Unemployment in Britain stands at 2.59 million. That may be mercifully lower than many experts might expect it to be, given the stagnant state of the economy. But it still means a million more people are now searching for a job than six years ago, before the credit crisis struck. Another 1.4 million say they are working part-time because they can't find a full-time post; and a generation of young people faces a grim struggle to join the 21st-century workplace.

Yet the coalition's priority is to cap the amount employers can be forced to pay out in unfair dismissal claims. Vince Cable – the caring face of the coalition, to the extent that it has one – announced on Friday that rewards will be limited to 12 months' salary. In principle, there's nothing wrong with the Department for Business giving recession-hit firms more certainty about their potential liabilities. But the real sadness about Cable's latest intervention is the signal it sends about the coalition's priorities during the deepest slump in living memory.

This is a government in the grip of a clapped-out ideology, as out of date as the suits from Margaret Thatcher's 1980s wardrobe that recently came up for auction: it's what Chuka Umunna, Labour's shadow business secretary, calls "retro economics", and it's wrong-headed, for four reasons.

First, it is nonsense to suggest that during the weakest upturn in living memory, when much of the eurozone – our biggest trading partner – is on the floor, the US is stalling, and British households are hamstrung by the debts from the boom years, what's holding firms back from hiring new workers is a bit of red tape.

It was this idea, still rife on the Tory right, that motivated venture capitalist Adrian Beecroft's report on employment law, commissioned by David Cameron earlier this year. Yet America's ultra-flexible labour market is stuck in the doldrums; while Germany, where employers face far more rules and regulations, has halved its unemployment rate since the peak of the crisis.

Beecroft's own report acknowledges the fact that his recommendations are based more on anecdote and hunch than sound economic analysis. "Quantifying the loss of jobs arising from the burden of regulation, and the economic value of those jobs, is an impossible task," he says. "How many more businesses would there be, how many people would they employ, how many more people would existing businesses employ, how profitable would all these businesses be? Who knows?"

Yet the Tory right continue to seize on his proposals, and others like them, as a way to unleash the "wealth creators", and kick-start growth.

Second, even if the argument that cutting red tape boosts jobs had firmer economic foundations, it's hard to see it as relevant to the UK. Analysis by the Organisation for Economic Co-operation and Development suggests that only the US and Canada make it easier for firms to fire their staff.

Third, though business confidence will have to be an important factor in restoring economic growth, consumers' mood matters too. Hard-pressed employees are hardly likely to feel more secure if they are told that it's now easier still for them to lose their jobs.

Finally, it's one legacy of the crisis of the past five years that a growing number of economists are beginning to argue that not only does slashing red tape not create new jobs, but increasing workers' bargaining power might actually help to generate recovery. The International Monetary Fund – hardly a hotbed of lefties – has made a link between widening income inequality and stagnating growth. The United Nations Conference on Trade and Development has gone further, and urged western governments to adopt a full-blown incomes policy – even more retro than Mrs T's shoulder-padded power suits – to boost the living standards of low-paid workers, and stoke domestic demand.

Those at the bottom of the pay scale, the argument goes, are more likely to spend what they earn – and create demand – than super-rich business owners whose wealth leaches away offshore, or piles up unspent. The idea remains taboo even on the left; but it may be that re-regulating the jobs market, not deregulating it, is a surer route to economic success.

Yet in a time of deep anxiety, the coalition's best plan is to cut the recompense for staff who have been chucked on the scrap heap through no fault of their own.