From the TUC

What’s behind the wage squeeze?

13 Dec 2013, by Guest in Economics

CITY AM’s Allister Heath had an op-ed in the Telegraph this week on the driving factors behind the UK’s living standards squeeze.

To be entirely honest I opened this article with a sense of trepidation and didn’t expect to agree with much of it at all. I was pleasantly surprised therefore to find that I nodded along to quite a bit of it, despite profoundly disagreeing with certain elements.

Heath opens by noting:

Ever since the Industrial Revolution, economic progress has been the norm. We have grown to expect each year to be better than the last, with pay rises taken for granted, barring the odd short-lived calamity. It is no wonder, therefore, that the relentless, seemingly never-ending national pay cut of the past few years has come as such a shock and caused so many to rethink all of their assumptions about the way the world works.

No disagreement from me here. As the TUC has pointed out – this in fact the longest real wage squeeze since the 1870s. And the driving factor has been weak wage growth rather than higher inflation.

Heath identifies seven factors for real wage weakness.

The first is low productivity:

Yet while the economy remains smaller, more people are in work than ever before, notching up a record number of hours, thanks to the near-miraculous performance of the jobs market. That is something to celebrate but it does mean that GDP per hour worked has fallen even more sharply than the overall economy, and that people with jobs are sharing in the pain. Given that we tend to be paid in proportion to what we produce, this collapse in productivity is the biggest reason why real pay has fallen.

I think we have to be careful about the causation here – I’ve written before on this and suspect that at least some of our productivity weakness actually reflects weak demand and a broken banking system – things that can be ‘fixed’ by policy.

But there is no doubt that the productivity figures remain a worry. My biggest concern is that current policy is acting to lock this in – moving us down the path of being a lower productivity and lower waged economy.

Heath’s second reason is higher taxes and more state spending.

Here I disagree. I’m not unconvinced there is any evidence that higher state spending (and taxes) as a share of GDP should have any real impact on real wages (especially real wages before tax). There are many examples in Northern Europe of countries that spend more but also pay better wages – usually countries with a much better productivity performance than us.

Heath’s third causal factor relates to higher pension contributions and higher NICS. His argument here is clearly informed by the recent Treasury briefing on productivity, labour shares and earnings. As I’ve written in a couple of posts already, I am far from convinced by this analysis –Ben Chu at the Indy is also worth a read on this.  

Heath’s fourth factors is compositional change in the labour market:

Another big change is that some professions now pay much more and others less. It is not just chief executives, bankers or footballers who earn more than they did 20 years ago: all private sector professionals in high-value-added industries, especially in services, have enjoyed much higher pay. But many lower-skilled workers and some other groups have seen their relative wages drop.

This is undoubtedly the case.

The bipolarisation of the labour market is now a well documented trend.  I’d recommend a look at recent Resolution Foundation research on this.

His fifth and sixth arguments are related to this and about the role of globalisation and technology. There is undoubtedly an impact from these major macro trends – although as previous TUC analysis has demonstrated they represent only a partial explanation.

Many advanced economies have experienced similar technological and trade patterns and yet the cause of real wages has varied. Clearly by themselves these trends can’t give the full picture. 

Although I am minded to agree that:

…in Britain’s case, these two factors have undoubtedly contributed to the relative drop in pay of some groups, and the rise of financial, professional and business services, as well as technology itself, as the source of well-paid jobs.

Heath’s final point is on immigration and again I’m inclined to agree that:

There is little up-to-date research that accounts for recent Eastern European arrivals. My guess is that the overall effect on wages is probably very small; some groups at the bottom may have lost out but less so than commonly thought.

I’d argue though that Heath is missing two important contributing factors.

First declining labour bargaining power – and here I have the rare pleasure of citing IMF research in support of my case.

And second – and just as crucially – the role of rising inequality. As James Plunkett has written:

Inequality accounted more than half (53 per cent) of the gap that had opened up between GDP growth and median wage growth from 1972 to 2008. Yet inequality has so far been missing entirely from government briefing on this issue. If there are still those who think high levels of inequality aren’t relevant to the living standards of ordinary workers, they too need to wake up.

When discussing wages it is really important to begin by defining your terms – whereas most of last week’s Treasury briefing focussed either on means or aggregates, what really matters for living standards is medians. And here there is worrying evidence, as Chris Dillow wrote earlier this week, we have a disconnect between rising GDP growth and rising living standards.

So what is to be done?

Heath concludes by arguing that:

The only way we will return to the sorts of decent annual pay rises we used to enjoy is if the Coalition finally gets its act together and unleashes a supply-side revolution.

Britain’s hard-pressed workers deserve nothing less.

Oddly enough I agree with this. Although I suspect my vision of a supply side revolution differs somewhat from Heath’s.