If you are worried about the Western middle class – and we all should be – you may have started to have some doubts about the virtues of flexible labor markets. In theory, flexible labor markets should make our economies more productive, and all of us richer, by making it easier for people to do the work the economy needs and to stop doing the work it doesn’t.
In practice, though, some economists who once championed flexible labor markets without reservation, like Daron Acemoglu of the Massachusetts Institute of Technology, have begun to have second thoughts. Acemoglu doesn’t doubt the positive economic effects of flexible labor markets, but he has begun to be concerned about their political and distributional consequences. They might help the economy grow overall, but they may also be contributing to the hollowing out of the middle class by weakening its political bargaining power.
That’s why a recent paper by Joao Paulo Pessoa and John Van Reenen, both of the Center for Economic Performance at the London School of Economics, makes such fascinating reading. Van Reenen and Pessoa set out to unravel the two big mysteries about Britain’s economic performance over the past five years. The backdrop to both is the devastation that Britain, with its oversize banking sector, suffered in the wake of the 2008 financial crisis.
“The big story in the UK is that the economy has shrunk by 2.5 percent since the pre-crisis period,” Van Reenen told me. “That’s the longest depressed economy in this country for more than a hundred years.”
Britain’s dismal economic performance certainly helps to explain the grimness of British politics at the moment, and the growing appeal of the nationalist fringe. But the story becomes more mysterious when you start investigating what is happening inside the country’s shrunken economy.