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Home , Real wages, Wage growth

CentrePiece Spring 2014

The pain of the UK’s Great has been spread more evenly than previous downturns, with falling real across the . David Blanchflow er and Stephen Machin ask why this happened, how it compares with the US experience and what the prospects are for recovering lost gains. Falling

here have been unprecedented 25 to 29 have seen real wage falls of the boosted to generate wage gains for all falls in real wages in the UK order of 12%; for those aged 18 to 24, workers, then poor real wage outcomes since the start of the recession there have been falls of over 15% (Gregg for typical workers may be here to stay, Ttriggered by the et al, 2014). just as they are in the . of 2008. This did not happen in previous The young have thus been faced with Realistically, it is hard to see the levels of economic downturns: median real wage a double whammy; they cannot find jobs real wages at the start of the recession growth slowed down or stalled, but it and there are still close to a million under being restored for quite some time. did not fall. Indeed, in past , the age of 25 who are unemployed, a Figure 1 shows what has happened to almost all workers in both the lowest and quarter of whom have been unemployed real for the median full-time highest deciles of the wage distribution continuously for at least a year. Even if worker in the UK between 1988 and experienced growing real wages. It was young people can find a job, it tends to be 2013, alongside – as if as a warning sign – the unemployed who experienced almost low paid and frequently has fewer hours the comparable experience of the median all the pain: they lost their jobs and much than they would like, often involving part- full-time US worker. of their incomes, and many were time rather than full-time work (Bell and The UK median worker did relatively unemployed for a long time. Blanchflower, 2011). well in terms of real wage growth from But in the and its Why has this happened and what are 1988 up to somewhere around the early aftermath, the economic hurt has been the pros pects for recovering the lost wage spread more evenly, with wages taking the gains that workers experienced relative to strain this time. The real wages of the previous recessions? Some commentators typical (median) worker have fallen by believe that significant real wage growth is around 8-10% – or around 2% a year coming, and that the prospects are good There have been behind – since 2008. Such falls for a return to the real wage growth unprecedented have occurred across the wage patterns seen before the downturn. distribution, generating falls in living We are more pessimistic. We believe falls in UK real standards for most people, with the that unless the division of economic wages since exception of those at the very top. growth becomes more fairly shared to Some groups have been particularly offset long-run trends toward s greater the start of the hard hit, notably the young. Those aged inequality and unless productivity can be Great Recession

19 CentrePiece Spring 2014

Figure 1: The prospects Real wage growth at the median (fiftieth percentile), full-time weekly wages, UK and United States, 1988-2013 of significant wage increases ■ Median, UK ■ Median, United States for typical 50% UK workers

40% are bleak

30% and is downgraded again at the next forecast. In the most recent forecast for 20% December 2013, the OBR is expecting real wage growth of 0.3% for 2014, which is 10% down from the figure of 2.4% estimated Percentage wage growth in the June 2010 Budget and even as late 0 as March 2012. In its February 2014 Inflation Report,

1988 1993 1998 2003 2010 2013 the of England’s Year Committee (MPC) made similarly over- Source: UK data from New Earnings Survey/Annual Survey of Hours and Earnings from optimistic forecasts for real wage growth: Gregg et al, 2014; US numbers from Current Population Survey, Bureau of Labor Statistics. ‘In the central projection, four-quarter growth in real pay turns positive towards the end of 2014, as productivity growth or middle part of the 2000s; but from this growth forecasts by the Office for Budget picks up’. This is despite the fact that in the point, real wage growth began to slow Responsibility (OBR) have been remarkably most recent earnings data for February down and then, in the wake of the 2008 over-optimistic. 2014, real average weekly earnings downturn, it fell very rapidly indeed, Table 1 presents OBR forecasts at six continue to fall at a rate of 0.8% a year. So moving into negative territory. Over the points in time for nominal average as ever, a rapid turnaround is expected in same period, the typical US worker fared earnings growth and real earnings growth real wage growth: but if it hasn’t happened rather badly, with real wages remaining (average earnings minus the OBR’s for years, why should it happen now? below their 1988 levels up to 2000. Aside forecast of the consumer index, CPI). We have some serious concerns with from a period in the first half of the 2000s Over time, each forecast has been this relative optimism. First of all, to date, and in 2009-10, when some very modest downgraded from the previous forecast, during the start of the recovery, the real wage growth occurred, real wage which then proves to be overly optimistic productivity performance of the economy growth at the median was very weak. Indeed, in 2013, median real weekly Table 1: earnings were about the same in the Office for Budget Responsibility (OBR) forecasts United States as they were in 1979. This is of average earnings growth probably of concern for the UK’s prospects since the United States went through a number of labour changes some Nominal 2012 2013 2014 2015 time before similar shifts in the UK. These Budget June 2010 2.3% 3.8% 4.4% 4.4% include greater ‘flexibility’ and a massive November 2011 2.0% 3.1% 4.3% 4.5% reduction in the extent of union March 2012 2.6% 3.1% 4.3% 4.5% bargaining over wages. December 2012 2.7% 2.2% 2.8% 3.7% Current policy debates about the role March 2013 2.1% 1.4% 2.7% 3.6% of falling real wages in generating falling December 2013 2.0% 1.5% 2.6% 3.3% living standards (for example, in discussions of the ‘squeezed middle’ and Real 2012 2013 2014 2015 the ‘top 1%’) make the question as to Budget June 2010 0.4% 1.8% 2.4% 2.4% whether the falls in real wages can be November 2011 -0.7% 1.0% 2.3% 2.5% reversed an extremely important one. So March 2012 -0.2% 1.2% 2.4% 2.5% what are the conditions in which real December 2012 -0.1% -0.3% 0.6% 1.7% wages could start to grow again and March 2013 -0.7% -1.4% 0.3% 1.5% quickly? December 2013 -0.8% -1.1% 0.3% 1.2% A widely held view is that when the

economic recovery kicks in seriously, then Notes: Average earnings = wages and salaries/employment; real earnings calculated as average real wage growth will return. But wage earnings divided by OBR’s forecast of CPI.

20 CentrePiece Spring 2014

has been weak and it has not created has started to fall (although David Blanchflower is professor of room for wage rises, even though it has it rose in the most recent release from the at Dartmouth College and a former been good news for employment and Office for National Statistics, ONS), so member of the MPC and CEP. Stephen unemployment. outsider pressures pushing down on pay Machin is CEP’s research director, professor Second, because unemployment has may have weakened a little. of economics at University College London not risen by as much as in previous But it is quite clear that the economy is and a member of the Low Pay Commission. recessions, when and if it falls, there is less still well below and there scope than in the past for it to boost is a large amount of slack in the labour Further reading wage growth through the usual wage market. We see little evidence of curve mechanisms (that is, the reverse of widespread skill , which would Brian Bell and John Van Reenen (2014) the wage-depressing effectsf o push up wages; and public sector pay ‘Bankers and their Bonuses’, Economic unemployment in Blanchflower and freezes with continuing redundancies Journal 124: F1-21. Oswald, 1994). continue to push down on workers’ Third, and a feature that predated the bargaining power. David Bell and David Blanchflower (2011) recession, because of inequality increasing Firms have started to perform better so ‘Youth Underemployment in the UK in the average earnings by more than median their ability to raise pay levels may have Great Recession‘, National Institute earnings, the wages of typical UK workers increased slightly – but so far we see no Economic Review, January: R1-11. are no longer keeping up with productivity evidence of any change in their willingness gains made in the economy. Indeed, as to pay. In line with our discussion of David Blanchflower and Andrew Oswald Figure 2 shows, measures of total inequality, this does raise a key question: (1994) The Wage Curve, MIT Press. compensation growth track productivity why, if nothing changes, wouldn’t they quite well, but median wage growth has continue to keep any gains to themselves? Paul Gregg, Stephen Machin and Mariña fallen behind since at least the early 2000s. It stretches credulity to believe that all of a Fernández-Salgado (2014) ‘The Squeeze Median wages seem to have become sudden bosses will hand over pay increases on Real Wages – And What It Might Take ‘decoupled’ from productivity growth to their workers when they have shown no To End It’, National Institute Economic because of rising inequality, which means inclination to do so for several years. Rev iew, forthcoming, May 2014. that a growing share of the from productivity growth is absorbed by pensions and higher salaries for top earners (Bell and Van Reenen, 2014). This The long US experience of stagnant again is something that the United States real wages might be viewed as a experienced earlier than the UK, and where real wage performance for the warning sign for the UK typical worker has remained poor for over 30 years. Figure 2: For significant real wage growth to re- Labour productivity, annual compensation, mean and emerge, all of these problems would need median wages, 1988-2012 to be tackled. Productivity would need a sharp increase of the kind experienced ■ Labour productivity: GDP per hour (GDP deflator) much earlier in the UK recessions of the ■ ONS employees mean hourly compensation (GDP deflator) early 1980s and early 1990s. There are few ■ ASHE average (mean) hourly earnings (GDP deflator) signs of this happening, and the problem ■ ASHE median hourly earning (GDP deflator) ■ has been magnified by the UK’s dismal ASHE median weekly earnings (CPI) 1.6 investment rates. Even if productivity were to rise rapidly, the tendency for longer-run inequality trends to cause an unequal division of wages from productivity gains to the top 1.4 (like bankers’ bonuses) would need to be addressed. Until that happens or until policy starts to address these issues seriously, it seems that the prospects of 1.2 significant, rather than modest, real wage Growth (indexed to 1 in 1988) increases for typical workers are bleak. The main drivers of wage pressure come from an intricate blend of ‘insider’ 1 1988 1992 1996 2000 2004 2008 2012 and ‘outsider’ forces – people who would Year like to work and are currently in or out of a job. There is some evidence that Source: ONS; New Earnings Survey/Annual Survey of Hours and Earnings; Gregg et al, 2014.

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