness of employment to variations in output, the rate of wage
inflation, and the trade-off between wage inflation and unemployment. The
effects of the reforms on the aggregate economy and on the manufacturing
sector are analyzed separately. The manufacturing sector is of particular
interest as the legislation concerning unions had the most direct impact in
manufacturing--where unions have traditionally had a stronger presence--than
in other sectors.

The labor market reforms resulted in a significant increase in the rate
of growth of labor productivity in manufacturing, but not in the aggregate
economy. This paper argues that the increase in the growth rate of
manufacturing productivity after 1980, as well as the improved speed of
labor adjustment to variations in output, can be attributed largely to the
success of the reforms in reducing industrial disputes and removing a number
of structural impediments in the labor market.

However, the labor market reforms did not succeed in moderating real
wage growth or improving the trade-off between wage inflation and
unemployment. This is attributed to two main factors. First, unlike a
fully market-based system, a decentralized wage-bargaining system with
unions is unlikely to produce wage moderation. Second, when relative wage
comparisons are an important part of the bargaining norms, decentralized
bargaining may prove more inflationary than a system with some implicit
coordination. Both standard econometric techniques and recent developments
in labor market theory are used to support these arguments.