Sunday, October 14, 2018
A new dawn for pay - or another false one?
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.

It has been a very long time in coming. So long indeed, that looking forward to a meaningful revival in pay and productivity has become the economic equivalent of Waiting for Godot. I won’t spoil the plot of the play but when I saw it, it went on a bit.

But has the moment finally arrived? The latest figures on productivity – the amount we produce for every hour we work – showed an uptick. As the Office for National Statistics reported, there was a 1.4% rise in the year to the second quarter, and this was the seventh successive quarter in which productivity had grown on this basis.

A sustained revival in productivity, as noted here, is the perhaps the most important positive development that could happen to the economy. I don’t have to quote Paul Krugman’s deadpan observation that “productivity isn’t everything but in the long run it is nearly everything”, but I will.

Productivity is the ultimate driver of economic growth and any improvement helps competitiveness, the public finances and is intimately connected to pay. And on this, it was a neat coincidence that Andy Haldane, the Bank of England’s chief economist, appointed a few days ago to also chair the government’s new industrial strategy council – with part of its aim to raise productivity – is also more upbeat on pay.

In a speech to the Acas Future of Work conference, he discussed the “puzzling pattern of rich jobs but poor pay growth”, the biggest reason for which has been weak productivity. As he put it: “Productivity growth pays for pay rises, at individual firms and for the economy as a whole. Over the past ten years, productivity has barely grown in the UK.” A lost decade for productivity largely (but not entirely) explains the lost decade for real wages.

But now, he suggested, a new dawn is breaking for pay. Average earnings growth has picked up to 2.9% and the Bank’s own evidence on private sector wage settlements suggest they are running at 2.8% so far this year, and above 3% in IT and construction. The 1% public sector pay cap, he noted, “has now been lifted and decisively so.” And, perhaps most tellingly: “Measures of labour market tightness have increased to their highest levels since before the crisis and, in some cases, ever.”

When a member of the Bank’s monetary policy committee speaks of stronger pay growth, there is always a swings and roundabouts aspect of it for households, certainly those with mortgages. The stronger that pay is, the more emboldened the Bank will feel in raising interest rates.

But the central question is a different one. Is this really a new dawn for productivity and pay? Just when we were ready to go home, has Godot lumbered into view?

Let me take productivity first. The ONS, when reporting the upturn, also noted that at 1.4%,”this remains noticeably below the long-term trend observed before 2008 when productivity growth averaged nearly 2% per year”. There are also a couple of clear caveats about the figures.

The more traditional way of measuring productivity, output per worker, is not doing anything special. It showed an annual rise of just 0.2% in the latest quarter, so is flatlining. The disconnect between the two is because while the number of workers employed rose by 0.9% over the latest 12 months, the total number of hours worked dropped by 0.2%. I would be a lot more comfortable if both measures of productivity were breaking out of their long period of stagnation. It is possible that the apparent improvement is a statistical quirk.

The other reason for scepticism is that none of the things that we think about as the drivers of productivity – investment, skills, better infrastructure, less intrusive regulation – have changed, and if anything they have got worse.
On pay, pretty well every economist would share Haldane’s view that a tighter labour market should be leading to stronger pay growth. The Phillips curve, the inverse relationship between wage growth and unemployment, still means something.

Without a sustained increase in productivity, however, pay could easily disappoint and, as noted, there are reasons for scepticism about that. And, as with productivity, none of the other “structural” factors the Bank’s chief economist also identified as holding down pay have changed, as he acknowledged. What he described as “tectonic” shifts in the labour market, including a decline in unionisation and collective bargaining, the power of employers and their unwillingness to pay up to stop staff leaving, the rise of the gig economy and self-employment, and so on, all remain in place.

Having said all that, in normal circumstances Britain would be due a sustained recovery in pay and productivity. The economy cannot go on indefinitely with stagnant real wages and productivity. Three years ago, when productivity growth pickled up to within a whisker of 2%, we seemed to be on the brink of something. But then it fell back. And, if you wanted to take an optimistic view of pay and productivity, you would not want to start when Brexit is looming

The Office for Budget Responsibility (OBR), the government’s fiscal watchdog, issued a Brexit discussion paper last week, warning that the fog will not lift in time for any withdrawal agreement to be embodied in its forecasts to appear alongside the October 29 budget. Whether it lifts in time for its spring update must be a serious doubt.

The OBR, citing the experience of the 1974 three-day week ( a quarterly fall in gross domestic product of nearly 3%) as an example of the kind of damage a no-deal Brexit could do, thinks there would be a drop in asset prices, including the pound, pushing up inflation and thus squeezing real wages again. In that environment, companies and households would rein back investment and the banks would reduce the supply of credit. Any gradual upturn in pay and productivity would be stopped in its tracks. And, while the economy would eventually recover from the shock, but “the effects on output could be very long-lasting”.

Even in the event of a deal in coming weeks, the OBR notes “that this will be just one additional milestone in the Brexit process”. A trade deal will take years while the new migration framework – reducing migration will more likely harm rather than help productivity – will also take time. “Much of importance for the economy and the public finances will remain to be determined,” it says.

That has to be right. And it is why we should be sceptical about a breakthrough for pay and productivity. As long as uncertainty persists, firms will be keeping a lid on pay rises and productivity-enhancing investment. There will be a new dawn. But there is the rest of a dark night to get through first.