Sunday, February 09, 2014
Pay and productivity are both due a rise
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.

Pay is of vital importance to most people in this country, productivity holds the key to our long-term prosperity.

So two vital questions. Will this be the year when real wages finally start rising again after a prolonged squeeze? And, closely related, is this when productivity shrugs off its post-crisis stagnation and starts growing?

The question of whether 2014 is the year of the real wage rise is a big one, economically and politically. On the most straightforward measure used by the Office for National Statistics (ONS), average weekly earnings adjusted for the consumer prices index, real wages began falling on annual basis in 2008, and they have not stopped falling yet.

This is highly unusual. The ONS has good data stretching back to 1964 and comparisons well back into the 19th century. A long run of falling real wages is rare and the cumulative scale of it, 6% or more, breaks all modern precedents.

The good news, to judge by a Resolution Foundation event I spoke at a few days ago, is that the squeeze may be over and we should see modest real wage growth this year. Before coming on to that, let me address one of the puzzles in the real wage story of falling real wages which has bothered me for some time.

People may be familiar with a regular finding about the US economy, which is that real earnings (measured by the real median wage) have been stagnant for decades. How could an economy grow, and benefit from rising spending, if people were not getting better off?

The answer is that they were getting better off. So, if we take the period 1980-2005, before the crisis, the US real median wage grew by a mere 3%, equivalent to stagnation. Within that, however, every group recorded much bigger increases: 75% for white women, 62% for non-white women, 16% for non-white men and 15% for white men.

How so? The composition of the workforce changed. In a period of rising employment, there was a big rise in the proportion of low-paid, many of them women, dragging down the median. In an apparent reversal of mathematical logic, everybody beat the average.

Something similar appears to have been happening in Britain. This is not to dispute that many have suffered a real wage squeeze, but the picture has been distorted by changes in composition.

The overall level of employment is just above where it was pre-crisis. Within that, however, there has been a significant rise in part-timers (with lower weekly earnings) - relative to full-timers. There has also been a fall in the proportion of public sector workers, who on average earn more, and a rise in the share of private sector jobs.

One striking result from the official annual survey of hours and earnings is that people who have stayed in work continuously (defined as more than a year in each survey) have done pretty well.

So, taking the 12 months to April in each case their pay rose by 6.8% in 2008, 4% in 2009, 4% again in 2010, 3.7% in 2011, 3.6% in 2012 and 3.3% in 2013. Their pay, and this is a large group, has mainly stayed ahead of inflation.

Does that suggest all the pain has been felt by everybody else, those new to employment or the job-changers? Possibly, though there may be other factors. One phenomenon in recent years has been the near-doubling, to almost 1.1m, in the number of over-65s working. For a variety of reasons, their pay requirements are lower than younger workers.

So what is the big picture? As I say, there was a real wage squeeze, though it may have been less intense than it appeared. Though this is not yet the message from the regular monthly data, I think that squeeze came to an end last summer, for reasons set out here before, notably broader wages and salaries data in the gross domestic product figures.

As for this year, the consensus at the Resolution Foundation - me, Nicola Smith from the TUC, John Philpott of the Jobs Economist and Ian Stewart from Deloitte, was that we should see modest real wage growth this year.

For me, the drivers were a tightening job market, with unemployment falling quite sharply and emerging skill shortages. Philpott saw the bargaining power of workers increasing as vacancies rise. Stewart attributed it to growing optimism in the corporate sector, while the TUC’s Smith attributed it to unions negotiating better terms for members.

What would turn modest real wage increases into the rises - averaging 2% a year - that used to be the norm? The answer is stronger productivity growth. The faster the growth in output per worker or per hour, the bigger the real pay rises that can be justified.

The ONS, in its latest economic review, points out how different the economy’s productivity performance has been this time. At this stage after the recession of the early 1980s, output per hour was 12.6% above its pre-recession peak. In the 1990s it was 19.9% up. This time it is 4.4% down.

Much of that reflects weak service sector productivity, down 6.9% on pre-recession levels, while manufacturing productivity is just 0.8% lower. Both, of course, should be well up.

“If recent reductions in labour productivity are reversed as the economy strengthens, the potential for more rapid and sustained economic growth without rising inflation may be greater,” the ONS says. The economy would shift out of the vicious circle of low productivity and weak real wages, into a virtuous circle as both move into a higher gear.

Can it happen? If it does not do so soon, it may never do so, and the productivity pessimists will have been proved right. I think it will, on the back of stronger growth in demand, rising investment and the scope for moving workers into higher-productivity roles. The tighter the labour market, the greater the incentives for managers to introduce productivity-enhancing measures.

That's the theory anyway. Let's hope it works in practice.