Can the UK economy move towards full-employment? This question is now being raised as total unemployment continues to decline and evidence grows that the economy has managed to avoid a recession in the current economic cycle.

What Is Full-Employment?

There is no unique definition of full-employment. Most economists are in agreement that unemployment cannot fall to zero since there will always be some frictional unemployment caused by people moving into the labour market (searching for work) and others switching between jobs and experiencing short periods of time out of work.

Full-employment might also be defined as a situation where the labour market has reached a state of equilibrium - i.e. when those in the active labour force who are willing and able to work at going wage rates are able to find work. At this point the remaining unemployment would essentially be frictional.

Several countries have made significant progress towards reaching full-employment in recent years. The chart below shows the standardised unemployment rates for the United States, UK and Germany since 1992. Germany clearly still has an unemployment problem - but in the States and the UK - the current unemployment rates are at their lowest rates for over twenty years.

Another interpretation of full-employment is when the total of people out of work matches the number of unfilled job vacancies. The problem with this is that estimates of the scale of job vacancies vary considerably. Some economists believe that the true number of jobs available is three times the official published figure.

How Close Is The UK To Reaching Full-Employment?

According to the claimant count measure, there are 1.2 million people claiming the Job Seekers' Allowance (4.0% of the labour force). The alternative Labour Force Survey puts unemployment somewhat higher at 1.7m (5.9%). In some towns however we have already reached effective full-employment

Assuming that full-employment is achieved when 2% of the labour force are out of work (i.e. when the employment rate has reached 98%) - the UK economy will have to create another 800,000 to 1,000,000 new jobs for full-employment to be achieved. Many of those unemployed at the moment are out of work for structural reasons and despite a series of active labour market policies designed to bring them back into work, they remain a major long-term problem for the economy.

The Risk Of Wage Inflation

Another obstacle to reaching full-employment is the risk that inflation will pick up as more people find work and total spending in the economy causes businesses to raise prices.

When unemployment is falling, there is pressure on firms to bid up wages both to attract and retain staff. Labour shortages that cause an acceleration in wage inflation might persuade the Bank of England to increase interest rates. This would slow down the economy and the rate of new job creation might suffer as a result.

Although the economy has enjoyed a sustained fall in unemployment over the last six years, bringing unemployment down much further may prove difficult.