The UK’s pay squeeze – no end in sight?

workersSince the Great Recession, and among the world’s richest economies, pay growth in the UK has been historically weak. The Economist magazine reported on 20th April that the pay squeeze in the UK has eased during the last year or two, but is by no means over.

Nominal wages are now growing at around 3.5% year, while real wages (adjusted for inflation) are growing at 1.5%. In a way, this slight improvement is to be expected, with employment at a high level and unemployment relatively low, creating a tightening labour market, and shifting bargaining power from employers towards workers.

Another piece of good news is that more of the jobs now being created have higher pay. To put it another way, the composition of the workforce is changing. As The Economist put it, “strawberry-pickers have made way for stock-pickers”.

This is also related to some improvement in productivity: output per hour has recently grown by about 1% a year. This performance is still poor historically, compared with much of the post-war period prior to the recession, but it is something.

The question is, can this performance be sustained or improved upon? With economic growth currently pretty sluggish, at under 2% per year, and productivity growth somewhat lower than that, companies will currently only be able to pay higher wages by squeezing profits, which will reduce the resources available for new investment and keep future output and productivity growth weak.

Alternatively, wage increases could be accommodated by firms raising prices, meaning that real wages rise by much less if at all, and making the prospect of interest rate rises more likely, in order to ward off inflation. This would also be likely to weaken investment and slow economic growth. Some combination of the two effects (profit squeeze and price rises) is also quite possible.

The only way for real wage growth to recover to its pre-crisis trend in a sustainable fashion is via an acceleration in productivity. Growth in output would then cease to be so reliant on job-creation, which is increasingly limited given relatively full employment and the tightness of the labour market, plus the impact of the slowdown in net immigration due to the prospect of Brexit on labour force growth. It would instead open the way for increases in both real wages and profits as the economy becomes more productive.

Productivity increases depend on the accumulation and combined improvement in the use of factors such as labour, capital and technology in production which, if the figures for the last decade or so are correct, has been pretty stagnant in the economy as a whole.

There are therefore various ways in which productivity growth could pick up. Firms could step up investment employing new technologies, resulting in new and cheaper products and more efficient production processes.

Continued tightness in the labour market, which should put more upward pressure on wages, may force firms to invest in labour-saving technology, rather than being able to rely on cheap labour. This seems to contradict the profit squeeze argument mentioned above, but it remains a possibility. It might also encourage firms to offer training which equips current and newly employed workers for more productive roles in the workplace.

Government can also play a major role, through the provision of improved infrastructure, labour market support in the form of training and relocation where necessary, and regional and industrial policies which incentivise decent job-creation in relatively deprived areas and the use of new technologies. The encouragement of more affordable housing would also help.

Nearly a decade of government austerity has ‘successfully’ reduced public sector employment in the poorer regions of the UK, but the vaunted flexibility of the labour market has meant that many of the new private sector jobs that have replaced them have been no guarantee against poverty. Is it any wonder that there is such discontent nationally?

Compared with much of the rest of Northern Europe, the UK remains highly unequal in regional terms, with London and the South East relatively productive and prosperous, and much of the rest of the country having been left behind. It is unlikely that a tight labour market will by itself significantly improve the UK’s economic performance in the ways explored here. But a range of enlightened policies combined with such a trend could be helpful.

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