It seems without precedent for the Governor of the Bank of England to carefully calculate how much worse off we all are as a consequence of wage increases consistently falling below inflation and then to broadcast this to the whole nation. This might normally be calculated in-house and kept under wraps. Although IDS analysis of pay rises and inflation has been pointing to the differences over the past year or so.

In his speech, he explains how inflation has risen, driven by high import prices, world energy prices, and the combined effects of the increases in VAT. The Governor says the rise in VAT this month will push up the level of prices by 1.5%. He explains:

‘The three factors I described – higher import and energy prices and taxes – have squeezed real take home pay by around 12%. Average real take-home pay normally rises as productivity increases – money wages normally rise faster than prices. But the opposite was true last year, so real wages fell sharply. As a result, in 2011 real wages are likely to be no higher than they were in 2005. One has to go back to the 1920s to find a time when real wages fell over a period of six years.’

You can hear the sharp intake of breath as both employers and unions involved in pay negotiations take in what the Governor is saying. How do employees seek to regain this lost income? Can employers meet higher expectations through productivity or work re-organisation? Can higher profitability in large companies turn into inflation matching pay increases in 2011? Are long–term pay agreements the answer with further increases linked to the RPI?   Will the Government continue to impose a two-year pay freeze on the public sector with its implication of further reductions in disposable income over 2011 and 2012?

We are aware that these are real discussions taking place up and down the country at the moment and that the median pay rise is now nearly 3% in manufacturing, which has enjoyed a better recovery than elsewhere. For the moment, though, most pay rises are falling short of the CPI and the RPI, both of which are heading for 5% in the near-term. Is this drop in disposable income compatible with economic recovery?

The real picture, however, is uneven with earnings growth stronger in some parts of the economy and weaker elsewhere.

The latest Average Weekly Earnings figures show an annual rate of growth of 4.2% in finance and business services, which makes up 20% of employment in the economy. Earnings growth was also strong in manufacturing at 3.5%, with 9% of employment.

Earnings growth overall in the private sector was weak at 1.9% because the higher growth in finance and manufacturing was offset by weak growth in the lower paying sector of wholesale, retail and hospitality (representing 23% of employment). Here the annual rate of growth was a mere 1.2% with the average weekly earnings flat at £295 a week between August and November, despite a rise in the National Minimum Wage of 2.2% in October.

A further downward pressure on private sector earnings came in construction (with 5% of  overall employment), where annual earnings  were negative for the fourth month running. They fell by -1.3 in the year to November.

Meanwhile, average weekly earnings in the public sector (with 22% of employment) grew at 2.2% in the year to November, having been fairly flat at this level through 2010. Earnings here will probably fall back towards 1% as more pay freezes kick in this year.

Private sector earnings may become stronger overall if pay growth returns in construction where there are several January 2011 increases coming through after previous pay freezes. For example, there are January 2011 rises of 4.7% in the national industry agreement for engineering construction and 3% in the plumbing industry.

This is widespread concern that these levels of inflation are much higher than forecast earlier in 2010 and are likely to be with us for much of 2011. The large rise in the CPI measure will be a blow to the Government and the Bank of England, both of whom seek to target policy on a rate of 2%.

Both the RPI and CPI will be pushed higher by the increase in VAT from 17.5% to 20% from January. The January figures will be released on 15 February 2011.

This does not bode well for economic prospects as the squeeze on incomes may mean that consumer spending will fall and hit output at a time of fragile growth.

There is also concern that CPI inflation may hit 4% in the next three months, with the possibility that the RPI may hit 5%. Most pay bargaining has resulted in pay rises of between 2% and 3% in recent months which means that the vast majority of employees are seeing their disposable incomes shrink by 2% or more. For public service workers faced with pay freezes this year the cut in real incomes is larger. And scheduled increases in National Insurance from April will further reduce pay in real terms.

It is a strange logic that concludes that a financial crisis that started in the top echelons of banking should be resolved by freezing the pay of nurses, teachers and social workers. Yet since early last year a growing clamour of voices, led by much of the press and then followed by many shades of politicians, have called for public sector pay freezes to resolve financial instability caused by the economic crisis. As part of this process there has been a widespread misreading of the official earnings statistics to try to show that all public sector workers earn more than all private sector workers.

The premise of their argument is that in 2009 all private sector pay was frozen and that therefore public sector pay should be frozen so that the ‘pain’ is shared in 2010/11. Yet the truth is that all pay was not frozen in the private sector in 2009. IDS research shows that around one-third of companies had pay freezes – centred on manufacturing, construction and road and air transport. Elsewhere, in energy, finance, retailing and pharmaceutical there were rises for most people and the most common level of increase was around 2%.

Bonus bombshell

The view that the whole of pay in the private sector was frozen (and that pay cuts were common) gained prominence when the Office for National Statistics published average earning figures last Spring. These showed that earnings for the private sector dropped to -3.6% in February 2009 and journalists and economists drew the conclusion that this reflected the depth of impact of the recession. In reality this drop back into negative figures was predominantly caused by a huge fall in City bonuses, the effect of which was sufficiently large to drop the statistics for earnings into negative territory for two months.

This is not to say that a lot of workers in manufacturing and construction did not face pay freezes and substantial loss of earnings through loss of shift pay and through short-time working. But it is to argue that what really was going on was misinterpreted – and that tendency to re-arrange the facts continues.

Crazy conclusions

This occurred again in January when the new Average Weekly Earnings (AWE) were released for the first time, on 20 January 2010, replacing the old Average Earnings Index. The new AWE expresses change in weekly earnings as opposed to the old series which was expressed as an index. Thus it makes it easy for those with an untrained eye to jump to amazing conclusions.

After the release of the figures, the main point made by a number of newspapers was that earnings growth in the public sector was rising at 3.8% as opposed to -0.1 in the private sector. In fact earning grew by 2.8% in the public sector and were only at 3.8% if you include the earnings data from the nationalised banks (Northern Rock, Lloyds Banking Group and RBS). A closer look at the AWE shows that in the same month (November) earning in manufacturing were up 1.6% on a year earlier and were up 1.8% in distribution, retail and hospitality. Once again the negative figure for the overall private sector was caused by lower bonuses than a year previously in the finance sector.

When the AWE figures were released the Daily Telegraph claimed that the new data showed that public sector workers earn more than £2,000 a year more than private sector workers. It developed this interpretation by comparing the weekly earnings excluding bonuses, which is not really comparing like with like. If you take the more real comparison of total pay, the public sector lead is just £6 a week(£313 a year). The figures really do show a different picture. They show the private sector weekly average at £447 and the public sector average at £453. They also show a finance sector average of £598 – in what was a very bad year for them – and the distribution, retail and hospitality average of £303 a week.

Apples and oranges

There is a very important point to make about comparing average earnings in the public sector with the private sector. You are not comparing like with like. Neither the private sector nor the public sector are homogenous wholes with similar skills composition and earnings distribution. The language of ‘counterparts’, which often creeps into articles on the subject, should not be used as there are few. The public sector employs less than a fifth of the workforce and is around 70% female. It has a higher proportion of people in professional roles. On average, those in the public sector have higher qualifications than those in the private sector.

Also, in recent years, we have seen the lowest-paid jobs in the public sector transferred (outsourced) to the private sector. There has also been a growth in employment in lower paid occupations in the private sector in areas such as retail, fast food and hospitality. Workforce composition changes as affect the average of the earnings in each sector.

Bounce time

The recession led to much lower pay settlements in the private sector than in 2008. One third of firms had freezes. Many firms in the engineering and car manufacturing sectors had short-time working and loss of earnings. This is reflected in the new AWE figures which dropped back towards zero in the first half of 2009. Since then there has been a slow but steady return towards something like normal working. Indeed, Nissan is currently putting on new employees. The AWE figures might well show rather buoyant figures for manufacturing in the first half of 2010 because they will be compared to such dire circumstances in the first half of 2009.

But watch out for what happens to earning in the finance sector, when the figures for February and March are published in April and May. They are more than likely going to show that big bonuses have returned where they shrank back a year ago, and this will produce a statistical bounce which will push the private sector into stronger figures just at the moment when the arguments for cut backs and pay freezes in the public sector will be at their height.