Sunday, December 20, 2015
Britain heads for another pay rise in 2016
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, the final frontier, or am I getting my Star Trek and my Star Wars mixed up? Anyway, what happens to pay over the next 12 months is important, in many respects.

At its most basic there is the question of whether most people can expect a pay rise, by which I mean the increase in their wages and salaries outstripping inflation, in 2016. There is the issue of how fast pay needs to rise to persuade the Bank of England to follow the Federal Reserve in raising interest rates.

There is also the question of whether Britain is a higher pay country than we often assume, even at the national minimum wage, which has important implications for David Cameron’s efforts to limit immigration from the rest of the European Union.

By happy coincidence, I took part in a Resolution Foundation (RF) discussion on the pay outlook a few days ago, chaired by Linda Yueh, featuring the RF’s Laura Gardiner, George Magnus and Michael Saunders.

We all took the view that there would be a real-terms rise in pay in 2016, which was encouraging, the differences of opinion being mainly whether it would be larger or smaller than in 2015.

At the end of last year average earnings were growing at 2.2% and inflation was 0.5%, so real wages rose by 1.7% over the course of 2014. That was a comfort. At a similar RF event nearly two years ago, I and others said there would be such an increase.

We do not yet have the figures for pay at the end of this year. The latest figures, showing a 2.4% rise in total pay, represented a deceleration compared with recent average earnings growth of 3%, though some of the numbers which make up the calculation. A sharp slowdown in pay growth in business and financial services, to just 1% in the latest month, may for example represent the lull ahead of the bonus season storm.

But let us say that average earnings will have risen by 2.5% in the final three months of the year. Inflation is likely to average precisely zero, so real wages have also risen by 2.5%. 2015 was better than 2014. Will 2016 be better again?

If you wanted evidence that the skill shortages emerging as a result of strong employment growth (up more than half a million over the past year) are pushing up wages, you could look at construction, where pay in the latest three months was 6.1% up on a year earlier. Outside that sector, however, despite reports of skill shortages elsewhere in the economy, there is scant evidence that the traditional Phillips curve relationship – the lower the level of unemployment, the higher is wage inflation – is exerting itself.

Pay settlements, while less important than they used to be, look to be stuck at around 2%. Allowing for drift and factors like the new national living wage, that suggests to me that wage growth over the course of next 12 months will be 2.5% to 3%. Some will get more some, particularly in the public sector, less. If that is the case, how much will real earnings rise? That depends on inflation.

For the second year in a row, the consensus among economists on inflation looks too high. The average prediction this month for inflation at the end of 2016 is 1.5%. That is higher than the Bank of England, 1.1%, and higher than I would expect. Inflation of between 0.5% and 1% at the end of 2016 would translate into a 2% real wage increase, not quite as good as this year but not bad. It would be a little above the prospective growth in productivity, which is running at just over 1.5%, but not excessively so.

What would it mean for the Bank and interest rates? Pay matters a lot for the Bank’s monetary policy committee. Minouche Shafik, one of the Bank’s deputy governors, is the latest to say so, highlighting the fact that pay growth has failed to accelerate as it expected, and has even gone into reverse.

If pay evolves as I suggest over the next 12 months then, alongside recovering productivity, it will give the Bank little reason to raise rates. Of course pay could be stronger, and of course there are other reasons why the Bank might want to follow the Fed. But on the evidence we have, and on the Bank’s signals, you would have to say it looks later rather than sooner.

Before I close on pay, a couple more things to say. One is whether the official figures are giving us anything like a realistic picture. Simon Briscoe, an independent economist and statistician, is particularly exercised by this and has written an extended blog on his website: The Bank might find it interesting.

Weak average earnings have dominated the debate in recent years, he says, with pay apparently still well below pre-crisis levels. But, as he puts it: “This does not (by and large) reflect falling wages for individuals. The great majority of people in employment have seen wage increases year on year. The average wage is low because millions of low paid jobs have been created …. When the dust has settled and the truth about the statistics emerges, there will be a rewriting of history.”

In similar, though not quite the same vein, it is not generally realised that Britain is, relatively speaking, a high-pay economy, even at the lower end. Britain’s draw, for workers from the rest of the EU, is usually thought to be because more jobs are available. Relative pay is, however, also important.

Michael Saunders of Citi points out that the existing national minimum wage is, when converted to euros, more generous than in any EU economy with the exception of Luxembourg. It is higher than Germany and France, double that in Spain, and roughly four times the level in Poland and most other eastern European EU members.

George Osborne does not intend to let it rest there. The new national living wage will be set at £7.20 an hour next April (the minimum wage is £6.70) and rise progressively to more than £9 an hour by 2020.

David Cameron has been trying to reduce the “pull” factor of Britain for EU migrants in his efforts to renegotiate the terms of Britain’s membership. Meanwhile his chancellor is busy increasing it by raising the statutory minimum employers have to pay. A case, it seems, of the right hand and the left hand not being very well coordinated.