Perverse incentives and productivity

The UK's labour market is something of a puzzle. Employment is at an all-time high, but unemployment is higher than might be expected from the employment figures and productivity is falling like a stone. Numerous explanations have been put forward for this apparent inconsistency, most recently by the ONS, the IFS and the TUC. Even FT Alphaville had a go at it. Needless to say, none of these bodies agree on the causes. I've read all these reports, and in my view all of them make useful contributions. If there is one certainty in this matter, it is that there isn't a simple explanation.

But I think they are missing something. The other day I wrote a post asking why there was such a rise in employment when unemployment was apparently not falling a great deal. Who are all these new people, where have they come from and why weren't they working (or unemployed) before?

This sparked an intense debate on twitter about the nature of the new employment. And from it emerged a picture of perverse incentives that I think goes a long way towards explaining not only the difference between employment and unemployment, but also the falling productivity since mid-2011.

The story starts with the ONS's report that 367,000 of the new "jobs" are actually people registering as self-employed. The TUC observes that this is 40% of all new jobs and the vast majority are sole traders. 60% of these new self-employment registrations have occurred since 2011 and the vast majority of people registering as self-employed (84%) are aged 50 or older. A high proportion are men. They work longer hours than employees and earn much less. RBS notes that the remuneration of people in self-employment is generally far lower than the pay of those employed. And it has not recovered since the financial crisis. Average self-employed incomes are still 5% below their 2008 level, whereas average employed incomes are 10% above the 2008 level. The rise in employed income is quite a bit less than inflation in the last five years, so the employed have suffered a cut in their real incomes. But the self-employed have taken a real beating. With real income collapse on that scale, you would expect self-employment to be falling, not rising. So the rise in self-employment is distinctly puzzling.

The ONS also reports that there has been a vast increase in part-time employment (including self-employment) and a corresponding fall in full-time. Many people say they can't get full-time work. And there is evidence that a high proportion of jobs created are low-skill and poorly paid. All of this supports the IFS's argument that labour is relatively cheap compared to capital and that companies are therefore substituting cheap labour for expensive capital investment. Forcing people to work with inadequate capital reduces their productivity: this may therefore be a contributory factor in the productivity puzzle. But it doesn't explain the rise in self-employment.

We know that the rise in employment in the last 18 months far exceeds the fall in unemployment. Therefore many of these jobs must be people who were neither working nor seeking work (unemployed) before. They aren't people who lost their jobs in the recession: the rise in unemployment in 2008/9 more-or-less matches the fall in employment. So they must be new entrants. It seems we are seeing an influx into the workforce of older people who perhaps had taken early retirement, expecting to live off their savings, and are having to return to work because very low interest rates have clobbered their fixed incomes. We are also seeing the entry into the workforce of people who previously were on other benefits, notably disabled people - many of whom may also be over 50 - and single mothers, though I suspect many of these people are pushing up the unemployment figures rather than adding to the employed total. And the employment figures, though not the unemployment figures, may also be pushed up by students working their way through college or university. Whatever the cause, the fact is that far more people are now working than was the case even 2 years ago, and a high proportion of these are over 50.

The problem with trying to return to the workforce when you are over 50 and have been out of it for a while is that you are perceived as being out of date, your skills have atrophied and there are younger people with more recent relevant experience. It is extremely difficult for older people, particularly men, to find work in a squeezed jobs market. In my twitter debate a number of older people commented that they had been forced to turn self-employed because they could not get a job. They were supporting themselves with what Rick calls "odd jobs" - casual work in a range of largely manual or low-skill occupations. This is consistent with the ONS's report that the most common areas of self-employment are cab/taxi driving, "other" construction services, carpentry & joinery, and farming. RBS says there is also a rise in the number of people claiming to be self-employed "managers", which is a useful catch-all for formerly high-skill retired people returning to the workforce. The picture is one of older men, and to a lesser extent women, trying to replace lost benefits or supplement private pensions with casual work until they reach the state retirement age. Entrepreneurial, this isn't.

This might contribute to the productivity problem. Older people may be less fit and energetic than younger ones, so might be slower - though they may have more experience, which would offset this to some extent. And they may not have a great incentive to work hard, since many are simply marking time until they are able to retire. Also, I hate to say this, but people who have been on incapacity benefit for years, or bringing up children, and are now forced to return to the workforce are not likely to be highly productive, at least to start with. But I don't think this is a sufficient explanation of the productivity drop. Older people may be slower but they aren't useless. And what about all the younger people apparently accepting part-time work instead of full-time? How are they surviving, with hugely reduced hours and falling real incomes? No, there must be something else going on too.

The BBC's Five Live programme yesterday suggested that work programme staff were actively encouraging people to register as self-employed if they were doing a small amount of low-skill, low-paid casual work such as cleaning or gardening. This was supported by a number of people in my twitter debate from their own personal experiences. Now why would job centre staff do this? Well, here is perverse incentive no.1. Getting people who are doing small amounts of casual work off the unemployment register benefits both the claimant and the job centre staff, since it relieves both of the burden of signing on (and off), managing constant claim changes due to casual work and dealing with conflicts between the requirements of job search programmes and the work already being done by the claimant. And it flatters the Government's unemployment figures.

But these people are not necessarily doing much paid work. As I said above, entrepreneurial they aren't. They are living hand-to-mouth, doing odd jobs for low pay interspersed with periods of no work. How can they afford to do this instead of claiming unemployment benefits?

This is where the second perverse incentive comes in. The self-employed, and the part-time employed, can claim tax credits. Working tax credit kicks in at 30 hours for a single person aged 25-59 with no dependents, and at 16 hours for people with dependents, people 60+ and people with disabilities. For a couple, working tax credits start at 24 hours between them of which one person must work at least two thirds. The number of hours a couple had to work to claim working tax credits was raised to 24 in April 2012 (previously it was 16 hours between them). At the time, Unison claimed that the effect would be that some couples would simply stop working - but tougher rules for out-of-work benefits may have forced them to remain in work. One of my twitter commenters stated that he did eight hours a week of very poorly paid self-employed work so that he and his partner could claim working tax credits.

The ability of part-time and low-paid workers to claim tax credits creates a perverse incentive for employers, too, because reducing hours instead of laying people off when companies are experiencing financial problems or depressed sales becomes a realistic alternative. In previous recessions, people have lost their jobs. Many people have commented that this time round, companies have held on to labour but reduced hours and wages. In my view this has been made possible by the existence of working tax credits. When put together with the reluctance of companies to invest in capital at the moment, there is clearly an incentive for companies not only to hold on to existing workers but to create low-paid part-time jobs to keep businesses "ticking over", knowing that people who really want full-time work will accept those jobs because tax credits will top up the wages. This seems like a good thing, because it keeps people in work, but if it means that companies are substituting cheap labour for capital investment and technological innovation, it does not bode well for future growth and prosperity.

But the biggest perverse incentive of all is in the realm of self-employment. Consider someone who is doing odd bits of paid work mainly for friends and family, interspersed with periods of no work. That person has no way of knowing what his hours of work will be from week to week. But to claim tax credits, he must be working a certain number of hours per week. So in his claim, that's what he states. He's not being untruthful: he is stating what he WANTS AND EXPECTS to work, not what he is actually doing at the time of the claim. The newly self-employed are business startups in the eyes of HMRC, so are not likely to have low productivity questioned for at least a couple of years. And as I pointed out above, job centre staff may be actively encouraging people who do casual work to register as self-employed. The assumption by both HMRC and DWP is that newly self-employed people are spending significant amounts of time promoting their business, so actual hours of work can considerably exceed paid hours. And this may indeed be true.

But self-employed work, particularly in services, is actually declining at the moment due to the fall in real incomes of the employed, who are the customers of the self-employed. So our newly self-employed are actually finding life very hard indeed and desperately need the tax credits in order to survive. The choice they have is between giving up the casual work and registering as unemployed, or overstating their hours of paid work. Which would you choose?

For me it is telling that the drop in productivity appears to coincide with the massive rise in self-employment since 2011, which itself is driven by changes to benefit eligibility criteria as well as the Bank of England's monetary policy. I know correlation doesn't necessarily imply causation, but I'm unimpressed with coincidences, especially when correlation would help to explain a perplexing phenomenon. Now if the new self-employed were genuine small business startups, then the fact that they appear to have low productivity in the short term would not be a problem - indeed it would indicate that the new business owners were doing significant amounts of unpaid work to develop their businesses, which would be a good thing. But as far as I can see, that is not what the evidence shows.

What emerges is a picture of mainly older and less able people forced back into the workforce, doing insecure, low-paid and low-skill work and managing to survive on starvation levels of remuneration only because of a generous system of tax credits. If this picture is accurate, it is appalling. Far from indicating that the economy is on the verge of recovery, the apparently high employment levels coupled with low productivity may indicate that it is in terminal decline. For as Rick points out, the only economies that rely on high levels of subsistence-level self-employment are very poor ones. Over-tight fiscal policy, callousness towards the less able, unnecessary risk-aversion by companies and banks, and unhelpful monetary policy are turning the UK into a basket case.

UPDATE. I have just found and read the Government's document from December 2012 describing the operation of the Work Programme intended to help the unemployed back into work. The link is here and I have added it below. From the document:
"Service providers are paid almost entirely for results - defined as sustained job outcomes for participants"
Service providers are entirely from the private sector and are paid on results. Quite generously paid, too, and the payments continue the longer the participant remains in work. Which of course if they are self-employed they will be, even if they aren't doing much, because the alternative is going back on to the Work Programme, losing benefits and waiting months for JSA to catch up. The Trussell Trust notes that benefits delay is one of the two main reasons why people use food banks. So there is an incentive both for providers to push participants into self-employment and for participants to remain in self-employment even if they aren't earning very much.

But there is no supervision of how providers achieve their results. This is deliberate policy designed to give providers a free hand in how they design their work programmes:
Previous UK welfare-to-work programmes specified in varying levels of detail what interventions providers had to deliver. The Work Programme, in contrast, gives providers far greater flexibility to design programmes that will work, using their experience and creativity. Rather than asking providers to make one-size-fits-all services work for a wide range of participants with varying needs, government is providing freedom for providers to personalise support for the individual in a way that fits the local labour market. This is sometimes referred to as a ‘black box’ commissioning approach. 
The combination of payment by results with no supervision of how those results are achieved is clearly an incentive to providers to focus on achieving results without consideration of actual outcomes for the participants concerned.

The Work Programme came into operation in June 2011 - which was when employment started to rise and productivity to fall. Is that a coincidence? Judge for yourself. I know what I think. This programme may be successful in terms of numbers, and is no doubt rewarding the providers handsomely, but at what cost to people's lives and the UK economy?

Related links

Self employed workers in the UK, February 2013 - ONS
The Productivity Conundrum, Explanations and Preliminary Analysis - ONS
The IFS Green Budget, February 2013 - IFS
TUC Economic Report, February 2013 - TUC
UK productivity puzzle possibly solved? - FT Alphaville
Startups or upstarts? self employment in the UK - RBS
Benefit changes timetable - Turn2Us
Work advisers "pushing jobless into self-employment" - BBC
Don't encourage the odd-jobbers - we have enough already - Flipchart Fairy Tales
What sort of countries have lots of self-employed people? Poor ones! - Flipchart Fairy Tales
The Work Programme - DWP
Fix the bureaucracy, for heaven's sake! - Coppola Comment



  1. Excellent post, thanks for taking the time to get as much information about the situation as you could, people like you seem to be doing the job we once expected from journalists.

  2. Yes, the substitution effect you refer to, whereby employers would rather take on labour than invest in physical assets, is a consequence of the lack of confidence employers have in the future. So there is an irony there - the absence of current and expected growth is causing employment to rise!

  3. Your analysis sounds depressingly plausible Frances.

  4. "...a vast increase in part-time employment (including self-employment) and a corresponding fall in full-time. Many people say they can't get full-time work. And there is evidence that a high proportion of jobs created are low-skill and poorly paid."

    These comments are certainly in tune with the situation in my household, where my wife (an experienced qualified teacher) is unable to get more than a few hours a week as a low paid Classroom Assistant, with the occasional day of supply teaching thrown into the mix.

  5. Frances, I think you are spot on. I know a number of people who are taking working tax credits and doing odd jobs to avoid going on jobseekers. One big part of their reasons to do this is that it's a lot less hassle to get working tax credit than to get jobseekers. And of course, you don't get pressure to accept jobs you definitely don't want, which you do if you are on jobseekers. But if HMRC thinks these are startups, they've lost the plot (not that I think HMRC ever had much of the plot, actually). These people couldn't possibly find enough jobs to support themselves fully, they know it, and they know they don't have to. And also, to manage on the small amounts of money that they have, they need a fair amount of free time. You can live on very little money if you cook from scratch and walk everywhere, but both those things take a lot of time. In effect, if they did get more odd jobs, it might not work out for them financially as well as you might think.

    On the other hand, I'm not sure if I'd call those incentives "perverse". In the sense that, if the economy picks up, who is in a better position to take advantage of it? These somewhat self-employed people, or those in jobseekers? I think on good economic times these people could become genuinely self-employed (or properly employed with the company they are effectively working for) more easily than the unemployed. And they're also likely to have a few more options on the job they get, instead of being forced on to the first one that comes along. The most perverse incentive here is the incentive that politicians have to imagine the picture in the rosiest possible light, but that's nothing new.

  6. I think your analysis is valid and applies also to other economies in EU. Just one point: *IF* we have to choose between
    a) employers laying off people and keeping only those who they need full time, and
    b) employers reducing hours an wages, while keeping more people employed

    then I think b) has some considerable merit from the point of view of the whole society. You see, unlike many other kinds of goods, employees are not something that you can store on a shelf for a prolonged period of time and expect them to stay good. They won't.

    If we expect times to get better in two years, or five years, of ten years, then it is better to have two employees at work on low hours and low wages until that time, rather than one employee at work with full hours and wages and another one out of work. Because after the ten years, the employee that was put on shelf is likely completely wasted: frustrated, has forgotten what it takes to wake up in the morning and go to work, very possibly killed by alcohol or Jeremy Kyle Show or whatever - unless he or she is so radicalized that he or she resorts to violence.

    That's an *IF* above. I don't really know with absolute certainty that this dichotomy is right, but I think it's quite plausible.

  7. Frances - fantastic piece. Don't you think it stands as an indictment of tax credits in general as a subsidy for low-paid (employed) work?

  8. In an internal review for the Norwegian tax authorities of a proposal on new legislation to stimulate entrepreneurs two years ago, I wrote an analysis that the main effect of this would be converting ordinary labor relationships into contracts between companies. For the tax authorities the effect would be a great increase in the complexity of the tax filings related to the same hours worked. My guestimate was more than four times the bureaucracy from an ordinary employment. It was of course not part of our official response.

    Nice to see others pick up the same trend and the consequences.

  9. With regard to employed people there is also a tax incentive to create part time rather than full time jobs. This is because employers national insurance (Cons job tax) of 13.8% is not incurred until wages exceed about £130 per week.

    For employers it is cheaper to to employ 2 people working 20 hours earning £125 than one person for 40 hours.

    I agree with the comments above that it is more equitable to employ two people part time than have one unemployed.But then neither will earn the living wage they probably need.

  10. Let me begin by saying I don't believe Universal Credit will ever arrive. It's too ambitious to be in any way practical. I imagine some greatly watered down version will limp in and be presented as UC just to save face for IDS and the poitical system that tolerates his presence. But UC as it's envisaged just ain't gonna happen. That said, the plan under UC (as I understand it) is for everyone on self-employment to be assessed as though they were earning minimum wage for 35 hours a week. That'll be deducted from their benefits before anything else is paid. Where will that leave all these people who've been conned into self-employment on the basis they'll always get tax credits and they won't really have to do any work? Since there won't BE any more tax credits, they'll be starving and most likely homeless too. That's the plan under UC which, as I say, I don't believe we need worry too much about as I can't see it ever happening as it's envisaged. But the plan itself is intersting...
    Let's switch tack and look at what's planned for the disabled. Off they go to their Atos assessment, and no matter how ill they are they're probably not going to pass. I hope we know why from the media, I don't want to go into it all again. After they fail, they have to appeal to keep receiving sickness benefits which are paid at the basic rate till the appeal decision which can easily be a year or more later. After April, under planned legislation before they can appeal they have to apply to the DWP for a reconsideration of the original verdict. There's no time limit on this reconsideration. While they're waiting for it, typically 6-8 months assuming it ever happens at all, they won't get any sickness benefits either, not even at the basic rate. Being disabled and unable to work, they clearly can't claim JSA (unemployment benefit) either. What are they supposed to live on? Good question. What are people pretending to work as self-employed so they can claim working tax credits going to live on if Universal Credit comes in? Again, good question.
    You know what? I don't believe what the Coalition has in mind is a recovery at all...

  11. You've missed Baxter the Robot. Increasing levels of automation means the only jobs left for people are either extremely manual or extremely intellectual. Steve Jobs told Barack Obama that the primary reason for moving production to China was the difficulty in finding the 30,000 quality engineering graduates in America. Now Apple are moving production back to America, their new automated factory will create .... 200 jobs. The only people needed on the production line are people who can diagnose and repair the robots.
    China has even been showcasing a burger flipping robot that can cook 1 burger a second to order. Within a few years, McDonalds will actually be a vending machine. What will those workers do?
    Fifty years ago, Buckminster Fuller was complaining about inspectors of inspectors, and people making tools for inspectors to inspect inspectors. That's always a way to make more jobs for people to be busy, and prove to a capitalist society they deserve to eat. Though increasing the layers of middle management or the PR budget doesn't increase productivity.

    1. I don't think Baxter is relevant. I was addressing the UK-specific problem that although employment is rising considerably, productivity is falling. Putting it another way, we don't apparently have difficulty finding jobs for people, but getting them actually to do something useful is a bit more of a problem. I suspect if anything we have cheap labour substituting for robots, not the other way round, because you have to pay for your robots up front so laying them off is a waste of capital, whereas you can lay off a temp worker at the drop of a hat and you won't have lost much. So Baxter is unemployed, actually. The trouble is that people on very insecure temporary or short-term contracts can't plan for the future, so don't spend any more money than they have to.

    2. Perhaps the deskilling trend of recent years has something to do with it?

      You end up with more staff but at a much lower wage level. Training is reduced to save costs and so efficiency / productivity falls further as does motivation.

  12. Hi Frances, would you say then the condition in terms of employment has been stagnant.

    1. It depends on the sector, of course - the labour market is not homogenous, and two sectors (construction and financial services) have suffered a severe contraction. But yes, overall I would say the picture is stagnation. That is borne out by GDP figures.

  13. International Brigade15 February 2013 at 00:03

    I work as an employment lawyer in a not for profit organisation. In the last 6 months here are some of the situations encountered.

    I have come across the following workers all required to work as self employed or to set up their own company to get/ continue to get work:-
    Agency Cleaner (working regularly cleaning one office 15 hours a week)- required to set up own company. Fee to company set at less than minimum wage.
    Seasonal agricultural workers (working for same farm for about 5 months)
    Care worker for an agency (you can see a number of ads on social care recruitment sites stating the hourly rate they will pay a worker or the higher hourly rate they will pay if the care worker trades as a company)
    Site manager working as self employed for 3 years(almost certainly an employee for employment protection purposes) Required to set up own sham company or have self employed contract terminated.
    Bookkeeper required to set up sham company to continue to do books of company she works for for 4 years.
    London Underground maintenance staff forced to work as self employed with new contractor (formerly employed).
    Teaching andlecturing jobs - educational institutions prepared to contract with one man band company to hire a teacher doing regular teaching activities.

    The pressure is coming from the employers and agencies to casualise the workforce.

  14. International Brigade15 February 2013 at 00:23

    I just wanted to add that I have not seen anything on this scale in 25 years of being an employment lawyer.

    I think the main abuse is now in requiring the setting up of small companies - even requiring the worker to sign a contract with an agency's nominated firm of accountants to establish the company.

    There needs to be a major crackdown by HMRC. The IR35 rules are a licence for tax avoidance on both the part of the main contractor and the workforce they engage. Most of these small companies never file returns with Companies House or tax returns with HMRC and just get struck off the register two years after set up - so even the Corporation Tax liability is avoided. The employers are often not paying more for externalising the provision of these services than they were paying by way of salary and employers NI contribution. HMRC needs to be going after the employers for forcing these sham contracts on the workforce.

    Result: casualisation of the workforce, worse pay and conditions, massive leakage in NI and Tax contributions from the PAYE system.

  15. Yes Jems, I am truly agree with you that we need more and more updated ideas on UK job markets with ease. However the global economy is hunting the scarcity of jobs in not only in UK but also in all over the world.

    Again thanks for your great efforts!


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