It’s a pity but no sur­prise wages aren’t in­creas­ing with in­fla­tion

Belfast Telegraph - Business Telegraph - - Economy Watch - By conor lambe, Danske bank econ­o­mist @conor­lambe

The UK econ­omy is ex­pe­ri­enc­ing a slow­down. In the first quar­ter of this year, real GDP grew by just 0.2%. In the sec­ond quar­ter of the year, eco­nomic growth was a mod­est 0.3%. One of the main fac­tors be­hind this low growth is the squeeze on con­sumers — a con­se­quence of high in­fla­tion and fall­ing real wages.

In Great Bri­tain, the lat­est data shows that nom­i­nal wages grew by 2.1% in the year to April-june 2017. How­ever, in­fla­tion cur­rently stands at 2.6%. There­fore, when price rises are taken into ac­count, con­sumers’ earn­ings are ac­tu­ally de­creas­ing.

The high rate of in­fla­tion is pretty easy to ex­plain — it’s mainly a con­se­quence of the de­pre­ci­a­tion in ster­ling fol­low­ing the EU ref­er­en­dum. But, given the ap­par­ent strength of the labour mar­ket, why is wage growth so sub­dued?

Eco­nomic the­ory sug­gests that a strong, or tight, labour mar­ket should re­sult in wages ris­ing rel­a­tively quickly. From the be­gin­ning of 2003 to the end of 2007, the five years pre­ced­ing the fi­nan­cial cri­sis, the UK econ­omy and labour mar­ket per­formed pretty well. Nom­i­nal wage growth av­er­aged just un­der 4% dur­ing this pe­riod. So per­haps the first thing to ex­am­ine when con­sid­er­ing the cur­rent rate of wage growth is just how tight the labour mar­ket re­ally is at present?

The mea­sure that re­ceives the most at­ten­tion when as­sess­ing the per­for­mance of the labour mar­ket is the un­em­ploy­ment rate. In the UK, the un­em­ploy­ment rate is 4.4% — the low­est since 1975 and 0.7 per­cent­age points lower than the 5.1% that it av­er­aged from 2003 to 2007. How­ever, analysing some other data sources can help to build up a clearer picture of the jobs mar­ket.

The UK em­ploy­ment rate is the high­est since com­pa­ra­ble records be­gan in the early 1970s and there are cur­rently 1.9 un­em­ployed peo­ple per job va­cancy, lower than dur­ing the pre-cri­sis years. How­ever, 12.3% of peo­ple work­ing part-time are do­ing so be­cause they can’t find a full-time job — higher than the 8.4% av­er­aged from 2003 to 2007.

And the pro­por­tion of peo­ple in tem­po­rary em­ploy­ment be­cause they couldn’t find a per­ma­nent job is also a bit higher now than it was in the mid-2000s.

This closer look at the data sug­gests there may be a lit­tle more slack in the labour mar­ket than the head­line num­bers sug­gest, and this could be re­strict­ing wage growth. But, on its own this is not enough to ex­plain why the cur­rent rate of earn­ings growth is ap­prox­i­mately half of what it was be­fore the fi­nan­cial cri­sis. I think there are two other fac­tors hold­ing back wage in­creases — Brexit-re­lated im­pacts and weak pro­duc­tiv­ity growth.

For many busi­nesses, the de­pre­ci­a­tion in ster­ling fol­low­ing the EU ref­er­en­dum has pushed the price of im­ported raw ma­te­ri­als up­wards. This has put costs firmly un­der the spot­light and, as such, some com­pa­nies are re­luc­tant to take on the ad­di­tional cost of sig­nif­i­cantly higher wages, even if work­ers ask for pay rises to match the higher in­fla­tion rate.

As well as this, con­sid­er­able un­cer­tainty re­mains around what ac­cess UK busi­nesses will have to EU mar­kets after Brexit oc­curs. When cou­pled with the slow­ing do­mes­tic econ­omy, the risks around fu­ture rev­enues are rel­a­tively high and this may also be lead­ing busi­nesses to hold off on of­fer­ing per­ma­nent pay rises to their staff.

Labour pro­duc­tiv­ity growth is a key de­ter­mi­nant of wage rises. Pro­duc­tiv­ity is de­fined as the amount of out­put a worker pro­duces in an hour. When the amount that each worker pro­duces is ris­ing quickly busi­nesses are more able, and will­ing, to of­fer high pay rises. How­ever, UK pro­duc­tiv­ity growth has been weak for a num­ber of years now. Pro­duc­tiv­ity fell in the first and sec­ond quar­ters of this year and out­put per hour is cur­rently lower than it was in the fourth quar­ter of 2007. Un­less pro­duc­tiv­ity growth picks up strongly, it is hard to see wage growth re­turn­ing to its pre-fi­nan­cial cri­sis lev­els.

Boost­ing earn­ings growth is not straight­for­ward but there are some ac­tions that pol­i­cy­mak­ers could take to com­bat the two fac­tors hold­ing back wage rises that are dis­cussed above.

Re­solv­ing the sep­a­ra­tion is­sues re­lated to Brexit, specif­i­cally around the fi­nan­cial set­tle­ment which ap­pears to be the big­gest stum­bling block at present, would al­low the UK and EU ne­go­tia­tors to move onto dis­cussing fu­ture trade terms. The UK Gov­ern­ment should do all it can to en­sure that the sep­a­ra­tion terms are agreed by the orig­i­nal Oc­to­ber dead­line.

It should also quickly seek to reach an agree­ment with the EU for a tran­si­tion deal that will main­tain ac­cess to EU mar­kets for UK busi­nesses while the fu­ture trade deal is ne­go­ti­ated and fi­nalised. This could re­duce some of the short-term risks for busi­nesses and make it eas­ier for them to grant wage in­creases.

Rais­ing pro­duc­tiv­ity growth is a longer-term chal­lenge and will re­quire poli­cies to im­prove the UK’S ex­ist­ing in­fra­struc­ture, in­vest­ment in skills and mea­sures to en­cour­age busi­nesses to in­no­vate and en­gage in Re­search & Devel­op­ment ac­tiv­i­ties. The Gov­ern­ment has al­ready an­nounced poli­cies along th­ese lines — for ex­am­ple last year’s Au­tumn State­ment had an in­fra­struc­ture fo­cus while this year’s Bud­get in­cluded a num­ber of ed­u­ca­tion ini­tia­tives. If pol­i­cy­mak­ers are to suc­ceed in rais­ing pro­duc­tiv­ity growth, th­ese things need to re­main high on the Gov­ern­ment’s pol­icy agenda.

In­fla­tion is fore­cast to re­main above the Bank of Eng­land’s tar­get over the next cou­ple of years. With con­tin­ued high price rises on the hori­zon, con­sumers are no doubt hop­ing that wage growth starts to pick up sooner rather than later.

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