Published in Whitehall and Westminster World (London), 13 May 2008

At a time when the world economy is going through its most difficult period for decades, there are few things to take comfort in. But one of them, so we are frequently told, is the state of the UK’s labour market.

Official unemployment is still relatively low by any standards. Only about 1.5 million people are currently classified as unemployed, which makes for an official unemployment rate of just over five per cent. This is in fact not too far from the level that most economists would call full employment, where joblessness is mainly a temporary thing resulting from natural fluctuations.

Unfortunately, though, official labour market data conceals a few unpleasant facts. Less than half of all recipients of out-of-work benefits are counted as unemployed. In addition to about one million people receiving Jobseeker’s Allowance, there are more than 2.6 million people claiming incapacity benefits, and more than 600,000 people on lone parents benefits, so the total number of out-of-work benefit recipients stands at over four million.

In fact, this total figure of welfare recipients has been remarkably constant over the past decade. While the government has had limited success in moving some people from benefits back into work, few dispute the fact that more needs to be done. The government itself has implicitly recognised this by commissioning former investment banker David Freud to conduct an inquiry into reforming the UK’s labour market institutions.

Freud’s recommendations, which he presented to the outgoing Blair government in March 2007, had one core recommendation, and that was to give the private and voluntary sector a more important role in employment services. Originally welcomed by Tony Blair and work and pensions secretary John Hutton, Gordon Brown and Hutton’s successor Peter Hain did not pursue these ideas further. Yet, more recently James Purnell, the third secretary of state for the DWP within a year, has signalled that the government now wants to move forward along the lines suggested by Freud – a step that was also welcomed by the opposition.

While there is now widespread and cross-party support for contracting out employment services to private companies and charities, little was known about international experiences with such policies. In other countries, after all, similar schemes had been in operation for years, so you might think that they hold valuable lessons for UK policymakers. For example, they could show whether, in principle, contracting out was as good an idea as everybody now believes. Perhaps more importantly, they could also show where the pitfalls lie.

This gap spurred Policy Exchange to commission research about five countries that have reformed the way in which they provide employment services to jobseekers: Australia, the United States (Wisconsin), Germany, Denmark and the Netherlands. These are also the countries that are most frequently mentioned in welfare reform debates. The task of the commissioned experts was twofold: on the one hand to judge the effects of contracting out employment services on employment and welfare spending; on the other hand, to identify any difficulties that had been experienced in
the process.

The overall results were encouraging. Altogether, the use of the private and voluntary sectors had brought improvements abroad. In Wisconsin, for example, welfare rolls fell by 80 per cent over three years. In Australia, a 50 per cent drop in job placement costs was achieved. In Germany, the unemployment count fell by one million in the two years after it started to reform its welfare state. Finally, both Denmark and the Netherlands have been more successful in getting lone parents and the disabled back to work than other EU countries.

Of course, it is difficult to attribute directly these achievements to specific welfare reforms. Apart from contracting out employment services, these countries had also introduced other schemes to make life on benefits a less attractive lifestyle. Nevertheless, the examples left little doubt that positive results can be achieved by involving private employment services.

Despite these encouraging results, the international experiences also showed that designing a contracting-out system for their labour markets is not easy. Australia is probably the best country to exemplify these problems, as the Australians went furthest with their reform programme. They experienced a problem of ‘perverse incentives’, with hard cases being ‘parked’ on benefits while agencies focused their efforts on easier-to-place clients in order to maximize outcome payments. There were also substantial ‘deadweight costs’, since many of the successful ‘outcomes’ achieved would have occurred even without the intervention of service providers.

Apart from that, there were cases of fraud where some of the providers used their success fees to pay employers for taking on jobseekers. After the prescribed period, however, these people were then laid off again. Basically, what happened in these cases was a conspiracy of employers and employment service providers against both the welfare state and the unemployed.

Such cases should be a warning against too much optimism for the implementation of employment services reform. There is likely to be a difficult reform process that will need a lot of testing and readjusting until it is got right and achieves what it is meant to achieve. But in light of a wealth of international experience, it should at least be possible to avoid the worst design flaws.