Sunday, April 21, 2013
Low pay begins to do more harm than good
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

The old labour market rules have been turned on their head: there has been a revolution.

One of those rules is that when growth is weak, employment does not grow. That has not been true in the past 2-3 years. Even last week’s softer job numbers, which showed employment slipping by 2,000 to 29.7m in the latest three months, showed an increase of 488,000 on a year earlier.

And even in those numbers, full-time employment rose by 60,000 in the latest three months, while part-time employment fell by 62,000. Economic inactivity fell to its lowest rate since 1991.

The other rule, also apparently broken, is that pay (average earnings) rises more than inflation. I know this should be true, and not just in recent times. In the 1990s, the Bank of England marked its 300th anniversary (it was founded in 1694) by looking back on three centuries of inflation.

Its analysis showed that after a torrid time for workers in the Bank’s first 100 years or so, things then improved a lot. By the end of the 20th century real wages (i.e. adjusted for inflation), were six times their level in 1800.

Rising real wages were the norm, independently of the ebbs and flows of trade union power. In the 1980s inflation dropped as low as 2.4% but average earnings growth never fell below 7.5%. Now, of course, things are different.

The latest average earnings figures show growth of just 1% over the past 12 months. That is the lowest since the current data series began in 2001 but you would have to go back very many decades, probably to the 1930s, for anything lower. Excluding bonuses, earnings rose by only 0.8%.

Inflation, on the latest figures, is running at 2.8% (3.3% for retail price inflation). Real earnings are falling, as they have been for most of the past five years.

These two broken rules, employment rising in a subdued economy and prices outstripping prices, are part of the same story. Looked at positively, it reflects the great flexibility of Britain’s labour market: pay restraint making possible a higher level of employment.

Looked at negatively, as some do, it is employers exploiting economic fragility to hold down pay. Either way, it means that the wage bill is being shared among a larger number of people.

Flexibility has kept a greater number of people in jobs. Most of the recent net increase in employment, 88% of it in the past year, has been among British nationals. My attitude so far is that this is good news. Far better to have more people in work, even if their real pay is falling.

Now I am wondering if you can have too much of a good thing. Even if inflation gets back to the official 2% target, it will still be running ahead of current earnings growth. In fact, we may be entering a period in which both employment and wages are weak. That is not quite the worst of all worlds but it is heading that way.

So what should happen? Some say the minimum wage, which will rise from £6.19 to £6.31 in October, should rise much more. Others think that all employers should pay what has been defined as the living wage, the minimum needed to get by, defined as £7.45 an hour (£8.55 in London).

The living wage is an interesting idea, and has been taken up by some employers, but I do not think it would be good to impose either it or a much larger minimum wage on employers. That would not only hurt marginal workers but it could be the last straw for marginal firms.

I do think, however, the private sector as a whole would benefit from higher wages. They would feed directly into stronger domestic demand, sorely needed by business. Consumer spending remains well below pre-crisis levels and retail sales are struggling to gain any kind of momentum.

The weakness of private sector pay is striking. Total private sector pay in February was 0.5% down on a year earlier. Though this was dragged down by lower bonuses, the picture for regular pay, up just 0.6%, was barely better. Public sector pay, up 1.1%, was stronger.

Imagine the difference it would make to demand if private sector workers, 79% of the total, were given increases of 3% rather than next-to-nothing. The CBI would risk a a re-run of the “Red Adair” headlines it attracted when Lord Turner was its director-general and bemoaned the decline in the workers’ share of GDP, but should it not encourage its members to sign up to a 3% club, for employers happy to award pay rises that at least keep pace with inflation?

The potential advantages would not, of course, just come through in stronger demand. Thanks to the tax credits introduced by Labour and other in-work benefits, employers have been able to free-ride on government largesse. That gets more difficult now most working-age benefits are now capped at 1% (in line with earnings growth) but has meant many workers have been spared the full pain of the real squeeze on wages, because the state tops them up.

Stronger wage growth would benefit the public finances both directly and indirectly, restraining welfare spending and boosting tax revenues.

I know what you are thinking. If private sector firms paid their workers more, they would employ fewer of them. Wages going up would mean employment going down.

That is possible, though could be balanced by two factors. One is the employment-generating impact of the greater demand resulting from higher wages. The other is that firms, particularly large ones, have very healthy balance sheets. They may not feel confident enough to invest but for most a relaxation of wage restraint would be easily manageable.

The more telling argument is about productivity, which has barely risen in the past three years and on some measures has fallen. Isn’t weak pay the natural corollary of weak productivity growth?

Perhaps, but it may be possible to turn things around. It is not quite a question of paying peanuts and getting monkeys but declining real wages may not be a recipe for rising productivity. If workers are demoralised, stuck in a rut, it could take a decent pay rise to jolt them out of it, and into higher productivity. That 3% club could be worth joining.