Economic theory teaches that people will make the optimal allocation of their time between work and leisure, and if they can’t earn why bother to work? That’s a choice neither individuals, nor the country can afford, says Paul Ormerod
The rise in worklessness is acknowledged across the political spectrum to be a serious problem. It has become much more acute since the pandemic and the lockdowns which took place.
In Grimsby, for example, more than half the population of working age is now on some form of benefit. Across the UK as a whole spending on disability benefits for anxiety and depression has doubled since the pandemic. Official figures show that £3.4bn was spent last year on personal independence payments to claimants allegedly suffering from these complaints.
These are just examples of the pervasive nature of the issue.
But could worklessness simply be a rational response by individuals to the economic circumstances?
The dominant trend in macroeconomics, both in academia and in policy making bodies, for the last few decades has been models with the exotic name of “dynamic stochastic general equilibrium”, or DSGE for short.
Central banks and institutions such as the IMF all have them.
These models, which rapidly become quite hair raising in their maths, have become an important element in the policy making process.
Trade-offs
The basic idea stems from a very influential paper written by two Americans, Finn Kydland and Edward Prescott, in the early 1980s. The authors subsequently received the Nobel Prize for their work.
In essence, Kydland and Prescott focused on the trade-off which individuals face between working and taking leisure. Work provides the income which people need for consumption. But they also value leisure time as well.
The authors argued that people try to achieve what is for them the optimal – the best possible – allocation of their time between work and leisure across their lifetimes.
How would they respond to a negative shock which temporarily reduces productivity?
For the Nobel Laureates, the answer is simple. At some point in the future, productivity will grow again and they can then earn more for any given amount of time which they spend working. But at the moment, they earn less and so their preferences shift to leisure rather than work.
The lockdowns of the early 2020s undoubtedly created a negative shock to growth and productivity. And so, according to the theory, it is entirely rational to spend less time working at present, perhaps even taking this so far as to choose not to work at all.
So perhaps we should not be too worried about the recent surge in worklessness. Once growth resumes, they will all make a rational choice to take less leisure and return to the labour market.
Unfortunately, we cannot be so sanguine. And some of the key reasons why have been set out in more modern developments of the original Kydland-Prescott model.
The seminal paper assumes an economy in which the free market functions smoothly. There are no real barriers to individuals working out and then exercising their rational choices.
Gradually, more and more features have been incorporated into the models to reflect many of the imperfections which impede the theoretically ideal working of the free market in the real world.
A crucial imperfection is what we could dress up in jargon as “path dependence”. Once you have taken a step on any particular path, your subsequent choices can become constrained and it might not be easy to move onto another one.
So if you choose to go on to benefits now, you may not be in a position to take advantage of the situation when productivity and growth improve. You make yourself less employable.
This is why it is important to alter the trade-off between work and leisure not in some hypothetical future but in the here and now. Keir Starmer is merely tinkering with the scale of benefit cuts which are required.
As published in City AM Wednesday 30th April 2025
Paul Ormerod is an Honorary Professor at the Alliance Business School at the University of Manchester, an economist at Volterra Partners LLP, and author of Against the Grain: Insights of an Economic Contrarian, published by the IEA in conjunction with City AM
