The economic effects of changes in labour laws: new evidence for the UK

Simon Deakin and Kamelia Pourkermani (April 2024), Digit Policy Brief

Summary

The economic effects of labour laws have been much debated. In seeking to protect workers, do they actually end up harming them and the economy? Do they introduce rigidities and distortions into hiring decisions, causing unemployment to rise? Or do labour laws, by protecting workers from arbitrary treatment, help to create a more productive, more inclusive economy?

We provide answers to these questions for the case of the UK, using a dataset which tracks changes in the content and strength of legislative protection for workers around the world from 1970 to the present day.

Using our dataset, we can estimate the impacts of the UK’s labour laws on four key economic indicators: productivity, employment, unemployment, and the labour share of national income (the share of income going to wages and salaries as opposed to dividends and profits). We find that stronger labour protection is associated with higher employment and lower unemployment. Particular types of labour laws, including those regulating flexible working, working time, and employee representation, can have positive productivity effects.

Given these more granular findings, we urge policy makers to look beyond simplistic arguments about regulation constraining productivity. Some labour law reforms may both enhance productivity and help to ensure that workers and firms share the benefits of productivity gains. This evidence should be considered as part of a wider strategy for addressing the UK’s relatively weak productivity performance.

Debating the relationship between labour law and productivity

In its 2008 Doing Business report, the World Bank argued that ‘laws created to protect workers often hurt them’ (World Bank, 2007: 19). It claimed that where legal protections were unduly burdensome or rigid, firms would be deterred from hiring, and the young and unemployed would find it more difficult to find work. However, in its 2015 report, the World Bank shifted its stance. It suggested that laws protecting workers against ‘arbitrary and unfair treatment’ could ‘increase job stability’ and, notably, ‘improve productivity’. Labour laws could be not just ‘too strict’ but ‘too loose’, leading to ‘losses of employment in an economy’ (World Bank, 2014: 231).

It has long been recognised that worker-protective labour regulation can induce firms to invest in new capital and upgrade systems of production. In Britain, the nineteenth century Factory Acts, which were the first in the world to regulate the length of the working day and week, led not to the loss of profits and employment which some had predicted, but to increased capital investment, improvements in labour productivity, and sustained employment growth (Moos, 2021).

Labour productivity is about the relationship between inputs and outputs: productivity rises when more output is achieved per unit of input. Productivity is not simply the result of worker effort (although that is part of it) but is also the result of firms investing in capital goods and equipment. Other determinants of productivity include the level of training workers receive and the capabilities of management. Improving productivity helps firms become more innovative and profitable, but it can also help workers enjoy the benefits of a shorter working day and week and, under certain circumstances, a more rewarding work experience.

Labour laws, by requiring employers to treat workers fairly, prevent firms from pursuing strategies based on exploitation and intensification of labour, in favour of those which mobilise the skills and knowledge of workers. In a well regulated economy, competition between firms to attract skilled and committed workers can lead to a ‘race to the top’ in labour standards.

Labour productivity in the UK has grown substantially in recent decades, but the rate of increase slowed considerably following the global financial crisis of 2008, and the UK has fallen behind other large economies in Europe and the G7 on this measure (Van Reenan and Yang, 2023). It is generally recognized that the UK has a productivity problem and that this is harming both firms and workers. Policy makers have focused on the need to encourage investment in capital goods and in skills as answers to this problem; labour law may also be part of the solution.

  • Regulate and protect forms of working
  • Set limits to the working day or week
  • Protect workers from arbitrary dismissal
  • Establish rights to collective bargaining and consultation
  • Protect rights to take industrial action

The University of Cambridge Centre for Business Research Labour Regulation Index is a comprehensive index of labour laws in 117 countries (representing 95% of world GDP), newly updated to cover just over 50 years, between 1970-2022. Our coding methodology and data is publicly available; earlier versions of the Index have been widely used by other researchers and policy makers around the world, with over a dozen major studies published to date. They mostly show that laws strengthening worker protection produce positive productivity and employment effects (for an overview, see Billa et al., 2024, forthcoming), reflecting a wider trend in the evidence base for this question (Brancaccio et al., 2020). We have now added new data (Adams et al., 2023) tracking changes in labour laws in response to, among other things, the Covid-19 pandemic and the rise of platform work. We are also working on a more granular analysis of trends in the regulation of platform work, which will be reported later in 2024.

Trends in UK labour laws

The Cambridge dataset enables us to explore the granular effects of different types of labour laws, including regulating flexible work; working time; dismissal; employee representation; and industrial action (Figure 1). The charts show trends in labour regulation over time in the UK and Europe. The vertical axis indicates the degree of worker protection, with a higher score indicating more protection. In each case, the degree of protection conferred by UK law is compared to the European average.

The UK’s labour laws have seen numerous changes over the past half-century. From a relatively high level of protection in the 1970s, they underwent a period of deregulation in the 1980s before reviving somewhat in the 1990s and 2000s. Throughout this time, the UK’s labour laws were less protective than the European average, during a period when labour productivity in the UK also lagged behind that of other large European economies.

While generally less protective than the European average, the UK’s labour laws are not markedly out of line with European trends (Figure 1). UK dismissal law, for example, is close to the European norm, and significantly more protective than equivalent laws in the USA. Some areas of UK labour law reflect the influence of EU law; this is particularly the case with respect to laws regulating flexible work (reflecting the implementation of EU directives on part-time, fixed-term, and temporary agency work) and working time (reflecting the impact of the EU’s working time directives).

Figure 1. Trends in labour regulation over time in the UK and Europe

The economic impact of labour laws in the UK

Using econometric analysis, we have estimated the effects of changes in different types of labour law on the UK economy over a 53 year period (Figure 2 and Table 1). We use impulse response function analysis to model the causal impact of a legal change on the economy. Our methodology is set out in more detail in a report for the International Labour Organization (Billa et al., 2024, forthcoming).

In the period we are studying (1970 to 2022), there were dozens of changes in UK labour regulation which could, in principle, have had various effects on the economy. We report here the average effect (rather than the impact of any single event) which changes in labour laws had in the UK over this entire 53 year period. We can see from Figure 2 that labour protections, on average, increased employment and reduced unemployment. No clear results were obtained when estimating the impact of changes in labour laws as a whole on productivity and labour share.

Figure 2. Average effects of changes in labour laws in the UK, 1970-2022
The impact on employment
The impact on unemployment

Note: The impact of the legal changes is represented as an impulse response function following the methodology set out in Billa et al., 2024 (forthcoming). Each chart shows the average change of the period under review (1970-2022). The dotted lines represent the range of outcomes falling within a 95% confidence interval. Source: CBR Labour Regulation Index (Adams et al., 2023) for data on labour laws; ILOSTAT database for productivity, labour share, unemployment, and employment.

Economic impacts of different types of labour laws

By virtue of the granular level of detail in the Cambridge dataset, we are also able to study the economic effects of different types of labour laws. These are reported in Table 1. Our findings here are subject to some degree of uncertainty in terms of the size of effects but allow us to identify the direction of change over time. Changes in the laws regulating flexible work, working time, employee representation, and industrial action had positive impacts on productivity for at least part of the period. Improvements in the laws on flexible work, working time, and employee representation consistently led to higher employment. There is the possibility that laws on industrial action contributed to higher unemployment, but also to positive productivity effects, and to a rising labour share of national income.

Our analysis enables us to differentiate between immediate and medium-term impacts (Table 1). In the case of laws protecting workers in part-time, fixed-term, and temporary agency work, there is an immediate positive impact on productivity. In the case of working time and employee representation laws, the effect on productivity is initially negative, but becomes positive over a period of time (up to a year or more after the introduction of the law).

This is evidence of a ‘delayed efficiency effect’, as found in other studies (see Adams et al., 2019). While labour laws, by imposing costs on firms, may have negative effects in the short-term, their longer term impacts can be positive, as employers adjust to new regulations by investing in capital goods, screening recruits more carefully, and providing firm-specific training. These efficiency gains may then translate into rising employment.

Policy recommendations

Our analysis shows that different types of labour laws have different effects on the economy. This granularity should be attended to in policy development.

If the goal of labour law reform is to increase returns to labour in the form of wages and salaries, strengthening the right to strike is likely to be an effective option. If the goal is to increase productivity and employment, reforms to the laws governing flexible forms of work, working time, and employee representation should be considered.

In seeking to address the UK’s acknowledged productivity problem, policy makers should consider the role of labour law reforms. Although labour regulation is only one of the factors which affects labour productivity, a combination of labour laws of different types may help deliver not just productivity gains, but the more equitable sharing of those gains between labour and capital.

Where labour laws contribute to rising productivity, increasing employment, and a higher labour share of national income at the same time, they help ensure that the benefits of productivity growth are not exclusively retained by firms, but are shared more widely with workers and households, in the form of higher wages and a reduction in the time spent at work.

Further information

The Centre for Business Research (CBR), established in 1994, conducts interdisciplinary, evidence-based research on the determinants of sustainable economic development and growth. CBR research has pioneered new methods of data collection and analysis of enterprise and innovation, novel approaches to macroeconomic modelling, and original datasets tracking legal and regulatory changes and their economic impact over time. The centre is based at the University of Cambridge Judge Business School.

References

Adams, Z., Bishop, L., Deakin, S., Fenwick, C., Martinsson-Garzelli, S., and Rusconi, G. (2019) ‘The economic significance of laws relating to employment protection and different forms of employment: analysis of a panel of 117 countries, 1990-2013’ International Labour Review, 158: 1-35.

Adams, Z., Billa, B., Bishop, L., Deakin, S. and Shroff, T. (2023) CBR Labour Regulation Index (Dataset of 117 Countries, 1970-2022) Codes and Sources, in S. Deakin, J. Armour and M. Siems (eds.) Leximetric Datasets [Updated 2023] Apollo – University of Cambridge Repository https://doi.org/10.17863/CAM.9130.2 (Cambridge: Centre for Business Research).

Billa, B., Bishop, L., Deakin, S. and Pourkermani, K. (2024) [forthcoming] ‘The impact of labour laws on the labour share of national income, productivity, unemployment and employment: first results from the 2023 update of the CBR Labour Regulation Index’, ILO Working Paper (Geneva: International Labour Office).

Brancaccio, E., De Cristofaro, F. and Giametti, R. (2021) ‘A meta-analysis on labour market deregulations and employment performance: no consensus around the IMF-OECD consensus’ Review of Political Economy, 32: 1-21.

Moos, K. (2021) ‘The political economy of state regulation: the case of the British Factory Acts’ Cambridge Journal of Economics, 45: 61- 84.

Van Reenan, J., and Yang, X. (2023) ‘Cracking the productivity code: an international comparison of UK productivity’ POID special report (LSE: Centre for Economic Performance).

World Bank (various years) ‘Doing Business Report’ (Washington, DC: World Bank).

Authors

Prof. Simon Deakin, Professor of Law and Director of the Centre for Business Research, University of Cambridge

Dr Kamelia Pourkermani, Research Fellow in the Centre for Business Research, University of Cambridge

This Policy Brief reflects the views of the authors and not those of the Digital Futures at Work Research Centre.

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