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The Breakdown in the Relationship Between Economic Growth and Pay

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With the fragile recovery in the global economy at very real risk of derailment, strategies for growth remain at the top of agendas across the world. But if we look at the period prior to the crisis of 2008-09, it becomes clear that we need to aim to do more than simply return to 'normal'.

Long before the downturn, there was evidence to suggest that increases in GDP were failing to feed through to broad-based improvements in living standards in a range of advanced economies: for too many ordinary workers, 'growth' no longer led automatically to 'gain'. Although the causes of this breakdown in relationship are many and varied, at their heart lays growing wage inequality.

In the UK, the share of every £1 of value generated in the economy being paid as wages to workers in the bottom half of the earnings distribution fell by a quarter between 1977 and 2010, from 16p to 12p. If we include bonuses in this calculation, their share falls to just 10p. The conclusion is simple: in recent decades the UK economy has become less effective at sharing the proceeds of economic expansion through the mechanism of wages.

But we are far from alone. Between 1970 and 2008, the value of GDP per person doubled in the US, but millions of Average Joes saw little if any improvement in their pay packets. From the Fred Nurks of Australia to the Otto Normalverbrauchers of Germany and the the Matti Meikäläinens of Finland, ordinary workers across advanced economies have increasingly been missing out on the gains of economic growth.

There are, however, major variations across countries in the persistence and magnitude of this phenomenon of growth without gain. At the Resolution Foundation we've compared the strength of the relationship between GDP and median wages over the past 40 years in a selection of ten major economies (that offer useful parallels and contrasts to the UK and together account for three-quarters of total GDP in the OECD), in order to identify and understand these differences.

Across all ten countries, the trend has been driven by the same three factors. The first relates to a fall in the share of GDP paid to employees and a corresponding increase in the portion paid out as profits. The second is a shift from wages to non-wage rewards such as employer pension contributions and health insurance which provide indirect benefits for workers but reduce their wage packets. The third factor is a product of the increasingly unequal distribution of the total wage pot, with a growing concentration of pay in the hands of top earners.

While all three factors have played their part, the one in which the distinction between those countries in which the relationship between GDP and median pay appears to have broken down completely and those in which it has simply weakened is clearest is pay inequality.

The chart below details trends in gaps between the pay of those at the 90th percentile in the earnings distribution and those at the 50th (the median) in three groups of countries: those in which median wages have consistently grown at less than half the rate of economic output (chronic); those in which the breakdown has been no less stark but much more recent (acute); and those in which the size of the divergence between median pay and GDP has been much less significant (mild). It shows that pay inequality grew most rapidly and ended the period highest within those countries in which the breakdown in relationship is most established and most severe.

The UK - in common with all advanced economies adapting to a post-crisis world - faces a choice. It currently sits within the acute group, and appears to be following the pattern set by the US several decades ago. Admission to the chronic group of countries can be avoided, but it will require a collective effort from policy makers, firms and workers. Wage inequality lies at the centre of this phenomenon, so it is perhaps here that levers can most effectively be reached for.

A wide range of questions will need tackling; from the appropriate level of the minimum wage, to control of top pay and the design of future skills policy. But by explicitly recognising the need to meet this challenge and by looking to the experiences of both those countries that have walked this path before us and those that have resisted some of the pressures to which we have succumbed, we can take the first important step toward restoring the link between growth and gain.