Higher costs for employers stunt Britain’s economic growth

An economy built on the availability of work is an important societal underpin. A healthy jobs market provides access to community, at a time when community is increasingly remote, or fractured. The availability of work also supports the confidence to invest in children, in housing, in oneself. Engagement with work offers the opportunity to learn and share new vocational skills, including digital skills which are increasingly central to a productive and competitive economy. Whilst the UK has certainly been ‘capital poor’ over recent decades – investing significantly less than comparable countries in its infrastructure - it has equally been ‘labour rich’. Even groups that have had, historically, more of a marginal attachment to the jobs market have seen increasing employment. Those born outside of the UK now have, for the very first time, a higher employment rate than those born in the UK. The employment rate of those aged over sixty-five has doubled in twenty years. Not everyone would welcome those changes, but it does at least speak to an economy that has widely offered jobs where jobs were sought. The alternative is not to be encouraged.

This is what makes recent developments in the UK labour market all the more concerning. Payroll employment has now declined by 194,000 since mid-2024. The UK’s unemployment rate has recently risen to 5.1%. This is up from 3.9% as recently as November 2023. Over the same period the unemployment rate in the G20 - a group of countries encompassing 85% of the world economy - has remained stable. This asymmetry between recent UK labour market trends, and those in comparable economies should concern those tasked with stewarding the UK economy.

So what is behind this change in the UK labour market’s performance? The contemporary explanation - one that makes economists sound smart and insightful - is to blame AI. With a disproportionately large share of workers in analytical, knowledge management and creative industries - those facing the vanguard of AI’s disruptive tools - the UK looks exposed. But comparing the use cases and investment in AI, with the sectoral breakdown of job losses suggests a different catalyst. Retail, hospitality, leisure and manufacturing have seen the largest job losses in recent years. AI may yet cause a decimation in white collar jobs, but this has not been the story so far.

A much more compelling explanation is the rising cost of creating, and sustaining employment in the UK. Employers are exhibiting indigestion to a raft of labour market legislation. All of it individually well-meaning, but collectively damaging to healthy jobs growth. The rising cost of employment in the UK has four components.

The first is the wide disconnect that has emerged between productivity and entry level wages. Since the National Living Wage (NLW) was introduced in 2016 the inflation-adjusted value of the NLW rate has gone up 32%. Productivity - measured by output per hour - has risen by just 6% over the same period. The Conservative Party don’t want to own this story as they presided over it. Labour Party-friendly think tanks have been the biggest advocates of going further and faster. The conspiracy of silence from all sides of UK politics is deafening. Low pay thresholds that rise by 2% plus productivity growth is consistent with the UK hitting its inflation target. The low pay policy enacted over the last decade is not. A National Living Wage that has decoupled from the value generated by employment has been a large contributor to sticky and stubborn inflation, and recent high interest rates.

The second factor is that over a similar timescale we have seen a revolution in UK pension participation, and contributions. Auto enrolment into workplace pensions has further contributed to the rising costs of employment. Similar to the NLW, the policy originates in well-meaning efforts - in this case to generate secure retirement incomes. It has however been done, in part, by increasing employer pension contributions independent of the productivity of those workers.

So employers had been dealing with these twin policy measures by passing through higher prices, squeezing profit margins, and identifying non-labour cost efficiencies. But then came a third, and a fourth policy headwind.

The choice of Employer National Insurance contributions as a £25bn/year tax increase to fund the spending goals of the Labour government was the third of these headwinds. This tax change, combined with the impact of higher pension contributions, means that total employer contributions to non-pay costs made up 9.4% of UK GDP during the second half of 2025. This is equivalent to £280bn/year. That is the highest level of social contributions by employers ever recorded by the Office for National Statistics.

Fourth and finally, the government introduced its Employee Rights Bill that was initially estimated to cost employers £5 billion/ year, albeit this has now been watered down to an estimated £1billion/ year. One of the reasons that financial markets that lend to the UK government are currently showing signs of nerves is that the architect of that final labour market reform, the former Deputy Prime Minister, Angela Rayner, is favourite to take over from the Prime Minister should he be forced to resign. Either she didn’t understand the cumulative impact of her legislation on the UK economy, or was not presented with that analysis by her officials. Neither diagnosis is positive for a high growth, low inflation UK economy under her stewardship. Financial markets are simply respond to what they see in front of them.
Business - the champions of growth - are looking for a government that understands that the UK economy has increasingly priced itself out of competitiveness for labour, as well as in energy markets, and in deploying capital for investment. It craves political leadership that takes on the challenges of lowering costs across all three of those areas. The latest data from the UK jobs market is telling the government that its plan isn’t working.