Why Labour is making labour more costly

The UK unemployment rate now stands at 5%. Outside the pandemic, it hasn’t been that high in a decade. The retail and hospitality sectors have been shedding jobs, and there are fewer vacancies now than at any time since April 2021.

That’s all rather gloomy. But set against that, there are early signs that the UK economy could be undergoing a productivity revival. That’s much cheerier: productivity is just about the most important economic metric there is. So, are these things related? And has this been the government’s strategy all along?

Whether or not there is a productivity revival depends on how you measure it. Looking at the standard Office for National Statistics (ONS) numbers, it’s a revival-free zone. But these estimates are based on the beleaguered Labour Force Survey, which has struggled with quality issues and low survey response rates. These have improved recently, but economists are still sceptical.

Under an alternative measure, based instead on payroll data from HMRC, productivity has increased by 2.7% since the third quarter of 2024. That’s equivalent to 1.8% per year, three times higher than the 0.6% per year we averaged over the 2010s, and not a million miles off the growth rates we enjoyed in the good old days before the 2008 financial crisis.

Fortunately, “there are good reasons to trust the HMRC payroll data, and therefore good reasons to think that the productivity rebound is genuine”, says Gregory Thwaites, associate professor at the University of Nottingham and research associate at the Resolution Foundation. So, if it’s genuine, what’s driving it?

In her first budget, Rachel Reeves increased employer national insurance contributions. Due to how it was designed, the change had the biggest impact on the cost of employing lower-paid workers. This was coupled with a chunky increase in the minimum wage. Evidence collected by the Bank of England suggests that a sizeable minority (between 30% and 50%) of firms responded by employing fewer people.

There are two reasons to think this could be related to the productivity uptick. The first is what’s often called the batting average effect. If job losses have been concentrated in lower-paid, lower-productivity sectors, the average productivity of the jobs which remain would increase. And that’s what has happened: between March 2025 and March 2026, the largest reductions in employment were in retail and hospitality, both of which are lower-paid, lower-productivity sectors.

Here, it’s noteworthy that in December 2023, the Resolution Foundation – then under the leadership of Torsten Bell, now an influential Treasury minister – argued that: “If some sectors grow, others will have to shrink … hospitality represents a higher share of consumption in the UK than anywhere else in Europe, because it is relatively cheap.”

Government ministers are unlikely to proudly trumpet about job losses in pubs and restaurants, but shrinking the hospitality sector could conceivably have been an unspoken part of the strategy.

The second, related development is what economists call “capital deepening”. The idea is, when it becomes more expensive to employ workers, firms invest more in “capital” (ie machines and equipment) to make the workers they do have more productive.

The proliferation of self-checkout machines within supermarkets is a good example. Tera Allas, honorary professor at the Productivity Institute, tells me that recent increases in retail productivity in the ONS data are “consistent with capital deepening, continued automation and digital adoption” – but that we’re still some way behind her native Finland, where it’s now common to see completely unmanned petrol stations and automated pizza vending machines. For UK supermarkets, the next frontier might be the installation of electronic price labels on shelves, rather than having a person go around updating them by hand.

The story above can’t explain everything – it can’t explain the strong productivity gains within areas like publishing or telecommunications, for instance. And the evidence is still far from definitive. Peter Dixon, senior economist at the National Institute of Economic and Social Research, cautions that “it’s too soon to say whether the recent increase in productivity will prove to be a statistical artefact”.

Even with those caveats, it’s worth asking: is this the government’s plan working as intended?

After all, as Gregory Thwaites puts it, “if the government was pursuing a plan to achieve stronger productivity growth by making labour more costly, this is how it would show up”. Accepting higher unemployment as the price to be paid for stronger productivity is a coherent choice to make. The key question, he says, is “what happens to the people who lose their jobs?”

Photograph by Getty Images