The human resources that contribute to GDP are bought and sold in the labour market. The greater the amount and quality of human resources supplied to the market the higher the potential level of GDP. But this potential will only be realised if there's sufficient demand for these resources, which is itself derived from the demand for goods and services.
The market demand for labour is measured by the number of people in work (employment), how much they work (hours) plus the number of unfilled job vacancies. Supply is measured by employment plus the number of people who are looking for work (unemployment).
The balance of demand and supply in the labour market is reflected in the level (or rate of change) of wages. If demand is high relative to supply, earnings will rise. This will increase the cost of employing people which in turn will cause demand for human resources to drop, easing the upward pressure on wages. If, by contrast, supply is high relative to demand, we would expect employment costs to fall and hence increase the demand for labour.
In periods of relatively high demand, the labour market is said to be ‘tight’. Unemployment will be low and there will be many unfilled job vacancies. When the supply of labour is relatively high, the market is ‘slack’ with few vacancies and lots of jobseekers.
Pay and real earnings
Pay is one of the clearest signals of labour market conditions. When demand for workers is high relative to supply, employers may need to raise pay to attract and retain staff. When demand weakens, pay growth usually slows, although the effects of this are not always seen immediately.
It is useful to distinguish between nominal pay and real pay. Nominal pay refers to monetary value that employees receive in current prices. Real pay adjusts this for inflation, showing whether earnings are rising or falling in terms of purchasing power. For example, if wages rise by 4% but prices rises by 5%, real earnings have fallen by 1%.
For people professionals, pay trends provide important context for reward decisions. However, external pay data should be used alongside internal evidence on turnover, vacancies, employee expectations, affordability and fairness. We have separate factsheets on reward, pay structures and pay progression, job evaluation and market pricing, bonuses and incentives, and pay fairness and pay reporting, which go into more detail about setting appropriate pay rates in your organisation.
Frictional and cyclical unemployment
There will always be some unemployment, because jobs cannot be advertised and filled instantaneously, and it takes time for people to move from one job to another. This minimum level of unemployment is called frictional unemployment (commonly estimated at around 3% to 4% of the workforce). A higher rate of unemployment than this suggests that some human resources are going unused.
Unemployment tends to rise and fall over the course of the economic cycle. It is referred to as a lagging indicator of the economy, because it takes a while (normally about six to nine months) for a slowdown in demand for goods and services to translate into a fall in demand for labour. The unemployment that emerges in this way is called cyclical unemployment.
Full employment
An economy operating at full capacity with no cyclical or structural unemployment is said to be at full employment. This situation was close to the norm in the UK and most other developed countries in the 1950s and 1960s and some of the 1970s.
Full employment defined in this way assumes that everybody who can work or wants to work is participating in the labour market.
