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Economic Uk Labour Market Essay

The UK labour’s market have seen a significant increase in income inequality. The labour market is “a market in which wages, salaries and conditions of employment are determined in the context of the supply and demand for labour.” (Bannock, G Et.al 2003) This disparity in income can be seen from the Gini coefficient, which is a widely used measure of inequality, at an all-time high in recent years, with a significant increase since 1980. This trend is unlikely to reverse especially as income inequality had not decrease during the previous Labour government despite its comprehensive measures aimed at reducing income inequality. This essay aims to describe the reasons of the growing income inequality in the UK and the extent to which it is possible or desirable for the UK government to try reverse this trend.

Demand for labour in the labour market is a ‘derived demand.’ This means that employees are demanded because there is a demand for the final good or service. (Gillespie, A 2007, 230) In a perfectly competitive labour market, wages for labour is determined by supply and demand for labour, with the wage rate being at the equilibrium level. When the wage rate is higher than the equilibrium, there will be an excess supply of labour as people are attracted to the high pay. This will lead to decreasing wage rates as a result of the excess supply until equilibrium is reached at W1 where quantity supplied equals quantity demanded. The similar theory applies directly opposite when wage rates are below equilibrium levels as shown from the diagram below.

The perfectly competitive labour market means that all employees would be paid the same. Under this model, workers will be attracted to the industry that pays higher wages, thus leaving the industry with lower wages resulting in a decrease in supply of labour. The decrease of supply of labour will then bring up the equilibrium wage in the market. Likewise the increase in supply of labour in the higher paid industry will ultimately bring down the wage rate to the point where wages are equal in both industries and when there is no further incentive to move between industries. This is shown in the diagram below.

However, in reality wage differences exists due to a number of factors. Firstly, geographical and occupational mobility undermines the ease of moving in and out of different industries. Secondly, the types and nature of jobs are all different and this affects people’s willingness to do them. Lastly the lack of information to all employees about the type of jobs available in the market also causes wage differences. All these factors means that the labour market in reality is a very imperfect market, which results in people earning different wage levels.

Some people can earn considerably more than others if supply for their skills are limited in the market, leading to the problem of income inequality. According to a report by the Institute of Fiscal Studies, it was shown that income inequality ratio between the bottom 10% and top 10% have risen since 1980s, from slightly above 3.0 to now above 4.0. It is also interesting to note that the middle 60% of distribution suggests that inequality have decline under the Labour administration, but the tail of distribution tells a different story with the gap of both ends widening tremendously. The UK Lorenz curve as shown below has a Gini value of 0.36 in 2007/08.

This increase in the income disparity is due to several reasons. Firstly, globalisation plays a very crucial role in this. In recent years, international trade has increased substantially due to decrease in freight costs and prevalence of cheap labour in developing country. This means that importing goods made from there are cheaper than those produced domestically by developed countries like the UK. Countries like UK tend to import goods produced with unskilled labour and export goods produced with skilled labour as a result. (Mankiw, G 2009, 391) This has lead to a increase in domestic demand for skilled labour and reduction in demand for unskilled labour. Companies that failed to compete globally created a problem of unemployment that resulted in people finding lesser skilled jobs in the service sectors, which effectively increase supply of labour in this market.

The second factor of this is the changes in technology. Advancement in technology have altered the relative demand for skilled and unskilled labour by ‘raising the demand for skilled workers who can use the new machines and reduce the demand for the unskilled workers whose jobs are replaced by computers.’ (Mankiw, G 2009, 392) This indicates that technology have empowered the top end with entrepreneurship skills, enabling them to be more productive whereas the bottom end suffered with loss of jobs. It is not practical for the country to impose tariffs to protect home grown industries against foreign competition, thus this has lead to the UK placing emphasis on high end, high value industries such as the financial sector. With the UK economy being dependent on industries that require high human capital, which is fairly inelastic on the supply curve, it only resulted in a further increase in demand of these people, thus driving up wages.

“Human capital is defined here as the knowledge that individuals acquire during their life and use to produce goods and services or ideas in market or non-market circumstances.” (Miller, R 1996, 22) Education and training received thus plays an important role in increasing wages as these people are more productive and their skills being in demand. Another reason of the income disparity is the reduction of power of the trade unions in the UK. Union membership peaked in the late 1970s at over 13 million and then fell dramatically in the 1980s as Margret Thatcher took on the trade unions today’s figure of about 7million. (How union membership have grown and shrunk, 2010)

Trade unions are useful in “seeking counterbalance of monopsony power of an employer by controlling aspects of the labour supply and by using whatever collective bargaining power they possess to negotiate wages higher without being at the expense of employment levels. (Riley, G 2005, 119) Thus reduction in the power of trade union means lower wages for workers.

In the book, The Spirit Level mentioned that “greater equality is the gateway to a society capable of improving the quality of life for all of us and an essential step in development of a sustainable economic system.”(Wilkinson,R & Pickett,K 2009,237) This was confirmed with a whole range of statistics identifying the problems of income inequality on the society, ranging from health issues, homicide rates, crime rates to the issue of social mobility. All these studies sums up the fact that a more equal society is a more desirable one. The UK government too have recognise this and have done several measures in a bid to reduce the income inequality between the upper and under class people.

The first measure of the UK government is to use fiscal policy by having progressive tax system and spending money on benefits. “The purpose of a progressive income taxation is to allocate the burden of tax fairly between different members of the community.” (Nightingale, K 2002, 14) The government does this by having an increase rate of tax as income increases. In the UK, the highest wage earners pay 50% of income tax while the poorest do not pay any tax. Another measure the government can do is to reduce Value Added Tax (VAT) on basic necessities which will enable the lower income groups more savings while at the same time reduce earnings for the higher income group who are more likely to spend on luxury goods. The high tax rate for high income groups is a feature of western countries such as UK which provide funding for government spending on a welfare state system. Subsidies thus will lessen inequality if they account for a larger proportion of a poor person’s income than a rich person’s. (Sloman, J 2006, 274)

However a common criticism of welfare programs is that they create incentives for people to become “needy.” (Mankiw, G 2009, 419) Having benefits as a means to cope for the needy is a good short-term solution, but it will be very inefficient for the country’s economy if people take advantage of this system and remain unemployed to rely on benefits instead of working. Another problem is that the high income tax on high earners may stifle their motivation to be productive and since they are people who are very mobile, they can move to places where there is lower income tax and which ultimately have an impact on the economy and reduces the country’s revenue on tax.

A long-term solution can be implementing a minimum wage, which will ensure low skilled workers being ensured a proper living wage. The problem of low pay as a result of excess supply will then be avoided, thus reducing the income inequality gap. However this creates a problem of surplus in the quantity supplied of labour as a minimum wage is essentially a price floor. As seen from the graph below, a minimum wage above the equilibrium point will create a surplus of L2 than the quantity demanded of L1. Thus firms will hire less workers, creating unemployment which again leads to increasing income disparity.

Another long-term solution is to increase citizen’s human capital as explained earlier would result in higher wages. The UK government can do this by increasing investment in education and give the poor access to education to enhance social mobility. Problems with this is the playing field is always moving as even if the bottom end managed to increase their wages, the problem of income disparity lies in people in the top end increases their income by a far larger proportion than the poor. The current UK government had in fact reduce government spending on education and tripled tuition fees for university as a result of huge debts deficit and this might have an impact on income disparity.

In conclusion, the trend of increasing income inequality in the UK labour market is due to factors such as globalisation and advancement of technology which effectively empowered the top 10% earners. Efforts by the UK government to reduce this income disparity by helping the bottom 10% all have its resulting problems thus it requires effective management between the benefits and drawbacks of the measures. Thus although it is seems unlikely to reverse this trend, it is worth noting that without these measures, income inequality would be much worse than the present situation.

References:

Bannock, G., Baxter, E., and Davis, E. (2003) The Penguin Dictionary of Economics (7th Edition). London; Penguin.

Gillespie, A. (2007) Foundations of Economics. Oxford; Oxford University Press.

Joyce, R. Poverty and Inequality in the UK, Institute for Fiscal Studies

Mankiw ,G. (2009) Principles of Economics (4th Edition) Beijing; Cengage Learning Asia

Miller, R. (1996) Measuring what people know: human capital accounting for the knowledge economy, Paris, OECD

(2010) How union membership has grown- and shrunk [online],
Available:
http://www.guardian.co.uk/news/datablog/2010/apr/30/union-membership-data [19 Nov 2010]

Riley, G. (2005) AQA Busines Economics and the Distribution of income, West Yorkshire, Tutor2u Limited

Wilkinson, R. & Pickett, K. (2009) The Spirit Level: Why Equality is better for Everyone, Great Britain, Penguin Books

Nightingale, K. (2002) Taxation: Theory & Practice, 4th edition, Essex, Pearson Education Limited

Sloman, J. (2006) Economics (6th Edition). Essex; Pearson Education Limited.

Biblography:
Bannock, G., Baxter, E., and Davis, E. (2003) The Penguin Dictionary of Economics (7th Edition). London; Penguin.

Gillespie, A. (2007) Foundations of Economics. Oxford; Oxford University Press.

Joyce, R. Poverty and Inequality in the UK, Institute for Fiscal Studies

Mankiw, G. (2008) Essentials of Economics (5th Edition). Kentucky; Cengage Learning.

Mankiw ,G. (2009) Principles of Economics (4th Edition) Beijing; Cengage Learning Asia

Miller, R. (1996) Measuring what people know: human capital accounting for the knowledge economy, Paris, OECD

Nightingale, K. (2002) Taxation: Theory & Practice, 4th edition, Essex, Pearson Education Limited

Riley, G. (2005) AQA Busines Economics and the Distribution of income, West Yorkshire, Tutor2u Limited

Sloman, J. (2006) Economics (6th Edition). Essex; Pearson Education Limited.

Wilkinson, R. & Pickett, K. (2009) The Spirit Level: Why Equality is better for Everyone, Great Britain, Penguin Books

(2010) How union membership has grown- and shrunk [online],
Available: http://www.guardian.co.uk/news/datablog/2010/apr/30/union-membership-data [19 Nov 2010]


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