Contact: Andrew Goodwin | agoodwin@oxfordeconomics.com 31 Jan 2022 Economist Andrew Goodwin Chief UK Economist +44(0)20 3910 8013 Research Briefing | UK A new era of weaker labour supply growth  After a decade of consistently strong growth, UK labour supply has slumped since the onset of the pandemic and we expect only a partial recovery this year.  The drop in labour supply is due to a combination of cyclical and structural factors, primarily virtually zero net inward migration due to the pandemic and a hiatus in the rise in the state pension age. Though immigration should rise now that travel restrictions have eased, strict post-Brexit rules mean it’s unlikely to return to pre-pandemic levels.  Participation rates, for males particularly, have also dropped. But we think this will quickly reverse given that the strong labour market recovery has created plenty of job opportunities and boosted wage growth. Rapidly expanding labour supply has been a key driver of UK potential output growth since the global financial crisis, mitigating the impact of low productivity growth. But labour supply fell sharply in the early stages of the pandemic and has remained low even as the economy has recovered strongly. We estimate that in Q3 2021, labour supply was 743,000 lower than it would have been had the 2010-2019 trend continued (Figure 1). While some of the drop reflects temporary, pandemic-induced, factors and is likely to reverse, we still expect labour supply growth to be much slower in the 2020s than in the 2010s, increasing the importance of solving the productivity puzzle. Two factors drove most of the strong labour supply growth of the 2010s: high levels of net inward migration and a rising state pension age. On average, net inward migration added around 250,000 people a year to the UK population in the 2010s, with the vast majority of these being of working age. Meanwhile, from 2010-2020 the state pension age rose to 66 from 60 for females, and from 2018-2020 to 66 from 65 for males. In the 2010s UK labour supply grew strongly, driven by rises in the state pension age and high levels of net inward migration. But the past two years have seen labour supply fall, and in Q3 2021 it was 743,000 lower than where it would have been had the 2010-2019 trend continued. This is partly due to the pandemic lowering participation and immigration. But a hiatus in the rise in the state pension age and more restrictive immigration rules suggest lower labour supply growth in future. Figure 1: Labour supply has dropped well below the pre-pandemic trend over the past two years 31.031.532.032.533.033.534.034.535.0201020122014201620182020Labour supply2010-2019 trendUK: Labour supplySource: Oxford Economics calculations using data from Haver AnalyticsMillions743,000 A new era of weaker labour supply growth Page 2 Working age population growth will be slower Support from migration and a rising state pension age is fading. Since the onset of the pandemic the International Passenger Survey has been suspended, so we don’t have reliable data on the level of migration. But experimental ONS data suggests that net inward migration dropped to just 34,000 in 2020 from 271,000 in 2019 (Figure 2). And with travel restrictions in place for part of 2021 and a new post-Brexit immigration system coming into force, it’s likely that net inward migration was similarly weak last year. Over the next couple of years, we expect to see some improvement due to the end of travel restrictions. Foreign workers are also likely to be attracted by the strong recovery in the UK labour market, which has created jobs and a pickup in pay growth. But in the current political climate it’s hard to see net inflows returning to the levels seen in the 2010s when there was free movement of labour from other EU countries. The latest ONS population projections assume that net inflows settle at 205,000 a year over the medium-term. But with the current immigration rules setting a high bar for potential entrants, we think net inward migration could settle at just under 100,000 a year (Figure 3). The impetus from a rising state pension age is also largely spent. The IFS estimates the latest rise to 66 from 65 increased the employment rate of 65-year-olds by around 8ppts. But in this decade the state pension age is due to rise by just one year – to 67 between 2026 and 2028 – with one further rise planned for the mid-2040s. A government review is ongoing, but it’s unlikely to recommend any changes this decade. So participation rates in the older cohorts are likely to rise at a slower pace than before. The combination of much weaker inflows from abroad and a mere one-year increase in the state pension age means we expect growth in the working age population to slow from 0.9% a year in the 2010s to just 0.3% a year in the 2020s. Indeed, by the end of the decade, we expect the working age population will shrink year-on-year (Figu