Sunday, December 24, 2006
Fight begins to keep a lid on pay
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

One anniversary that has not been much commented on — perhaps because we prefer to forget — is that it is 30 years since Britain’s darkest economic hour, the IMF crisis of 1976.

Thirty years ago, in a deeply humiliating episode, the men from the International Monetary Fund came to London from Washington to hammer out the terms for what was then the organisation’s biggest ever loan to a country in trouble.

The previous year, inflation had topped 25% and wage costs were rising by more than 30%. The pound was under intense pressure.

In December 1976, the Labour government published its letter of intent to the IMF, promising to cut public spending and keep a tight grip on the money supply as a condition of getting the loan. James Callaghan, prime minister at the time, also pledged to continue a tough policy of wage restraint through a formal incomes policy.

It could have been worse. There were powerful voices in the cabinet that favoured import controls as the way out of the country’s economic woes — a strategy that could have set things back for decades.

Anyway, we got the money, the policies insisted on by the IMF got Britain out of the crisis, albeit with a few hiccups, and the rest is history.

I mention this now, not just as a reminder that there was more to the 1970s than the Morecambe & Wise Christmas show, but also because the men from the IMF have been back in town.

In its latest assessment, part of its regular so-called Article IV surveillance, the IMF describes Britain’s macroeconomic performance as “impressive”, says the medium-term outlook is for “strong and stable growth” and is particularly taken with London’s continued rise as a global financial centre.

But the IMF, as is its constitutional duty, has some concerns about the public finances, warning that government debt (excluding the chancellor’s many off-balance-sheet items) is heading perilously close to the official ceiling of 40% of gross domestic product. It argues against tax rises, which it says would do considerable damage, warns that the government must face up to “tough choices” in next year’s comprehensive spending review, and is concerned that the public finances may not be robust enough to cope with international shocks.

The team from Washington has another concern, which it shares with members of the Bank of England’s monetary policy committee (MPC). Thirty years ago, the question of whether pay would behave itself was of paramount concern. It is again, although on a smaller scale.

The IMF puts it starkly. Unless the Bank’s verbal warnings on the need for wage restraint work, it will have to follow up with action, namely further interest-rate rises.

As far as households are concerned, it seems, they will get it either way. Incomes have been squeezed by higher energy prices and rising taxes. If they seek to compensate for this by demanding more pay, the MPC will be obliged to come down on them like a ton of bricks, squeezing them further with mortgage-rate hikes. Net savers, of course, would celebrate.

This is also preying on the MPC’s mind, as was made clear in the minutes of its meeting this month (which resulted in a 9-0 vote to leave Bank rate at 5%). Migrant labour is helping to keep wage increases down, it said, but high headline inflation (2.7% on the consumer prices index, 3.9% on the retail prices index) is pushing in the other direction, as is the recent rise in the national minimum wage — up 5.9% in October to Ł5.35 an hour.

“While inflation was still projected to fall back in 2007 as the effect of higher energy prices faded, the committee remained concerned that the pick-up in the near term could affect forthcoming pay increases,” the minutes said.

So far, the evidence is of a modest rise in wage inflation but nothing more. In the year to October average earnings including bonuses rose by 4.1%, compared with 3.9% in September. Most of this appears to have been due to increased overtime working and the rise in the minimum wage.

Wage settlements may be edging higher, but no more. Industrial Relations Services said basic pay settlements were stuck at 3% in the three months to the end of November. The Engineering Employers Federation has seen an increase, but only from 3% to 3.1%.

This, however, is crunch time. Things have changed immeasurably from the days when most people’s pay was determined by national arm-wrestling sessions between big employers and big unions. John Philpott, chief econo- mist at the Chartered Institute of Personnnel and Development, points out that with the exception of the big public-sector pay deals, most increases are now determined locally, at the level of the individual firm.

Even so, this is a challenging time. Between 60% and 70% of annual wage and salary increases are determined between the beginning of January and end of April. Both the Bank and the Treasury expect inflation to fall back to 2% in the coming months, measured by the consumer prices index, but perhaps not soon enough.

So the question is whether pay will continue to show saintly restraint over the winter and early spring, or whether it will respond to the provocation of rising prices. The latest official figures confirm the extent of the squeeze on income growth; real household disposable incomes rose by only 0.2% in the third quarter and were a mere 1.3% up on a year earlier.

As far as the public sector is concerned, which is 60% unionised, the government has no choice but to battle it out. Gordon Brown has set a 2% ceiling for pay rises in the public sector, which for reasons of wage drift and other factors means in practice rises of rather more than that.

The situation in the private sector, which is less than 20% unionised, is rather different. Currently, private-sector pay is growing by roughly 4%, against 3% for the public sector. It is the private sector the Bank will be watching most closely in the coming weeks for signs of a breakout in pay.

Will the Bank have a clear enough picture by early February, seen by most people in the City as the crunch time for interest rates? My hunch is that the Bank will flirt with a rate rise in February but decide there is insufficient evidence. By May, the inflation outlook should have improved enough to head off the need for such a hike. But in this, as in so many respects in recent days, there’s a lot of fog around.

PS: Thanks to the many people who helped me out with the song lyric “People moving out, people moving in” at the start of last week’s column. It was, of course, Ball of Confusion, the Temptations’ Motown classic of 1970. It has also given me the idea for this year’s Economic Outlook Christmas quiz.

Below are fragments of 10 songs, all vaguely connected with economics. I need the name, artist or show, and approximate year. Younger readers may need the help of parents, grandparents or their Uncle Google. The prize will be the usual signed copy of Free Lunch, a couple of other economics books, and lots of glory. Answers to be e-mailed to me by midnight on Wednesday January 3, with the result to be revealed on Sunday, January 7. As a tiebreaker, perhaps a suggestion for an economics-related song title not on my list. So here goes.

1: I work all night, I work all day, to pay the bills I have to pay.

2: Grab that cash with both hands and make a stash.

3: Lie for it. Spy for it. Kill for it. Die for it.

4: A mark, a yen, a buck or a pound, a buck or a pound, a buck or a pound.

5: I’ll buy you a diamond ring my friend.

6: You play the guitar on the MTV.

7: At first we started out real cool. Taking me places I ain’t never been.

8: The silver dollar has returned to the fold. With silver you can turn your dreams to gold.

9: The best things in life are free.

10: He loves gold. He loves only gold.

Good luck, and happy Christmas.

From The Sunday Times, December 24 2006