Amidst one of the highest inflation rates among advanced economies, the United Kingdom is grappling with an overheated job market and soaring inflation, with signs pointing to a decline in immigration from Europe as a contributing factor, according to a recent report by Goldman Sachs Research. The report highlights that while overall immigration to the UK has increased post-Brexit, the influx of people is now predominantly from outside Europe, with many arriving for humanitarian reasons and to pursue studies.
Goldman Sachs economists James Moberly and Sven Jari Stehn reveal that European migration had a significant impact on the UK’s labor market after the European Union’s enlargement in 2004, which saw several countries joining the bloc. However, the effect waned as migration from the EU decreased after the 2016 Brexit vote. While inflation in the UK is driven by various factors, the report asserts that the tight labor market is contributing to the country’s persistently high inflation rates, with core inflation reaching 7.1% in May, compared to 5.3% in the US, and regular private sector pay increasing by 7.9% in April year-over-year.
Resilient demand for workers partly explains the wage and inflation pressures, but the availability of labor has also played a crucial role, with the supply of workers remaining near pre-Covid levels. In contrast, countries like Canada and the euro area have experienced notable increases in their labor forces.
The report notes that the relative shortage of additional workers in the UK is often attributed to Brexit, which restricted the movement of workers between the UK and the EU. However, the data reveals that total immigration into the UK has actually increased since the EU referendum, with net long-term international immigration reaching 606,000 in 2022, compared to 329,000 in 2015.
A significant shift in the structure of immigration has occurred since the post-Brexit migration regime was introduced in 2021. The regime now emphasizes skills over geography, resulting in a sharp drop in EU immigration, especially from Eastern Europe, while inflows from non-EU countries have risen notably. Additionally, the primary reason for immigration has shifted from seeking work in the UK to humanitarian purposes and education. Before Brexit, net inflows from the EU were predominantly work-related.
The sectors that traditionally attracted the highest percentage of EU workers, such as agriculture, accommodation and food services, and support services, have also experienced the largest rise in vacancy rates and the biggest increase in the jobs-workers gap. While the influx of non-EU workers may partially offset the shortage of workers in these sectors, the report emphasizes that the new migration regime, which is skill-based, may not be able to fully address labor market tightness in cyclical sectors that fluctuate with the economy, potentially leading to greater market volatility.
Furthermore, the report questions whether non-EU immigration can provide the same offset to business cycle fluctuations as EU immigration did. It suggests that while immigrants from outside the EU may contribute less to demand due to remittances sent abroad and shorter stays, they may add more to the labor supply through higher participation rates.
In conclusion, the Goldman Sachs Research report indicates that the post-Brexit change in immigration flows has played a role in the UK’s labor market overheating, although the precise magnitude of this effect remains difficult to determine. The report foresees a slow rebalancing of the labor market through slower demand, even as the UK’s inflation rates remain significantly above those of other advanced economies. As the Bank of England recently raised its main rate by 50 basis points and is expected to hike rates further, the report highlights that the central bank still has considerable work ahead to tackle inflationary pressures effectively.
