Why Wage Growth Will Likely Be Lower for Longer

19/02/2016 17:02 GMT | Updated 18/02/2017 10:12 GMT

This week's labour market data release showed several rosy points and several less than bright trends. First, the good stuff. A fifth of a million more people were in work compared to three months ago, and over half a million more compared to a year ago, pushing up the UK's employment rate to 74.1%, the highest on record. Unemployment decreased by 0.6% compared to a year ago, as roughly 172,000 people came back into the workforce. The number of people that have effectively exited the labour market (so-called economically inactive) fell by almost 100,000 compared to three months ago and nearly 175,000 compared to a year ago as many re-entered work.

Much of the negative attention was paid to the relatively slow rate of pay growth, which grew by 2.0%, excluding bonuses (which, given the vitriol launched at bankers' bonuses post-crash, have taken a back seat in financiers' remunerative packages - financial and business service bonuses shrunk by 10% compared to a year ago). When inflation, which sat at 0.2% over the period, is factored in, wages actually grew by 1.7%.

It is tricky to make comparisons to ghosts of economic cycles past, but over 2004 - 2007, wages grew by roughly 4%. Much of this was the build up to the crisis, where consumption was growing, confidence filled sails, and we were running up a hill towards a cliff. But this comparison of abnormality to abnormality has gone on for too long. If anyone peers back into the bubble phase of recent British economic history with nostalgia, that is a waste of both their and their audience's time.

1.7% real wage growth is not the most impressive of numbers. Pay tends to reflect productivity, which, as Thursday's ONS figures show, continues to puzzle, and to the uninformed, disappoint. Productivity reflects the amount that is produced given the amount of manpower and capital that is put in. The average German, French, and American worker produced 11, 15, and 38 percent more than the comparable British one did in 2014. Paul Krugman's oft-toted adage that productivity isn't everything, but in the long run it is almost everything, is fair, but comparing apples to oranges will likely leave people hungry.

These productivity numbers need context if they are going to be used as a comparative. Essentially, their productivity stats reflect how each country has evolved in the post-crisis era. France saw a large increase in unemployment, and many of this group of people have become a large pool of structurally unemployed people that do not factor into their productivity statistics. Those that remain in work seem more productive because the number of people being measured is smaller. The German economy remains more than twice as reliant as the UK on manufacturing, where productivity gains have traditionally been easier to achieve (and easier to measure), and is home to a remarkably rigid labour market. This makes sense in Germany (and manufacturing-oriented economies more generally) as it incentivises firms to invest in their equipment and people with the idea that employees find it difficult to leave, but is infeasible in service sector-oriented economies like the UK or the US (think marginally more fuel efficient cars, rather than the development of Uber or Citymapper). The US had higher rates of unemployment than the UK because it has a more flexible labour market, but it also has also had higher employment rates during its recovery for the same reason. At the same time, however, it became home to an increasingly larger pool of structurally unemployed people that have only just started to re-enter the labour market, so its productivity statistics share the same bias as France.

Given the costs associated with some of the decisions that its comparative countries have undertaken, these high productivity statistics do not seem as flattering. The UK has not experienced 'hysteresis', the jargonistic word that applies to those that find themselves unemployed in a recession and have difficulty making it back into the workforce, to any great extent, nor has it sacrificed freedom for efficiency or accommodated a large pool of unemployable people. Rather than abruptly firing everyone like the US, recovering based solely on short-term contracts, as in France, or relying on continued (and now shaky) growth in emerging markets, ie China, like Germany, the UK's firms and employees struck a bargain: while domestic debt was paid down and international markets were sought, employers would not reduce employment where possible, while employees would not ask for a pay rise.

This has led to a situation where relatively high employment levels were maintained while the economy shrunk, leading to a low productivity statistic that macroeconomists and politicians have come to point at when looking for something to complain about (or blame their opponents for).

Ironically, the relatively low level of productivity is due to several things that many of the same economists and politicians point to with pride (or take credit for). An employment rate that has hit record levels, an unemployment rate that is at a decade low, and a shrinking pool of young or structurally unemployed people shifting back into work.

So how does this relate to low pay? In a nutshell, the effects of the crisis are still being felt and as a result, pay growth is likely to remain low in the near future. Those employed are still foregoing wage increases as they pay off their debts and build up enough savings to buffer against future uncertainty (while mindful of a labour market that was hyper-competitive not so long ago when times were a bit tougher - or, if coming from an EU country where unemployment is in double digits, like Spain or Italy, perhaps a bit fearful of asking for too much), while those entering the labour market are the young (the 18 to 24 year old unemployment rate decreased by 2.3%, while employment increased by 2.4%, compared to a year ago). The roles the young take tend to pay less (think bartenders and baristas) at places that pay less. The number of vacancies at small firms (those that employ between 1 and 9 people) increased approximately 11% compared to three months ago, while the sectors that saw the highest levels of vacancy growth compared to three months ago tend to be both low-paid and filled by the young: wholesale (14.9%), retail (7.4%), wholesale (14.9%), and arts and entertainment (23.7%), compared to financial services or professional services, which saw declines of 7.1% and 4.2%, respectively, over the same period. At the same time, in preparation for the national living wage, firms have started to prefer paying less for a 21 year old than a 25 year old, and have made the corresponding hiring decisions.

So it is likely that wage growth will continue to be low while productivity will continue to disappoint when compared to neighbours near and afar. At the same time, the very things that underpin those less than rosy figures are the factors driving the UK's strong economic performance in a rather lacklustre global economy. Let's not forget that this is the case, but more importantly, let's not pretend that it isn't.