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The Coalition should implement no fault dismissal

    There’s evidence and principle to support no fault dismissal

    It seems like the Beecroft Report is set to cause an almighty row within the Coalition. As all agreed on last night’s Newsnight discussion, the vast majority of the report is not contentious and is very similar to Dominic Raab's excellent CPS pamphlet Escaping the Strait Jacket . The main point of disagreement appears to be on the reforms surrounding ‘unfair dismissal’.

    Beecroft proposes that current unfair dismissal legislation should be abolished and replaced by a new compensated no fault dismissal. This has been portrayed by some in the media as a ‘hire and fire’ policy. But Beecroft specifically ruled out allowing dismissal of employees at any time whilst paying the employee only for his or her contracted notice period.

    Instead what Beecroft proposes is essentially to extend redundancy arrangements to allow firms to move on employees even when the job would continue to exist. Employees would get the same notice period and termination payments as if they were being made redundant. Laws will still exist to protect those who feel they have been dismissed because of discrimination.

    This is a perfectly sensible suggestion, and is being blocked by the very same people who objected to many of Margaret Thatcher’s successful labour market reforms as an ‘erosion of workers’ rights’. As Beecroft outlines, there are three main channels through which it will improve the performance of the UK economy:

    • Efficiency of workforce allocation: some firms are currently unwilling to sack underperforming employees and replace them with better performing ones, and would be more inclined to do so.
    • Productivity: because of the knowledge of firm reluctance to fire poor performing staff, some workers don’t work to their potential, and would be more inclined to do so if they could be more readily replaced.
    • New employment: for small companies, taking on employees is a huge risk – if this risk can be dissipated somewhat through this change, then more new jobs are likely to be created.

    A more productive, efficient economy with new net jobs compared to the status quo. What’s not to like?

    As far as I can tell the objections to Beecroft come on four different levels:

    1)      Some argue that there is no evidence that the change would create any jobs and that the UK already has very flexible labour markets

    2)      Some argue that we don’t want to create a ‘hire and fire’ culture

    3)      Some argue that it would increase uncertainty and further depress consumer confidence

    4)      Others merely say that it is not a big issue right now

    Let’s take each of these in turn:

    1)      It is certainly true that, according to the OECD, the UK already has the 3rd most flexible labour market regulations. However, this is not a reason to rest on our laurels. Western and developed countries must wake up to the fact that our competitors going forward are the emerging markets, not those already in the OECD. What’s more, our overall labour market flexibility position hides key differences in a number of areas. On hiring and firing practices, we have the 36th most flexible in the world, behind, among others, Denmark, Iceland, Georgia, and Malaysia. Why not aim to be more competitive in this area?

    On the evidence, the most recent study by the IMF did, indeed, find that a more flexible labour market led to lower unemployment, after controlling for a range of other macroeconomic factors. In fact, the conclusion of that report was even starker in support of Beecroft’s policy:

    “Our findings indicate that, after controlling for other macroeconomic and demographic variables, increases in the flexibility of labor market regulations and institutions have a statistically significant negative impact both on the level and the change of unemployment outcomes (i.e., total, youth, and long-term unemployment). Among the different labor market flexibility indicators analyzed, hiring and firing regulations and hiring costs are found to have the strongest effect.”

    More generally, it is of course extremely difficult to strip out other factors to examine the effectiveness of supply-side policies.  The world economy is facing huge challenges at the moment and it would be wrong to claim that employment law reform is a silver bullet. But given the uncertainties that surround the global picture, is it not imperative that we do everything we can to remove barriers to employment and growth?

    This is particularly true in small firms, which BIS analysis in 2011 showed created two-thirds of all new jobs between 1998 and 2010. For these, employing someone is an extremely risky decision, especially when you are unaware of whether your business is going to be affected by the on-going Eurozone crisis. It’s logical that firms would be more inclined to employ if they bore less risk of their business taking a turn for the worse.

    2)      The most trivial argument against it comes from those who protest that they object on principle. Michael Oakeshott, for example, has said repeatedly on news programmes that he doesn’t want to see the creation of a ‘hire and fire culture.’ And yet in the next sentence he agreed with Dominic Raab MP that it was right the Coalition had extended the qualifying period before an employee can bring an unfair dismissal claim from one year to two. Surely, as a matter of principle, this is exactly the same thing. Why should someone be treated any differently because they have been working for a company for one and a half years compared to two and a half? Oakeshott’s acceptance of the qualifying period extension proves that he recognises taking on employees is extremely risky. But his opposition to the Beecroft proposal suggests that he believes that this risk doesn't exist after the employee has worked for you for two years - an extremely arbitrary cut off point.

    It’s worth bearing in mind here that employers are unlikely to want to get rid of good employees. It would only affect the small minority who do not pull their weight. And there is no way the proposal could possibly raise the level of unemployment – when jobs no longer exist, the employee would be made redundant. Compulsory No Fault Dismissal would therefore only be used where an employer is replacing one employee with another.

    3)      Building on the previous argument, some state that this law change would create uncertainty for workers about the future prospects for maintaining a job and so would depress consumer confidence, lowering growth. This seems far-fetched and insignificant. Likewise, this is an area where there is absolutely no evidence to suggest it is true. If it was the case, then it would also be an argument against the extension of the qualifying period, as outlined above. Likewise, the US didn’t seem to have much of a problem with consumer confidence in all the years in the build-up to the crisis, despite their more flexible hiring and firing practices. And this argument seems to completely ignore another potential effect: that people currently coasting in their jobs will become more alive to the fact that there is high unemployment, providing a ready supply of workers for their job if they fail to perform. If this increases productivity and wealth, it could generate more new jobs!

    4)      There are of course many other things which the Government could be/is doing to raise our long-run growth rate. But this doesn’t mean that these micro measures focused on employment law are invaluable. Two-thirds of all net new jobs in industrialised countries over the past ten years have been generated in firms with less than 50 employees. The ability to have the flexibility to react to ever-changing economic circumstances is now more important than ever, as Germany recognised when it undertook its supply-side package which has contribute to its competitive position today. While these policies might not have huge immediate effects on growth – the economic rationale that it will make the economy that bit more efficient, productive, and potentially encourage small business expansion is good reason to push ahead.

    So, there’s evidence that more labour flexibility works. It’s an extension of a principle we utilise already. It’s theoretically sound. Why on earth wouldn’t the Government do it?

    Ryan joined the Centre for Policy Studies in January 2011, having previously worked for a year at the economic consultancy firm Frontier Economics.

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    Comments

    WILLIAM WALTER - About 3051 days ago

    An excellent article, which I whole heartedly support.

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    David Ashcombe - About 3051 days ago

    Mostly sensible arguments, but undermined by the political realities.

    The article is incorrect about only "poor" workers being affected, as employers will want to get rid of good workers and do - sometimes that is the economic reality and necessity. So "fire at will" policies will result in good employees losing their jobs if an employer needs to reduce costs or change direction. And those job losses will be unpopular.

    But the major issue that this recommendation doesn't address is the reason that employment protection has grown up in the first place - a failure by the market to set an adequate price for termination of an employment contract. A reasonable financial settlement arrangement (e.g. 5% of pay x length of service - five weeks for a two year employee, six weeks for a ten year employee) would provide reasonable protection to employees while removing the need for many of these employment protections that constrain employers, while giving employers a reasonable cost to include in their economic decision making.

    It is that failure to set a market price for "no fault" dismissal that has led to the increasing burden of employment regulation, which unfortunately has ended up constraining employer flexibility. Setting a price that is fair to both employees and employers would deal with this market failure and enable the possibility of flexible labour markets. After all, if my mobile phone company believes it reasonable that I should have to pay a fee to terminate my contract early, why shouldn't employers accept that they should have to pay an appropriate termination fee for ending an employment contract.

    I believe that if you don't deal with that problem in the employment market then the simple fact that employees outnumber employers significantly in the electorate means that there will be an inevitable pressure to strengthen employment protections - which is how we got to the current position.

    I am sure that is why Cameron is backtracking on this at the moment: tragic stories in the run up to the next election of hardworking loyal good 20 year employees losing their jobs, with no or minimal compensation, would be a gift to Labour.

    DA

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    Ryan Bourne - About 3051 days ago

    David,

    The Beecroft proposals entail the no fault dismissal option generating a redundancy package - they would get compensation.

    But on whether this is a 'fair' price - well, what is fair? Your settlement arrangement seems pretty arbitrary. At the moment there is a huge supply of unemployed workers who would like to enter the labour force.