A strong supply of labour with the right skills – having the right people available for the right jobs in the right place – is one of the key foundations of a healthy and resilient economy. Organisations that have the staff they need are more able to take advantage of new opportunities, innovate and lift their own productivity.

“Labour supply is a critical ingredient of economic growth,” stated Neil Carberry, CEO of the Recruitment and Employment Confederation. “The higher quality that labour supply is, and the better directed it is, the better the outcomes will be.”

Supply and demand imbalances in the labour market

One of the issues that the UK is grappling with is an imbalance in supply and demand in the labour market. Jon Boys, Senior Labour Market Economist at the Chartered Institute of Personnel and Development (CIPD), explains: “In terms of demand, there have been record high vacancies [since the pandemic]. This has come down over the past 12 months, but it’s still at a very high level. On the supply side, unemployment rates are still low. Unemployment is not necessarily always bad, and some friction is always needed; people might have recently finished studying, or they might leave one job and look for a better role. But we’ve used up a lot of that slack, and few people are unemployed.”

While there are signs that the UK labour market is starting to loosen, with the unemployment rate rising from 3.8% to 4.3% in the three months to July 2023, it remains below the long-run average (6.7%). Similarly, while the number of job vacancies, a good indicator of labour demand, has eased from a record high of 1.3 million in early 2022, the number of vacancies is still more than 20% higher than before the pandemic, and the number of unemployed people per vacancy remains less than half the historical average.

“While the UK’s jobs market has come off the boil a little recently, this largely reflects the lagged impact of rising interest rates and a floundering economy starting to put firms off from attempting to recruit, despite still facing chronic staff shortages,” says Suren Thiru, Economies Director at ICAEW.

Constraints in labour have served to increase wages, often at unsustainable rates for businesses, with the high inflationary environment – and consequent rises in other costs – exacerbating any problems. The ICAEW’s Business Confidence Monitor, one of the largest and most comprehensive quarterly surveys of UK business activity, shows that between Q3 2021 and Q2 2023, average annual salary growth nationally stood at 3.2%, compared with 2.2% in the two years (2018-19) pre-pandemic and 1.0% a decade earlier. In Q1 2023, annual salary growth data reached a record 4.7%, the highest annual increase since the survey started in 2004.

Average annual salary growth

Source: ICAEW Business Confidence Monitor

The gains have been particularly strong in the IT, and Communication and business services sectors, each with an average annual wage increase of 3.5% since Q3, 2021.

Changing of the generational guard

There are many reasons for the UK’s shrinking workforce, but one of the biggest drivers is a changeover in generations. Carberry explains: “The biggest and most important thing for companies to understand is that we live in a fundamentally different labour market now than the one we lived in 10 years ago. The public debate gets very focused on things like Brexit as a driver for [labour shortages], but arguably, the real thing we need to consider is the retirement of baby boomers – 30% more babies were born in Britain in 1964 than in 1977. And that big generation of the 50s, 60s, very early 70s, is now moving to retirement, and smaller generations are replacing it.”

Added to this is a shift in the ages people start and end their working lives, Carberry points out. “Typically, people aren’t coming into the workforce until at least 18, whereas in the 1960s and 1970s, people regularly started work at 16 or, in some cases, even earlier. On the other end, people are extending their working lives. And in fact, maybe some of the shock we’re seeing post-pandemic isn’t actually because of the pandemic. It’s because of people who delayed retirement after the abolition of the default retirement age about a decade ago and deciding in the pandemic that it was time to stop.”

A shrinking workforce

The UK’s economic inactivity rate – the proportion of people who are neither working nor looking for work – which had been generally falling since records began in 1971, has risen dramatically since the start of the coronavirus pandemic. Increases in economic inactivity in the first year of the pandemic were largely driven by those aged 16 to 24 years, while more recent increases were driven by those aged 50 to 64 years.

Although rising economic inactivity also occurred across G7 countries as they went into lockdown, this trend has largely reversed in all countries except for the UK, where it has continued to rise. The UK economic inactivity rate between May and July 2023 was at 21.1%, 0.9 percentage points higher than before the pandemic.

A key focus from government and businesses has been efforts to reverse the economic inactivity rate. Long-term sickness is a particular issue among economically inactive people, so efforts have also been made to provide extra support here.

Increased sickness in the UK population also poses difficulties for employers. Data from the ONS shows that the sickness absence rate reached 2.6% in 2022, the highest since 2004 when it stood at 2.7%. “There is lots of evidence for increased sickness,” states Boys. “The number of people inactive due to sickness has increased, the number of people claiming disability benefits has increased, and the number of people dying has increased. All these were trending down pre-COVID; now they’re higher than before the pandemic. This is taking people out of work.”

While labour shortages are damaging for businesses, they also have serious implications for the wider economy. As Thiru explains: “A shrinking labour market is a key concern as it limits a country’s potential output. Potential output is essentially an economy’s speed limit because it is the maximum amount of goods and services a nation can produce when it is most efficient and without stoking inflation. A constrained labour supply is severely limiting our ability to increase output without driving up inflation such as through higher wages.” According to Oxford Economics, the UK has the second lowest growth potential in the OECD.

Guy Opperman, Minister for Employment, states, “We know challenges remain [in the workforce participation] and have taken decisive action to tackle this by investing £3.5 billion in employment support, including £2 billion specifically on measures for disabled people and people with long-term health conditions.”

Alongside the investment in employment support, the government also announced a range of other measures in the 2023 Spring Budget, notably extending the provision of subsidised childcare to more families to encourage stay-at-home parents to return to work. From September 2025, the current 30 hours of free childcare during term time for 3-4-year-olds will be extended to all working parents of under-fives.

Struggling to plug labour shortages

In some quarters, there have also been calls to liberalise immigration to plug shortages. “Immigration is very instant, so it’s a tempting valve to push,” notes Boys. However, the government’s immigration policy post-Brexit has become much tighter, with the points-based system introduced in January 2021 seeking to attract high-skilled workers to the UK but reduce the number of low-skilled migrant workers in a bidto cut total net migration.

Research from the CIPD suggests that despite staff shortages, just 15% of employers have sponsored a migrant worker since its introduction. One particular criticism is that it fails to help sectors, such as transport and hospitality, that are experiencing significant worker shortfalls but cannot access labour through the current system. The potential to make the system more user-friendly and accessible for SMEs is also highlighted as critical to driving uptake.

Chronic skills gaps and mismatches

But the challenges facing the UK are not just to do with pure labour supply. There is also the issue of skill shortages and mismatches. For instance, ICAEW's BCM survey finds that many businesses consider the availability of non-management skills as a growing business challenge (see below). A decade ago, just 10% of businesses cited the availability of non-management skills as a rising issue, but in 2018-19, this had increased to an average of 24%, and since Q3 2021, it has increased to 37%. Production industries have particularly struggled, with 27% of businesses in these sectors citing shortages as a growing challenge before the pandemic and 41% since.

Availability of non-management skills

Source: ICAEW Business Confidence Monitor

Availability of management skills is also a concern, though this has traditionally tracked below availability of non-management skills. Here, an average of 15% of businesses surveyed by the BCM considered this a rising challenge before the pandemic, but this has changed to an average of 23% since Q3 2021 (see below).

Availability of management skills

Source: ICAEW Business Confidence Monitor

The Skills Shortage Bulletin from the Edge Foundation highlights how skills shortages in the UK are numerous and growing. Prominent examples include a lack of green skills, with PWC research highlighting a shortfall of 200,000 employees; a scarcity of digital skills, with one study from Gallup and Amazon finding that 72% of businesses have digital skills vacancies, but that only 11% of UK workers have advanced digital skills; and then there is a dearth of manufacturing skills, with the Manufacturing in Excellence report showing that 57% of manufacturers struggle to access a skilled workforce. And so, the list goes on…

“While a key factor driving the skills gap is the shortage in labour supply”, Thiru says, “the lack of a strong system for retraining and upskilling workers to operate effectively in the workplace and take advantage of changes in the economy and technology is one of the main contributors to the skills crisis.”

This skills mismatch is preventing businesses from reaching their productive capacity; as research from the OECD highlights, “a higher skills mismatch is associated with lower labour productivity through a less efficient allocation of resources.” The same report also found that the UK could improve productivity by 5% or more if it reduced skills mismatches to the level of best-practice nations.

There is, unfortunately, no silver bullet when it comes to the UK’s myriad skills shortages. As with all these problems, it will take a long-term plan to be set out by policymakers after listening to employers of all sizes, and it will then take UK businesses – and the chartered accountants that support them – to play their part in understanding what needs to change and helping to implement those policies day in, day out.