Mysteries of the middle class mount amid recession

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 said. "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.

Given the prolonged recession, economists would normally predict that unemployment would soar. It has risen, but, Van Reenen said, "not nearly as much as you would expect, and not as much as in, for example, the United States," where the economic contraction has not been as prolonged. So, when it comes to jobs, Britain has surprised on the upside.
The second riddle is a less cheerful one: While employment has held up relatively well, given the country's poor economic performance, productivity has plunged, an unanticipated departure from the pre-crisis trend line.

"We are 12 percent lower in productivity today than we would expect," Van Reenen said. "That is the puzzle. Why has this happened?

Van Reenen and Pessoa propose a single answer to these two mysteries: Flexible labor markets. In contrast with previous economic downturns, the British economy today has a much less sheltered workforce. The result is what classical economic theory would have predicted: The job market has adjusted more successfully to the shrinking economy than it did during previous downturns.

But that good news comes at a price: The flexibility in the British labor market has been in wages, which have shrunk even more than the economy as a whole.

Source: ARAB NEWS