KNUTSFORD, UNITED KINGDOM - MAY 20: In this photo illustration coins to the value of GBP 6.50, the equivalent to the future UK minimum wage, sit on a wallet on May 20, 2014 in Knutsford, United Kingdom. From October 2014 the UK minimum wage will increase by 19p an hour to GBP 6.50. Yesterday Labour Party Leader Ed Miliband said that a future Labour government would set a statutory minimum wage target linked to average earnings (Photo by Christopher Furlong/Getty Images)

Why aren’t wages rising?

17 May 2017, by Kate Bell in Economics

Today’s labour market figures presented yet another iteration of the puzzle of the UK labour market in recent years: why are higher employment rates not pushing up wages?

Traditional labour market theory tells us that as unemployment falls, workers feel more secure in their jobs and more able to push for wage increases, employers need to pay more to attract a more scarce supply of new recruits, and wages should therefore rise. But today’s figures show the opposite happening: employment has risen – to a new record high employment of 74.8 per cent, but wages have fallen by 0.2 per cent in real terms.

Some of the fall in ‘real’, or inflation-adjusted, wages is of course explained by the higher inflation the UK has experienced as a consequence of the devaluation of the pound. Inflation (CPI) in March (the most recent month we have pay figures for) was 2.3 per cent, its highest level since September 2013. But even before inflation is taken into account wage growth in March was slower than in February, falling from 2.9 to 2.4 per cent.

There are several competing explanations for why this is happening.

First, the idea that although the employment rate is rising, there’s more ‘slack’ or unused labour in the economy than the headline rate shows. The persistence of nearly a million people in zero hours contracts, and the significant increase in self-employment, much of it low paid, suggest both that employers may still find it easy to get the workers they need if they want to expand production, and that workers may not feel secure enough in their jobs to ask for more wages – we know that people in both ZHCs and self-employment already face a significant pay penalty.

Second, the problem of ‘productivity’ – or the amount of value that each worker produces. Productivity increases are sometimes described as a cap on wage increases – with employers unwilling to increase pay faster than any increase in the bang for their buck they get from each worker. Productivity has fallen significantly since the financial crisis, prompting a vast literature on the ‘productivity puzzle’. Figures today from the ONS show the strong growth in employment against the weak growth in GDP meant a quarterly decline of productivity of -0.5%.

In their latest Inflation report, the Bank of England attributes at least part of this slow productivity growth to a weakness in capital investment by businesses, limiting the extent of efficiency gains through, for example, new technology (see the chart from their inflation report below).

(Bank of England Inflation report, p. 22).

But, as a recent paper from the Economic Policy Institute in the U.S. argues, low investment and low wages risk trapping the economy in a vicious cycle. If low investment is, as they argue, a consequence of weak overall demand, low wages will help contribute to that weakness. Moreover, low wages also increase the relative cost of spending on capital as an alternative to labour, further limiting investment. It may be the case therefore that boosting wages is necessary to boost productivity – rather than endlessly waiting for the latter. It’s arguable that increases in the National Living Wage could be a test case for this theory.

Of course, the government could also raise demand directly through its own investment and spending more generally. As my colleague Geoff sets out here, government investment has been persistently weak, contributing to weak economic growth, and feeding into the current situation of a low productivity, low wage, high employment economy.

Finally, however, we need to do more to explain why workers’ aren’t responding to lower unemployment with greater demands for higher wages – another way of saying that as the Bank of England put it, there is “a lower equilibrium rate of unemployment than in the past.” It’s unsurprising for a trade unionist to argue that this reflects a decline in workers’ bargaining power – but that doesn’t make it untrue.

That’s why we think that boosting workers’ ability to organise has to be a critical part of the effort to get wages rising again. It’s not just that it would help strengthen their hand in pay negotiations. We know that when workers’ have greater voice and representation, their productivity rises (as my colleague Tim Page sets out here). We also know that trade unions have been at the forefront of the fight to make jobs more secure – whether fighting zero hours contracts at Sports Direct or winning better rights for drivers and couriers in the logistics industry. The labour market may currently be puzzling. But the responses needn’t be.