My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
The squeeze is back. Real wages have stopped growing in Britain, a few months earlier than expected, thanks to the combination of rising inflation and sluggish pay growth.
After just over two years in which households appeared to have put the financial crisis behind them, and average earnings comfortably outstripped the rise in prices, a couple of years in which real wages fall is in prospect. Regular pay rose by just 0.1% in the year to the December-February period, and that tiny rise looks to be the last for a while.
The first and prolonged fall in real wages from mid-2008 to the autumn of 2014 was directly attributable to the crisis. It was the mechanism by which living standards fell to reflect Britain’s permanent loss of gross domestic product; the lost growth that will never be recovered.
This second fall in real wages reflects two things. Weak oil and commodity prices provided the basis for the recovery in real incomes from autumn of 2014, with the plunge in oil prices from $110 a barrel in mid-2014 to below $30 a barrel in early 2016. The partial recovery from that fall has been one factor pushing up inflation.
The other is sterling’s Brexit-related drop. The pound’s fall, which was the direct result of last summer’s referendum result, and to the Theresa May’s approach to the negotiations – no single market and no customs union – is now the factor coming through most strongly in the inflation figures.
One way of measuring the sterling effect is the difference between Britain’s inflation rate last month, 2.3%, and that in the eurozone, 1.5%. That difference will grow in coming months as inflation in Britain heads towards and possibly above 3%.
This second fall in living standards is the adjustment to what the currency markets, and the majority of economists, think will be a poorer, slower-growth future as a result of Brexit. The fact that we have been here before in terms of falling real wages, and quite recently, may or may not make it easier to bear.
Real wages are, of course, made up of two components. Inflation is one, growth in wages in cash terms, what economists would call nominal wages, the other. The fact that it only takes a small rise in inflation above the official target of 2% to squeeze real wages shows how strangely depressed is the growth in real wages.
Britain’s unemployment rate is currently a very low 4.7%, which is good news. The last time it was this low, in August 2005, average earnings were growing by 4.7%, roughly double the current. If you believe in anything like a traditional Phillips curve – in which falling unemployment pushes up the growth in wages and vice versa – earnings should be growing a lot faster.
Why are they not doing so? A couple of candidate explanations can be quickly ruled out. One is public sector pay policy, which limits most workers to a 1% increase. But, while public sector earnings are growing more slowly as a result, just 1.4% a year at present; the increase in regular pay in the private sector, 2.4%, is also much weaker than past relationships would suggest.
Is it all down to those migrant workers from the EU? We are seeing the first signs of a reduction in EU migrant workers who, contrary to what you may have read in recent days, come here overwhelmingly to work. Unemployment among EU nationals In Britain is under 4%.
There is, meanwhile, no evidence that UK migrants have pulled down wages to any significant extent. Steve Nickell, formerly of the Bank of England and Office for Budget Responsibility, saw his words to a parliamentary committee last year seized on by the anti-migrant lobby. But, as he pointed out recently, any impact on wages, even for the unskilled in Britain, has been “infinitesimally small”.
Meanwhile, migrant workers from the EU14 – the other members before Eastern European enlargement – are the highest paid of any group in Britain, according to new research from the Office for National Statistics. Two in every five EU migrant workers are overqualified for the jobs they do.
If not public sector pay and migrant workers then what? Though the rise in employment has slowed, and in the latest three months was just 39,000, its composition has improved. So one explanation for weak pay growth, that there was insecurity at the heart of Britain’s job creation machine, reflected in part-time, temporary and zero-hours jobs, is losing its explanatory power.
The ONS, analysing the latest labour market figures, noted that a “compositional shift” from part-time to full-time employment is occurring. The share of part-time employment reached a record high of 27.6% in 2012, in the wake of the crisis, but has now dropped to 26.5%, just above its pre-crisis average of 25.5%. The proportion of part-timers who cannot find full-time work has dropped from a 2013 peak of 18.4% to 12.6%. All this should be consistent with rising wage pressure.
Even weak productivity, itself a long-standing explanation for weak wages, does not tell the full story. Productivity, output per hour, is up by 1.2% over the past year, which is nothing to write home about but is a lot stronger than the rise in real wages. In fact, real wages in recent years have lagged behind even a disappointing productivity performance.
The weakness of wages, on the face of it puzzling, may be easier to explain than appears. Firms can point, not just to the fact that the past few years have been ones of uncertainty, with another layer added on to that uncertainty by Brexit, but also to other demands, from pensions through to business rates and the apprenticeship levy. Some have been particularly affected by the national living wage, which this month has risen by an inflation-busting 4.2%. They are in no mood to grant bigger pay increases than they need to.
Employees, meanwhile, seem to be happy with a 2% pay norm, and less willing to move jobs in search of higher pay than in the past. If an acceptable pay increase a few years ago was 4% or 5%, now it is 2%. Some would say that stronger unions would break us out of this new norm, and perhaps they would, but only at the expense of higher unemployment.
If pay sticks at about 2% while inflation moves higher, does that guarantee weak consumer spending? Not necessarily. During the long squeeze on real wages which ended in 2014, spending was kept going by rising employment; even if individuals were squeezed, the overall wage bill was increasing. Households can borrow, or run down savings, as they did in the second half of last year. The more they see the squeeze as temporary, the more they are likely to “look through” it, though borrowing tends to fall when real incomes are squeezed.
The “look through” point also applies to the Bank of England. Most of its monetary policy committee intends to look through this period of above-target inflation, unless or until wage growth accelerates significantly, which would be seen as embedding higher inflation into the economy. If the growth in earnings stays more or less where it is, the Bank will be reluctant to hike rates.
I am not sure about the wisdom of this. There is a danger in tying monetary policy to any one indicator. If, indeed, we are in a period when wage growth trundles along at 2% indefinitely, and this is the new equilibrium, it implies that the so-called normalization of interest rates will never happen. Rates would stay at the “emergency” near-zero levels established at the height of the crisis. That cannot be healthy.