Current account deficit rains on George Osborne’s parade

The chancellor made the most of yesterday’s news that GDP growth for the last quarter of 2015 was slightly higher than expected and the UK’s post-recession growth has now overtaken the average for the G7. He said:

Today’s figures confirm that Britain remains one of the fastest growing major advanced economies, finishing the year with stronger economic growth as annual business investment and living standards strengthen further.

Well the first bit is true:

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Chart from ONS Quarterly National Accounts, 31 March 2016

Not sure about that last bit though. Household income might be higher than it was a year ago but it fell slightly during the last quarter of last year.

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Chart from ONS Economic Well-being, 31 March 2016

So did some other things. GDP and GDP per head might still be rising but Net National Disposable Income (NNDI) fell again in the last quarter. NNDI is the income payable to UK residents. This is effectively GDP minus income owed to foreign residents plus income from abroad owed to UK residents. (See previous post.) Once foreign investors had taken their cut, the amount of GDP payable to people in the UK fell during the last quarter.


Source: ONS Economic Well-being, 31 March 2016

The gap between what foreign investors take from the UK and what UK investors take from abroad is part of yesterday’s other big story, this country’s current account deficit with the rest of the world. The shortfall between money coming into the UK and money going out is now at its highest since the ONS started counting in 1948.

The RBS Economics team published a presentation yesterday putting all this into context. The balance of the income from Britain’s investments has been negative for most of the last 40 years but got quite a lot worse during the last few.


Chart from RBS Economics, 31 March 2016

How much of a problem is this? The RBS economists warn against crying wolf, arguing that the current account has been bumping along like this for years.


Chart from RBS Economics, 31 March 2016

Duncan Weldon doesn’t agree:

The economics team at RBS are far less concerned than me. And whilst they are completely correct that the current account has historically been a poor indicator of recessions or steep currency falls, I’m not sure that means policymakers can ignore it. It’s at least a potential vulnerability — and I’d rank it along side productivity growth & median wages as one of the UK’s three key short to medium term challenges.

To me it’s a warning light and one that is now flashing. That doesn’t mean we face an imminent crisis (although it does mean any Brexit vote could trigger a reappraisal of UK risk appetite and get a far bigger reaction than if the current account deficit was smaller) but it does perhaps tell us that something else has gone amiss in the economy.

And, outside the two major wars, this is the worst it has ever been:

GDP growth is all very well but if a lot of it leaves the country then most people won’t be any better off. Eventually, if there is more money going out of the country than coming in, it will affect living standards. Someone, be it government, companies or households, will end up borrowing more.

Of course, this could all be a blip. It may be that the last few months of last year, with its rising current account deficit, drop in productivity and falling wage growth, will turn out to be an anomaly in an otherwise healthy recovery. Perhaps the OBR was a bit premature when it called time on the recovery.

But, as Duncan says, there is a sense that something has gone amiss. This has been a hideously slow recovery. As the blue line on the second graph shows, it’s only in the past year or so that people began to feel they had recovered from the recession. There are signs that a mediocre recovery might already be running out of steam. It feels like a party that never really got going.


Ambrose Evans-Pritchard thinks we should be very worried:

In a sense, Britain is like a giant hedge fund. Its financial players borrow short and lend long on a huge scale across the world, earning a fat spread in good times. This income stream has shriveled up in our new era of secular stagnation, negative rates, and a global savings glut.

Yields have fallen to historic lows. The Government is betting that the current account deficit will fall again automatically as the world economy returns to normal and yields rise again, and therefore that Britain will be let off the hook. This may be wishful thinking. Low returns may now be a permanent way of life.

So the income from abroad that used to get us off the hook on the trade deficit might have dried up for good. This couldn’t have come at a worse time:

The moral of the story is that if you want to call to a referendum on such a neuralgic issue as EU membership, don’t do it when you are running the worst current account deficit in 244 years of recorded history.

No doubt we will hear more about this in the next few weeks.

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UK employers pillaging Europe’s talent

The UK has one of the highest rates of overqualification in Europe. Research by the Institute of Public Policy Research two years ago placed Britain towards the upper end of the overqualification league table for those with both graduate and upper secondary level qualifications.

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A report last year by the Chartered Institute of Personnel and Development, looking specifically at graduate overqualification, presented a similar picture.

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A couple of weeks ago, reflecting on the number of foreign graduates I have come across in London doing clerical and administrative jobs, I wondered how much of this might be due to immigration. Recent OECD figures indicate that, since the recession, the UK has seen one of the biggest rises in the rate of over-qualification of foreign-born workers.

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Data from the ONS, released earlier this month, supports my hypothesis. The ONS looked at the number of people with qualification levels above and below the mean for their jobs. It found that, until the middle of the last decade, both over qualification and under qualification had been falling.

Screen Shot 2016-03-29 at 11.21.55The decline in under-education is, in part, due to a cohort effect. Younger workers with higher qualifications have raised the average level of education in a given occupation while those who came into that occupation when the qualification bar was much lower have been retiring.

But it is the rise of over-qualification that is the most interesting. It can’t be entirely attributed to the recession as it was rising before the downturn in 2007 and has continued to rise ever since. Something else happened in the middle of the last decade though; EU enlargement and a consequent rise in immigration. As this next chart shows, the over-qualification rate among eastern European (EU10) migrants is way higher than that of any other group.

Screen Shot 2016-03-29 at 11.36.32Interesting also is the recent rise in overeducation among those from the old EU. This is consistent with the rise in migration from western European countries since 2012. My anecdotal data about London being full of Spanish and Italian graduates doing administrative jobs may not be far wide of the mark.

This chart also shows that the overeducation rate among the UK born has barely shifted since the early part of the last decade, which suggests that most of the rise has been due to immigration.

The age profile of the overeducated shows them to be concentrated in the 25 to 34 age group. According to the CIPD, more than half the eastern European migrants in the UK are in this age group.

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Screen Shot 2016-03-29 at 12.02.07Migrant workers from the EU don’t tend to come straight from college. Most come after they have some work experience. Degree-qualified employees already attuned to the world of work, willing to work for relatively low pay. From an employer’s perspective, what’s not to like?

At a Resolution Foundation event last year, Alison Wolf suggested that immigration might have had an impact on the amount of training investment by employers. There has certainly been a decline in training since around the same time that immigration and over-education levels began to increase. Having found a pool of cheap, well-educated and work-ready employees, have employers decided they no longer need to train people? Why build when you can buy for less?

Britain’s employers must be among the luckiest in Europe. Thanks to the dominance of English, education systems throughout the world teach young people our language. Freedom of movement and low regulation and low payroll taxes mean that it is easy to employ people from anywhere in the EU and the risks of doing so are minimal. There is an almost inexhaustible supply of high quality and inexpensive labour from which to recruit.

All of this raises another interesting question though. If Britain’s employers are happily pillaging Europe of its brightest and most talented people, how come the UK’s productivity is in the doldrums?


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Another threat to the deficit target: Tory MPs

A couple of people asked me, earlier this week, what the hell was happening with welfare cuts. Are they on? Are they off? What does no more cuts really mean? I was as clueless as the next man, though, which is hardly surprising given that several different messages were coming from our governing party. At one point I wondered if even George Osborne knew what was going on.

As Patrick Butler explains, when the government says no more cuts, it means no more cuts other than the ones it has already planned. Even then, says Tony Wilson, if the welfare cap is breached in one area, the Treasury will look for more cuts in others to compensate. In other words, no more cuts means no more than the £12.8 billion we have already said we will make.

This should come as no surprise. No more welfare cuts, in the sense that many people have probably understood it, would mean the deficit reduction plan would be in ruins. In this parliament, cuts to social security play a far bigger part in the government’s plans to reduce borrowing than they did in the last one.

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Chart via FT

Furthermore, since this chart was done in the autumn, the OBR has cut its forecast for tax receipts. If they are right that leaves another £56 billion to find. Take out that dark blue block of welfare cuts and the whole thing falls apart.

All of which makes the noisy opposition to disability benefit cuts by some Conservative MPs a bit disingenuous. The party’s flagship policy, and the stick with which it has very effectively beaten Labour, is debt reduction. If you were elected on a Conservative slate you must, therefore, either support cutting welfare, cutting public services or increasing taxes. The deficit cannot be eliminated without some combination of the three.

The trouble is, the folklore around welfare says that there is an army of scroungers out there leeching of everyone else. Many MPs, despite having lots of clever people to brief them with the facts, still seem to believe this. But, if ever there were lots of work-shy layabouts, there certainly aren’t now. These days, people on benefits are more likely to be in work, retired or disabled than unemployed. It’s easy for newspapers to come up with anecdotes about scroungers but there are not that many of them. There are certainly not £12 billion worth.

This graphic from the IFS last year neatly illustrates the problem. Reducing welfare costs by £12 billion means taking a big slice out of the benefits paid to the disabled and those in low-paid work.

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To take £12 billion off the welfare budget, then, will inevitably hit people who a number of Conservative MPs think of as the deserving poor. Whether they are the elderly, the low paid on tax credits or people with disabilities, there will be vocal opposition to cutting their benefits.

Regular readers of this blog will know that I have never believed the government could make £12 billion worth of welfare cuts. The events of the last week  show that while many Conservatives might support welfare cuts in the abstract, they don’t like the reality. Since that IFS chart was published, David Cameron has already ruled out cuts to child benefit. The tax credit cuts have been kicked down the road for now but when they reappear in a different form there will be another row. When it becomes clear that the National Living Wage isn’t offsetting benefit cuts, some Tory MPs will start making noises about that too.

As Steve Richards remarked, Conservative MPs support public spending cuts while opposing nearly all attempts to cut public spending. It is probably infuriating for George Osborne but if (or more likely when) he misses his 2020 deficit target, his own MPs will have played a big part in knocking him off course.

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Self-employed slide further into poverty

The state of self-employed incomes doesn’t seem to be getting any better. Research published by the Social Market Foundation yesterday found that the proportion of low paid self-employed, based on both hourly and monthly earnings, has increased significantly since the recession.

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Around 55 percent of the self-employed have monthly incomes that are less than two-thirds of median employee earnings.

This, says the SMF, is only going to get worse once the National Living Wage comes in. The self-employed are not covered by the NLW so, as the NLW rate rises, the gap between the self-employed and employees will increase. By the end of the decade, the SMF calculates that over half the self-employed will be on hourly rates below the minimum wage.

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The research also found that a majority of the low paid self-employed don’t have any income from other sources and even where they do, most don’t have very much. Some of the self-employed might be hobby-jobbers with income from elsewhere but for most of them, their business is their main gig.

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This bears out Michael O’Connor’s findings last year, based on a FOI request to HMRC, that, whatever their other sources of income, the mean incomes of the self-employed are, well, mean!

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The widening gap between self-employed pay and the minimum wage will cause problems for those people claiming tax credits. Universal Credit will start from the assumption that someone is making the minimum wage and will then top up their income accordingly. It will make no allowance for those who might be earning less. This can only make the income gap between the employed and self-employed even wider.

This army of impoverished freelancers may prove attractive to employers who want to keep their wage costs down. The SMF comments:

Effectively, with the National Living Wage acting as a floor for employees, there is a risk that low pay continues to exist, but largely invisible, through self-employment. Further, the self-employed are not entitled to same rights as employees, such as holiday and sick pay. There are different tax implications: elements of National Insurance do not apply to the self-employed. This means that this is not simply an issue of an excluded group living in greater relatively poverty. The divide in the way in which Government treats employees and the self-employed is making it artificially cheaper for firms to move to a model of firm-contractor, and away from the employer-employee model of working.

The steady fall in self-employment after mid 2014 went into reverse almost from the day the National Minimum Wage was announced. Last month, self-employment reached another record high. Many firms seem to lack the resources or capability needed to make the sort of productivity gains that would cover the cost of the NLW. It will therefore be tempting for them to side-step the problem by replacing employee jobs with new self-employment opportunities.

As the old saying goes, the poor will always be with us. Now, though, we call them micropreneurs. Perhaps that takes some of the sting out of what is otherwise a truly mind-boggling pay collapse.

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The economy’s British summer

The spring equinox was at 4.30 this morning, heralding lighter evenings and, we hope, much warmer days. Last week’s economic forecast by the Office for Budget Responsibility felt distinctly autumnal though.

This, the important story from the budget, barely made it onto the front pages. Most of the headlines were about the sugar tax. Only the Guardian mentioned the forecast £56 billion deterioration in the public finances. It is the cause of that black hole that was the real story  on Wednesday.

Some spotted it early. In this great video, recorded just after the chancellor had finished speaking, the FT’s Chris Giles said that the OBR had forecast lower growth, like, forevuuuh!

OK, he didn’t actually mean forever but for the period over which it is possible to make any reasonable judgement, the OBR has effectively told us that growth will bump along at just over 2 percent. We described a period of similar growth as a mini-downturn in 2002, a sign of how far our expectations have shifted. In other words, then, the OBR has decided we’ve had all the post recession bounce we are going to get.


Chart by Resolution Foundation

The chancellor got his excuses in early a couple of months ago, blaming global economic headwinds and a cocktail of risks from the rest of the world. The OBR was having none of it though:

Real economy indicators around the world have not been as weak as financial markets, so we have made only relatively small downward revisions to our forecasts for world GDP and world trade growth, with knock-on implications for the UK’s export markets.

No, what really blew a hole in the public finances was a home-grown problem. Low productivity:

The most significant change we have made to our domestic forecast since November has been to revise down our estimate of potential productivity growth, which in turn reduces the sustainable level of GDP and our forecast for GDP growth over the next five years.

[P]roductivity growth in mid-2015 seemed consistent with our long-held assumption that the post-crisis drag on productivity growth would ease as the financial system returned to full health and that it would be back at its pre-crisis historic average rate of 2.2 per cent by the end of the forecast period. That pick-up appears to have been another false dawn.

The productivity plummet at the end of last year killed all that optimism stone dead.


Chart by Office for Budget Responsibility

The upshot of this is that the OBR’s productivity forecasts have been revised down every year, as this chart from the Resolution Foundation’s excellent budget briefing shows.

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Chart by Resolution Foundation

The report comments:

This change reflects the OBR’s assumption that more of the weak productivity growth post-crisis represents a permanent shift in the UK’s potential to grow, with the pick-up in productivity growth in mid-2015 now being described as a ‘false dawn’.[1] This goes further than the concern that has dominated the productivity discussion to date – namely the scale of the productivity hit endured after the crisis. Instead, it implies that trend productivity growth has fallen.

Productivity is already around 17 per cent below where it might have been in the absence of the post-crisis stagnation. If the trend rate of productivity growth has fallen, then this gap will widen – rising to 24 per cent by the end of the forecast horizon.

In other words, the OBR has given up on productivity growth returning to normal, at least for the rest of this decade.

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Chart by Resolution Foundation

This, says the Resolution Foundation, will have an impact on pay growth. Based on these forecasts, it doesn’t expect real-terms median employee pay to get back to its pre recession level until sometime after the next election.

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Chart by Resolution Foundation

The result of this is much lower tax revenue than the chancellor was hoping for. Some of this shortfall is due to the raising of tax allowances but most of it is simply due to weaker pay growth.

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Chart by Resolution Foundation

So there you have it. Stubbornly low productivity eventually feeds through to a £56 billion black hole in the public finances.

Most people, including me, thought that, as the economy improved, the labour market would start getting back to normal. We assumed that some of the features of the recession, like low investment, low productivity, wage stagnation and high self-employment, would start to unwind. They did, for a while, then over the past few months things seemed to go into reverse again.

This wasn’t what was supposed to happen. Past recessions have always been followed by booms which have made up for lost growth. This time we have had a much more severe downturn but the post recession recovery never really got going.

GDP growth March 2016

Source: ONS, OBR


It reminds me of one of those classic British summers. After a long cold winter, everybody is waiting for the warm and sunny days to arrive but they never quite do. We get the odd hot spell but none of them seem to last very long. The abiding image of the summer is pouring rain at Wimbledon and overcast days at Headingley. Before you know it, there is that first whiff of autumn in the air and everyone is asking where the summer went.

Like the weather forecaster in late August, telling us that we have probably seen the last of the hot days, the OBR told us last week that the best of the recovery is behind us. The economic nights are drawing in and we are now into a period of low growth for the rest of the decade.

Of course, the OBR could be wrong. As Chris Giles says, “this one of the most sudden and nastiest changes of view it has offered to date.” Some people think it is being way too downbeat and its chairman Robert Chote said productivity forecasts are some of the “least certain judgements that any medium term forecaster has to make”.

It could be that the  last few months was the blip, not the previous year. We may still see another spurt of growth. Perhaps the recovery is not quite over yet. Perhaps, but then again, you know what those British summers can be like….

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OBR repossesses the sofa

At first sight, the cuts to public service spending outlined in yesterday’s budget don’t look that much bigger than those in the autumn statement. As these charts from the OBR’s Economic and fiscal outlook show, day-to-day spending on public services is set to fall by £11.6 billion, £1.2 billion more than the chancellor forecast in December. There is also no end-of-parliament boost, of which more later.

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This sounds like a lot and public service providers will find the cuts difficult to make but the reduction in spending is nowhere near what we were talking about this time last year and a very long way from the sheer lunacy of the previous autumn.

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An extra year to meet the target, some optimistic revenue forecasts and shifting more of the deficit reduction burden onto welfare helped to ease the pressure on public service spending.

Since the autumn, though, things have gotten that bit worse. The OBR has downgraded its productivity forecast and its growth forecast for the rest of the decade.



Charts by Resolution Foundation

This, says Chris Giles, is “unremittingly bad”:

There are two big judgments the OBR has made in this Budget: lowering the outlook for productivity growth, and reducing the expectation for the rise in the overall size of the economy.

The first matters for growth with the OBR now thinking the UK can sustain an expansion of only 2.1 per cent a year. When Gordon Brown was chancellor, he thought a “cautious” estimate was 2.75 per cent a year and this lowers income and revenues without lowering public spending.

The second matters for tax revenues, which are levied on incomes, spending and profits, all of which are affected by inflation. Cut nominal GDP forecasts and tax revenues come down even if the exchequer makes some savings from lower forecasts for interest payments on government debt.
In the Autumn Statement, the OBR gave the chancellor an unexpected £27bn windfall to spend between 2015 and 2020. On the same basis, it has taken away £52bn today.

£27 billion to £52 billion? Looks like the OBR has repossessed the sofa and charged interest.

The upshot of this is that, by 2019, annual tax revenues are set to fall some £16 billion short of the November 2015 forecast. To get back to his surplus target by 2019-20, the chancellor will therefore need to find more money from somewhere. As this OBR chart shows, he is helped by the UK’s record low borrowing costs and he has made the rest up from tax increases and cuts to spending on public services and welfare.

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The sharp-eyed among you will have spotted an item labelled “Public service pensions measure”. This is a plan to increase public sector employers’ pension contributions. The OBR explains:

[T]he Government has also placed an additional £2.0 billion a year squeeze on departments in that year by raising planned public service pension contributions, in line with a lower discount rate, but not compensating them for the additional costs they will face. This reduces borrowing by displacing other departmental spending within existing expenditure limits, while reducing net spending on public service pensions.

People who know a lot more about this than I do were somewhat baffled:

But in my simple head, if you make public service providers pay an extra £2 billion into their pension schemes, that is money that has to come off the budget for day-to-day services. In effect, then, this amounts to an extra £2 billion stealth RDEL cut. So the £11.9 billion cut to day-to-day public service spending shown in chart 4.5 is actually £13.9 billion.

You will also notice an extra £2.5 billion of welfare cuts on the chart. Now I am still extremely sceptical about the government’s ability to achieve the welfare cuts it has already outlined, so I’m far from convinced about the additional saving. Without further tax increases, any shortfall in welfare savings will fall back on public services. That would bring us to cuts of £16.4 billion, not far short of where we were last summer.

There is something else about this that doesn’t ring true though. As Chart 4.5 above shows, most of the cuts come in the last year of this parliament. The government will, apparently, go from a £21.4 billion deficit to a £10.4 billion surplus in one year.


Chart by Resolution Foundation

This isn’t what governments usually do in an election year. Accepted practice is to do all the nasty stuff early in the parliament and then give a bit away at the end.

Will any of this really happen, wonders Chris Giles:

Who knows? 2019-20 is just before the next election, so politics suggests it is not the optimal time to be imposing huge tax increases and spending cuts. There is still plenty of time for Mr Osborne to hope something good turns up and he can change his plans.

I’ve long thought that David Cameron and George Osborne are more Micawber than Machiavelli. The sofa has been repossessed but, who knows, another one might turn up before the end of the decade.

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Graduates and the finishing school effect

“Kiss that graduate pay rise goodbye,” says the Times’s financial editor Patrick Hosking. He was commenting on a recent Bank of England report on the composition of the UK workforce which noted that, while the proportion of graduates has gone up over the last two decades, their pay premium has gone down.

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The Bank comments:

There are a number of possible explanations which would be consistent with this finding. For example, if demand for highly skilled workers has not kept pace with an increase in supply, an increasing number of graduates would also lead to a decrease in the wage premium for those with degrees. Alternatively it is possible that the large increase in individuals studying for a degree in the United Kingdom has led to a fall in its signalling value (the ability of degrees to correctly identify more talented individuals) and thus the amount of pay which those with degrees can command.

There is something in both of these explanations. As the number of graduates has risen, a lot more of them have gone into occupations that, at one time, we would not have described as graduate jobs. CIPD research published last summer found that the percentage of graduates had increased in all occupational groups since the early 1990s.

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We would expect the graduate share of professional and managerial jobs to increase but their colonisation of the administrative, skilled and personal service occupations is perhaps more surprising.

At a Resolution Foundation event last year, Andrea Salvatori presented some findings from his work on job polarisation. He found that here are more graduates doing middle skill jobs now than there were 30 years ago while “non-graduates have also seen a major shift in the distribution of their employment from middling to bottom occupations.” Not only are there fewer mid-level jobs but a lot of those that used to be done by non-graduates are now filled by people with degrees.


The CIPD research found that the growth in the number of graduates had outpaced the growth in the number of high-skill jobs in most European countries but that this trend was particularly marked in the UK. This left the UK with a relatively high number of graduates overqualified for their jobs.

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Does this mean that the UK has produced too many graduates? Perhaps, although there are other good reasons for getting degree aside from landing a higher paying job. I wonder, though, whether some of this is due to the number of graduates from elsewhere in the EU coming to the UK and doing non-graduate jobs.

Some of this is due to the difference in pay levels. Graduates can earn more in the UK doing a middle skill job than they can get at home doing a graduate job. But there is also something going on that I call the finishing school effect.

My data for this is largely anecdotal but bear with me. A number of European graduates I have spoken to recently explained that having worked in London means they get better jobs when they return home. One even told me that employers are now looking askance at people who haven’t left the country for a stint abroad. Graduates will, she told me, take any job in London. They are not bothered whether it is a graduate level job and, for the most part, neither are their employers. If you take a job on reception, in finance support or course administration for a big firm it might lead to bigger things but, even if it doesn’t, the mere fact of having worked in the City, West End or Canary Wharf adds cache to your CV.

McKinsey’s recent globalisation report concluded that the world only has eight truly global cities. Only one of them is in Europe and that city is London. It’s no surprise that young people are drawn to it from elsewhere in Europe.

A UCL CReAM report found that the UK has become a magnet for well educated EU migrants.

Even more remarkable is the immigrant population’s educational achievement, which has been consistently higher than that of the native population since 1995, with an increasing gap ever since. Whereas in 1995, about 13% of the UK born and 14% of the EEA immigrant population (excluding those still in full-time education) held a university degree, such was the case for 15% of the non-EEA population. By 2011, the percentage of natives with a degree had nearly doubled, to 24%, while the percentage of EEA and non-EEA immigrants had increased even further, to 35% and 41% respectively.

So the proportion of migrants with degrees is higher than that of the UK born population. As the CIPD found, in a 2014 study, a lot of those EU graduates are working in low- to middle-skill jobs. Screen Shot 2015-07-07 at 10.05.07

The report also found that EU migrants are concentrated in mid-twenties to early thirties age band. In other words, most come to the UK when they already have some work experience. A job in London can then be a stepping stone to a future career here or a gold star on the CV making a graduate more marketable back home or anywhere else.

OK, my data for this is anecdotal and circumstantial but surely some of the UK’s relatively high graduate over-qualification must be due to the attraction it holds for foreign graduates who are prepared to do all sorts of jobs. It is true that some UK born graduates are also finding themselves having to take lower-skilled and lower-paid jobs but that isn’t the only reason for the graduate colonisation of lower skill occupations. It’s yet another symptom of the UK’s, and especially London’s, idiosyncratic labour market.

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