Sunday, November 12, 2017
Time for a pay rise? Let's see some productivity first.
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.

Something, it seems, is stirring on pay. After years in the doldrums, and with pay growth apparently stuck at 2% when inflation is 3%, two surveys in the past few days have suggested that, finally, things are beginning to pick up. Bearing in mind that there have been plenty of false dawns before, is this at last the moment?

One of the surveys, from the Bank of England’s regional agents, clearly influenced the monetary policy committee (MPC) when it raised interest rates earlier this month. It suggested that, in comparison with pay increases this year of 2% to 3%, the outlook for next year was somewhat higher, 2.5% to 3.5%.

The other, from the Recruitment and Employment Confederation (REC), a monthly survey of recruitment agencies, suggested that shortages of available candidates are starting to have an impact on pay. Starting salaries for permanent staff rose at their second strongest rate since November 2015.

“Anecdotal evidence suggested that candidate shortages and strong competition for staff had driven up starting salaries in the latest survey period,” the REC said. “Data indicated that rates of pay inflation were sharp across all monitored regions, with the steepest increase seen in the South of England.”

Unite, the union, is urging 9,000 Ford production workers at Ford – always a trendsetter – to accept a pay offer worth 4.5% in the first year and a minimum of 6.5% over two years.

In many respects this is not a huge surprise. Unemployment, at 4.3% of the workforce, is at its lowest rate since 1975. If the traditional Phillips curve, the inverse relationship between wages and unemployment, means anything, it should mean bigger pay rises when unemployment is this low.

Recruitment difficulties, as highlighted by the Bank’s agents and the REC survey, are increasing. Some employers are already suffering the loss of EU migrant workers, or are having to compensate for the drop in their earnings expressed in euros, Polish zlotys or other foreign currencies as a result of sterling’s post-referendum weakness.

Inflation, 3% on the basis of the consumer prices index, 3.9% according to the retail prices index, is running ahead of pay, so real wages are falling. In the past, the current combination of inflation and unemployment would be associated with average earnings growth of 5%, not 2%.

If this is the moment, it would be a cause for some celebration in official circles.
The Bank would be even more convinced that it is doing the right thing in gradually raising interest rates. Faster growth in wages would be good for the public finances and ease some of the political pressure on the government. Beleaguered retailers would have a little less to worry about.

But there are two questions to address about the prospect of faster growth in pay. The first is: is it real, or another in the series of false dawns since 2010? The second, is it healthy?

On the first, a note of caution is justified. The Bank’s regional agents have been reporting a pay settlement norm of 2% to 3% for some time. The fact that this has been associated with average earnings increases of around 2% can be put down, as the Bank does, to compositional changes, in other words a rise in the proportion of lower paid jobs.

This, according to the Bank, reduces earnings growth by 0.75 percentage points. So, even if the agents’ intelligence is right, it may only convert to average earnings growth, as reported by the Office for National Statistics, of about 2.5%. Though inflation is expected to fall next year, it will not on this basis do so by enough to deliver any meaningful rise in real wages.

Another reason for caution is the outlook. The European Commission has just released a gloomy set of forecasts for growth in Britain, to which the response might be: they would say that wouldn’t they? But other forecasts also point to slower growth in Britain, despite a stronger global economy.

Britain’s labour market has been a great success, a minor if not a major miracle, as I wrote a few weeks ago. But slower growth will take its toll and the assumption that we are looking at a future of ever lower unemployment may be tested.

The increase in employment over the latest 12 months, to June-August, was about half that of the previous 12 months. And, while traditional full-time employment had been driving the growth in jobs, in the latest three months it was dominated by an increase in part-time self-employment. You write off Britain’s job market at your peril, but one or two signs of softening are emerging.

The second question is that, if it is happening, is an acceleration in pay a good thing? For those in receipt of it, and for the government, it would be. But, as far as productivity is concerned, higher pay looks to be putting the cart before the horse.

The same Bank agents’ survey that picked up rising pay pressures also found that businesses are quite downbeat on investment intentions, which point to “moderate” investment growth over the next 12 months and even weaker over the following two years. Investment is one of the keys to raising productivity.

There is an argument that only recruitment difficulties and pay pressures will force businesses to boost productivity but this is one of those chicken and egg questions. What comes first, higher pay or productivity? There is no doubt that, for business, higher pay funded out of productivity gains is infinitely preferable.

If higher pay is indeed starting to come through, it suggests that something rather old-fashioned is happening. A fall in the pound pushes up inflation and leads to pressure for higher pay, without a matching rise in productivity. The gains in competitiveness from the weaker pound are soon eroded. That has been the pattern in the past. If it is starting to happen again now, that definitely would not be good news.