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Wages are coming under the spotlight again. There is new data, and new estimates from the OBR. The truth is that until wage growth starts to outstrip inflation, the UK economy will struggle to grow. Is there a solution?

Average wages grew by 1.2 per cent in the three months to the end of January. That was both with and without bonuses. Inflation, as measured by the CPI, was 2.7 per cent. Look at this chart, it may be quite pretty in the sense that it has lots of bright colours, but the story it tells is far from pleasant.

wages_inf

Yet at the tail end of 2011 many economists were forecasting a UK recovery later in 2012, built on the assumption that growth in average wages would finally begin to outstrip inflation. Okay, most economists got inflation wrong. But they got their forecasts wrong in another respect. Growth in average wages was expected to increase. Instead it has fallen from 2 per cent annual rises at the end of 2011, to a mere 1.2 per cent.  I never did understand why they were so sure wages were about to rise. Now I am beginning to think that they just guessed.

Talking of guessing, the Office of Budget Responsibility reckons growth in average wages will outstrip inflation next year. It reckons that in 2014 average wages will rise by 2.7 per cent, while inflation will be a mere 2.4 per cent. By 2016, it is forecasting wage growth of 4 per cent, and inflation falling to the 2 per cent target. I have no idea why it is so optimistic. I presume it is just assuming that in three years times the data will return to its historical average.  Maybe it will, but I have my doubts.

OBRwagesinflation

But one question still hovers rather unpleasantly. If real wages aren’t rising, how can the UK grow? Well, one way is via debt. Consumers may not be earning more, but if house prices rose they could perhaps justify running up credit card bills, topping up their mortgage. Enter stage right, George Osborne, who used his latest budget to try to create a housing boom. I have already made my feelings on this clear. Creating bubbles in house prices is no way to create an economic recovery, although I would temper my criticism by saying that at least Osborne‘s plan should create more new houses.

Another way forward is via exports. Actually, there is some reason for optimism here. The fall in sterling has helped, although the Eurozone authorities do seem to have a found a new wheeze to keep the euro down, and that is called screwing Cyprus. But UK exports to the BRICs, China especially, have been impressive.  UK exports to China have risen eightfold since 2000.  See: Is the UK finally cracking overseas markets?

Remarkably, the UK car industry is almost exporting as much as it is importing. If the trends we have seen during recent years continue, later this decade the UK may find it is enjoying a trade surplus.

But drill down into the data and theories, and one truth stands out. There is a way the UK can see wages rise and exports grow, but it relies on productivity. Our record in this respect is awful. According to the ONS, output per hour in the UK was 16 percentage points below the average for the rest of the major industrialised economies in 2011, which was the widest productivity gap since 1993. On an output per worker basis, UK productivity was 21 percentage points lower than the rest of the G7 in 2011.

It is good news that the UK has recently seen growth in jobs and falling unemployment. Considering the plight of the UK economy, the data on UK employment is remarkable. But falling unemployment is being paid for by falling wages. If productivity rose, employers could afford to pay higher wages, and exporters would, in any case, become more competitive.

Only via investment and creating a more entrepreneurial economy can the UK crack this challenge.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees


Showing 1 comment

  1. Garry Hawkins

    Michael,

    The problem for the UK is that for all the focus on exports, which is good, the percentage of GDP created by manufacturing is currently in the region of 11%.

    This compares to figures (off the cuff you understand) in the low twenties percentage in the mid-1980′s.

    This loss of capacity is desperately difficult to make up – especially without some sort of economic miracle (such as a shale gas revolution for example) to kick start it.

    The UK is incredibly good at providing services, particularly financial services – but also growing areas like engineering services – think of Rolls Royce selling a service package with its Trent Engines. Engineering specialists in Derby watching banks of computers detailing jet engine performance of a China Eastern flight from Shanghai to Sydney…

    But the trouble is, exporting services is difficult. The EU single market has yet to be opened up in this respect and it’s not easy selling insurance into China and India.

    This all rather suggests an incredibly slow long term recovery, until such time as the debt is paid off, or more likely, inflated away.

    As for the employment/productivity dichotemy – I’ have a feeling there may be some issues with the figures.

    Yes, we have issues of zombie banks/companies and individuals desperately holding onto capital/staff and jobs. Yes we have companies holding onto staff, worried about the cost and that they won’t be able to replace them in the event of a rapid upturn.

    If there was such a shortage of well trained staff – wages would have to rise to attract them to take up the jobs available.

    This doesn’t seem to be happening. It maybe that the wages on offer are so low, that potential applicants have moved into alternative careers – or – the opportunity cost of such low wage is just not worth the candle.

    Immigration may also be a contributory factor = folks who are prepared to work for less than indigenous folks are willing to work for.

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