The outlook for wages in Britain

This column first appeared in the March edition of Fund Strategy. The accompanying graph is available to see here.

This column may be a little more personal for readers than normal. It concerns the likely trajectory of wages in the near future. In particular whether there are any signs of an upward trend after the pain of recent years.

Of course you may be one of the lucky few who have enjoyed a rising real income since 2008. But for most people in Britain it has been a miserable time for living standards.

The accompanying graph from the Office for National Statistics (ONS) helps illustrate how bad things have been. Real wages shrunk in every period from the second quarter of 2010 to the third quarter of 2013. This is the most long drawn-out decline on record.

Nor does the situation look any better when examined from a broader perspective. According to the Institute for Fiscal Studies, a respected think tank, real median household incomes in 2013-14 were 6% below their pre-crisis peak. That covers a longer time span than the ONS study (since economic output peaked in the first quarter of 2008) and more than wages alone (since household incomes also include welfare benefits, returns on investment and the like). Nevertheless the IFS itself says the fall in average incomes was mainly driven by earnings.

At last, however, things appear to be looking up with GDP rising by 0.7% in the final quarter of 2013 according to the provisional estimate by the ONS. This means that GDP was 1.9% higher in 2013 than the year before.

This news is certainly welcome but it needs to be put in perspective. GDP has risen since 2009 but it is still 1.3% below its peak in the first quarter of 2008. At that rate it will take a year or two for output to return to its level of seven years earlier. It GDP had instead risen at 2% year, a relatively modest rate, over that period then total output would be about 15% higher than with the pain of the downturn.

However, if the figures are adjusted for the increase in employment since late 2009 the sums come out a little differently. Although output has increased since then the number of people employed and the number of hours worked has risen faster. In other words output per hour – a key measure of productivity – has continued to trend downwards.

This matters because, everything else being equal, productivity is the key determinant of earnings. In a more productive company the employer can afford to pay more to his employees.

That explains why the idea that companies always try to minimise their employees’ wages is wrong. In a highly productive company – say a factory with lots of advanced machinery – it is possible to pay high wages to the relatively small number of employees. In contrast, a factory with little automation is likely to have many employees but pay them each relatively little.

In other words the main consideration for employers is not to pay its employees the lowest wages possible. It is, rather, to make healthy profits. In theory this can happen with a well-paid workforce and lots of automation.

Wages tend to be cut, at least in real terms, either when companies are facing tough times or the overall economic climate is harsh. In such situations wage cuts are often seen as a temporary means of shoring up profits.

From this perspective the prospects for wage growth do not look good in the coming years. Even assuming economic recovery continues – which is far from certain – it could still take years for productivity to return to its previous peak.

Perhaps the recent pronouncements by politicians on the minimum wage provide a sign of hope. Not that Fund Strategy readers are on such low incomes – at least hopefully not.  But if politicians are willing to increase the minimum wage then perhaps they will take a more relaxed attitude towards others increasing their incomes. The recent call by George Osborne, the Chancellor, for an above inflation increase in the minimum wage could certainly be read that way. Labour has gone a little further with Ed Miliband, the party leader, calling on firms to voluntarily introduce a living wage at a slightly higher rate than the minimum.

Interestingly other countries are also talking about minimum wages. Barack Obama reiterated his call for a higher federal minimum wage in his recent State of the Union address. In Germany the new grand coalition government has adopted the minimum wage under pressure from the Social Democrats.

But look at the rhetoric more closely and it seems politicians are more interested in keeping wages down rather than raising them. The talk is of everyone being willing to take sacrifices together. From this perspective everyone else should be willing to limit their ambitions to make the minimum wage possible for the least well off.

I take no pleasure in making such a gloomy prognosis for wages in the coming years. On the contrary, I would like to see a sharp rise in incomes. However, the precondition for such an increase is a strong improvement in corporate investment and productivity. Unfortunately, few seem to be taking such a perspective at present.