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September 17th, 2017

High employment and low wage growth

Another month goes by and another month of extremely confusing employment data.  The good news is astoundingly good: record levels of employment, 40 year lows of unemployment and record numbers of job vacancies per unemployed person.  These are statistics that would indicate a booming economy and you would normally expect rapid wage growth.  Indeed, economists have a concept of NAIRU (non-accelerating inflation rate of unemployment), which is a not very snappy way of saying that if unemployment goes below a certain level, wages will rise and feed into inflation.  Effectively, it’s the law of supply and demand being applied to the labour market.

That isn’t happening in Britain despite all those employment records.  Wage growth has been lacklustre for years, with no sign of it picking up any time soon.  Whatever NAIRU is in Britain, we don’t seem to have reached it yet.  Why?

I’m not an economist so I don’t have the answer.  Since the economists don’t seem to have the answers either, however, I feel entitled at least to look at some of the possibilities because they are central to the politics of the age.  The public mood seems to be that the economy is not working for the bulk of the population.  If this is true, finding the reason and addressing it should be the urgent priority of all parties.  If it is not true, politicians have a still bigger problem explaining this.

So what are some of the possibilities?

The statistics are wrong

Whenever you are confronted with an apparently-contradictory set of data, you should always consider whether the data are accurate: Garbage In, Garbage Out.  The simplest explanations are often correct, so we should take this possibility seriously.

The possibilities for data errors include: fewer people in work than the statistics show; more people seeking work than the statistics show; salaries are rising faster than the statistics show.  No doubt there are others – data can go wrong in lots of ways.

The Office for National Statistics has a justified world class reputation for the quality of its statistics.  That doesn’t mean that they are necessarily accurate, especially when they are measuring things that are hard to measure.  Getting representative samples in a rapidly changing society is difficult (as the nation’s opinion pollsters would gloomily agree after the last two general elections).  Pay in small businesses, which collectively employ a large  proportion of the workforce is estimated indirectly.  It is conceivable that salary rises, for example, are not being adequately captured if sectors with higher wage inflation are being underweighted by the ONS.  It is also possible that the number of immigrants has been undercounted (many won’t want to be visible, which makes this rather more likely).

The statistics are misleading us

Let’s assume, as we must in practice for now, that the statistics are right.  That doesn’t mean that they are being correctly understood.  For example, average salary increases might be muted in part precisely because more workers are joining the employment market if those employees are joining at the bottom.  If ten employees are earning £20,000 a year on average and an eleventh starts work on £10,000 a year, the average declines to just over £19,000 a year.  Indeed, the other ten could each receive a 5% pay rise and average pay would be stagnant.

The employment data need to be understood carefully too.  The ONS collects information for this series only on 16-64 year olds.

The supply of labour is bigger than conventionally understood

Since the Second World War, work has been seen as something that you do between finishing your education and retiring.  But in fact there have been three big shifts in the workforce in that time.  First, women have entered the workforce in large numbers.  When the Queen came to the throne, one in three women worked.  Today, over 70% of women between 16 and 64 work.  This is still some way behind the 79% of men that work, so there still remains scope for further growth here.

Secondly, Britain has welcomed large scale migration.  Last year, 11% of all workers were non-UK nationals.  They are far more likely to be overqualified for their jobs than UK nationals and more likely (in the case of EU nationals, much more likely) to be working longer hours than UK nationals.

Thirdly, many are not stopping work when retiring.  10% of those aged 65 or over are in work (just under 4% of the entire workforce).

All three of these sources of new labour may potentially give employers recruitment options that mean that they are not under the wage pressure that one might expect.

That said, I don’t buy this at all.  By far the single biggest growth in the workforce in this period was caused by women joining it.  Real wage growth was largely buoyant throughout the post-war period when this took place.  Any downward pressure on wages was more than outweighed by other upward pressures.  Net immigration is now waning and at present at least we are seeing no net increase in older workers in the workforce.  It seems likely that something else is at play.

The demand for labour is smaller than conventionally understood

Another possibility is that employers are using labour precisely because it is cheap. Some may do so rather than paying for more expensive technological alternatives, and any attempt by employees to increase their wages will be rebuffed on that basis.  Other employers may choose to use labour in the UK for reasons of convenience rather than outsource the work to other lower wage economies.  If so, employees are competing against both technology and workers in other countries to a far greater extent than previously.

If the equilibrium were balanced in this way, you would not particularly expect the workforce to be increasing.  To make sense of that you would need to conclude that other pressures (reductions in social security benefits) were pushing people into the job market.  And indeed, that is what is happening: social security benefits are undergoing a further squeeze at present, almost unnoticed.

So perhaps this is a part of what is going on.  Those on benefits are seeing those benefits cut and are rationally deciding to take whatever work they can get.  As a result, employers are not feeling any great pressure to raise wages.  The unkind might call this exploitation.

What might that mean politically?

Much of the political focus to date on low wage growth has been on immigrants and poor productivity.  But if it is in part a function of austerity, the political parties should be looking instead at addressing low pay and looking for the effects of that to trickle up.  Both main parties are proposing to increase the minimum wage, which would help, as would looking to employers of the low paid to pay more towards their support (whether by outsourcing social security provision, taxing them more per low paid employee or otherwise).  In the longer term, workers are only going to be able to compete against their international competitors and work with technology if they are more skilled, so education remains a very high priority.

And, just perhaps, the trend of reducing social security benefits needs to be reversed.  One of the reasons that it is paid is to keep people off the breadline.  If it is no longer doing that, more money needs to be found from somewhere.  Just a thought.

Alastair Meeks