What has been the impact of falling real wages on the UK economy?

One of the features of the UK economy in the credit crunch era has been the fall in the level of real wages. This represented quite a sharp change in what economists and analysts considered the natural order of things which went as follows. Inflation was invariably assumed to be on target of Consumer Price Inflation or CPI rising at 2% per annum and wages were assumed to rise at 4% per annum giving real world growth of 2% per annum. Some were relatively risque and assumed real wage growth of 1.5% or 2.5% per annum but the general principle remained that real wages rose and expectations of this were clustered close together. So the falls of the credit crunch era came as a shock and made a lot of economic work from that time useless for analysing the situation. However we should not be too harsh as for a long time this was actually true as shown by the analysis of the Office for National Statistics below.

Adjusting for these price increases to give an estimate of real earnings growth, full-time employees were on average 62% better off in 2011 than in 1986.

They are soft-soaping us a bit by using CPI as their inflation measure up to 17 years before it was introduced as using Retail Price Inflation would lead to a lower real wage estimate but the overall principle of rises remains.

The Trade Union Congress presents a different perspective

We know that since 2007 such growth quickly ground to a halt and then slammed into reverse course and the TUC have presented this in a different way.

On the eve of the recession in 2007 workers across the UK were earning a total of £690bn (in 2012 prices). However despite rises in employment, a combination of falling real wages, reduced hours and changes in the kind of jobs people are doing has reduced the UK’s total pay packet by 7.5 per cent over the last five years – a real terms annual cut of £52bn in 2012. The UK’s overall pay packet fell to £638bn last year.

I have mentioned the depressing effect on the UK economy of falling real wages and we see that one way of putting this is that some £52 billion of likely demand in the UK economy has vanished over the credit crunch period. Those who say or imply that inflation does not matter have a direct contradiction to their claims in that number as above target inflation has palyed a full part here. Also the advocates of policies such as Quantitative Easing have an itemised cost to the inflation that it contributed too. Remember these days they have been reduced to arguing that everything would have been worse without it (counterfactual) whereas here we see an example of how it has been worse with it! Along this road we see that easier monetary policy can lead to weaker economic growth should it have the effect of generating higher inflation and lower real wages which of course has been the UK experience.

The Regional Pattern is not what you might have expected

The weaker areas could perhaps have been guessed.

The North West experienced the sharpest cut in its overall pay packet between 2007 and 2012 – a fall of 10.6 per cent or £7bn last year. The South West, West Midlands and Scottish economies have also seen employees’ overall pay packets shrink by around ten per cent.

However London has only seen a fall of 3.9% in real wages making it the region least affected. Seeing as we were promised substantial wage cuts and reform in our (London based) banking sector this might come as something of a surprise. But as ever we end up suspecting that the job and wage cuts have mostly come at the lower end of the spectrum moving the pain outside London. Those in authority seem  continuously to dodge any form of axe.

As the TUC is concerned about excessive executive pay I think that they have missed something of an open goal here by not emphasising this point more. They are on better form here.

The average chief executive now earns 145 times more than the average wage.

Inequality has risen too

In spite of the effect of the national minimum wage inequality has risen according to the TUC.

The poorest half of the population have borne the brunt of Britain’s shrinking wage pie, and now receive just 12p of every pound of UK GDP – a 25% fall since the late 1970s.

Some care is needed here as our poorest half are substantially better off than they were in the late 1970s in absolute terms but are relatively worse off if compared to everyone now.

The balance between capital and labour

The TUC puts it thus.

For the last thirty years the British economy has seen a steady shift in the way national income has been distributed, away from wages and towards profits.

It is a shame that they did not give us any measure of this trend. Although we do know from the International Labour Organisation that a falling share of wages in developed economies is widepread and that it fell from 66.1% in 1990 to 61.7% in 2009.

So we are left with the impression that the good years hid to some extent a trend which is much clearer in the bad times we are now in. The other side to the equation is that more money is going to what Karl Marx called “capital” as he no doubts spins ever faster in his grave in Highgate.

Comment

This issue of falling real wages is getting increasingly serious as it continues. This was added to in March by the fact that the nominal level of wages fell too meaning that I am waiting for tomorrow’s data for April already! Was it a one-off  affected by changes in bonuses or are we on a darker road? However if we return to the real wage issue we see that its fall does a pretty good job of explaining why the UK has recovered so poorly from the credit crunch. If you have a lower real income then you are to say the least fairly likely to spend less and we see why UK consumption and thereby economic growth has been weak.

We can add to this by factoring the other influences on the UK economy such as the reduced income for savers as interest-rates fell. This was magnified in real terms by the same above target inflation which hit wage earners and was again a contractionary influence. So for our so-called expansionary monetary policy to have worked it would have needed to have had an extraordinarily strong effect on borrowers consumption. Along that road we have the genuine worry which has been a theme of this blog for some time that policies such as QE may even have a contractionary effect on the economy. That can put you on a very dark road if you wonder if those implementing it had figured that out…. Is all the cheap credit that is available around many parts of the world a way of hiding this reality?

If we return to the analysis of the TUC they have a simple answer to the problem.

BRITAIN NEEDS A PAYRISE

If only it was that simple!  There is of course the danger that some and maybe many industries are in a globally competitive market and that wage rises will simply persuade them to leave the UK. How we deal with globalisation is a big conceptual issue and we need to do a bit better than failing to tax global companies which seems to have become the default option.

So we find ourseleves with a question which goes way beyond the borders of the UK. What can be done about the falling share of labour?

This entry was posted in Financial crisis, General Economics, Income, Inflation, Quantitative Easing and Extraordinary Monetary Measures, UK Inflation Prospects and Issues and tagged , , , , . Bookmark the permalink.
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  • Neil

    Limiting a Chief Execs pay to a muliplier of average pay for employees in said company would be worth a shout !! CEO wants a pay rise, he needs to improve his employees average pay first.
    Would that work??

  • Anonymous

    I doubt it. CEO creates an extra company and outsources the labour to it, the original company then only consists of a few execs and the average pay multiplier is subverted.

    Make the execs accountable to the shareholders in private businesses and accountable to the voters in the public sector. Any citizen ought to be able to request a referendum on for example “Limiting the local council chief’s salary to £80,000″ and a simple majority of voters can choose to reject a council leader’s 250K salary.

  • anteos

    great article as always Shaun.

    I would argue that the impact of inflation has been worse.If we look at the research by tullet prebon:

    http://ftalphaville.ft.com/2013/02/20/1393672/the-real-rate-of-british-inflation/

    Not that it would bother merv with his massive RPI index linked gold plated pension, underwritten by the very people he was robbed.

  • James

    Shaun,
    very interesting as ever.
    One thing that must be wrong in the TUC figures is the statistic quoted about CEOs earning 145 times more than the average wage. If you take the average wage as, say, £25,000, that would make the CEO on £3.6 million. Perhaps they meant FTSE 100 CEOs.
    I dont know of any CEOs outside the FTSE earning anything like that.

  • Anonymous

    Does nobody here ever fundamentally question the capitalist system? Or is it a quasi religion, never to be questioned? Loads of the usual excuses, no doubt, just like for the Soviet model, but that failed in the end. The free market (so-called) has evidently failed too. What next?

  • Jimbob

    The reduction in growth of wages should have been offset by the BofE lowering interest rates, which usually puts more money into the pockets of those with mortgages (people and businesses alike), stimulating demand and stimulating labour, until rates are raised again. Since the credit crunch however, the banks have not passed on the benefit of the low interest rates (except to the lucky few on pre-crunch tracker products). Instead, they have increased their margin to shore up their balance sheets. Conventional economic policy has failed because of the continued weakness of the banks.

  • James

    A very good question, but rather hard to see what else can deliver:
    1. Rising wealth
    2. Welfare on the scale expected by western voters.
    I spent some time in the Soviet Union before perestroika and can tell you that it had:
    1. Most of the excesses of the west (privilege for the few etc, just the political not financial elite)
    2. Not much wealth to spread around anyway
    3. A very unpleasant centralised state machinery deciding everything.
    I would phrase the question slightly more in terms of how do we get capitalism to deliver for the majority not the minority ( I have no answer btw)

  • Neil

    Hi Abune,

    The capitalist system never existed always has been a mixed
    system, the so called free market and free enterprise (SME) is long dead submersed by regulations, red tapes taxations and the ever failing schooling system (producing slightly instructed and robotised people but no educated people with at least an ounce of critical thinking). This 19th century frame of references (Capitalism, communism etc…) is no longer sustainable but with debts.
    Gratefully our unemployed youth are waking up to the reality of the system imposed unto them by their elders. (The elders voted for this system while the youth could not vote).To quote one of the youth reflexion lately overheard… Why should we move a finger…Let’s the elderly who lead us into this mess…make the revolution for themselves…
    Here is Justathought, I do not know why I am ending up posting as Neil ???

  • Anonymous

    I think your point about the current system only being sustainable by debt gets to the heart of it. How can a system based on debt be sustainable? It seems to me to be mathematically impossible. Can all the debt in the world ever be repaid? And if it can’t (which seems to me to be obvious) then can the solution be yet more debt? Again, to me, the answer seems obvious, but the political class, of all available flavours, offer only that solution. Which is worrying in terms of democracy, never mind economics.

  • Anonymous

    Hi Abune,

    I agree with James that the capitalist system is a better option than all the others we’ve tried. It’s not perfect but I’d try to fix it’s flaws through evolution, not revolution.

    Decent effective regulation helps the people – monopolies, cartels and chicanery ought to be punishable and mostly prevented in a fair market.

    Certainly the UK’s light touch regulation is a complete failure, with offending bankers receiving a slap with a wet bus ticket for LIBOR fraud. I’d suggest jail and asset recovery as more appropriate punishment.

  • James

    If you look at a long historical perspective, it IS unsustainable to live off debt. History provides several different responses:

    1. Default. Used many many times from Spain refusing to pay back (Jewish) lenders in the sixteenth century, to Greece (three times, I think) to post-revolution France, Russia etc

    2. You invade someone else and steal their money. Latest example A Hitler who ran up huge deficits building those nice autobahns

    3. Currency collapse. Many examples, including Germany in the 20s (although this was external debt rather than deficits)

    To modern politicians, who have the added irritation of pretending to listen to voters every few years, these probably seem a little extreme, so we go round and round doing anything to avoid the spinning plates stopping, including QE, longer and longer dated gilts, etc etc.

  • Ian.Jones

    I do believe it is called globalisation. Labour in the West now has to compete with hundreds of millions of additional labour resources in the East. Capital meanwhile can exploit the new opportunities in the East. It is only a matter of time before the Labour in the West comes after the capital holders unless they spread the wealth. I wouldnt hold my breath.

  • Anonymous

    Surely no system can deliver rising wealth for everyone, given that we live on a finite planet? Maybe the growth model has hit the buffers. Do economics courses include any reference to the exponential function, I wonder?

  • Neil

    Hi Abune,

    I can attested that during my MBA courses I had to swallow some economics and can tell you that the exponential function was largely ignored. However how many are aware of it regardless of understanding it?

    To quote Isaac Asimov

    Democracy cannot survive overpopulation, as you put more and more people into the world, the values of life not only decline, it disappears. It doesn’t matter, if someone dies, the more people there are, the less one individual matters. We must recognise that population growth is the immediate cause of all our resources and environmental crisis.

    And Dr. Albert Barlett

    You cannot sustain population growth and you cannot sustain growth in the rate of consumption of resources in a finite resourced world….it is not debatable!

    Based on those two quotes, you can have some insights to where we are heading… toward change,
    the only constant in life… Civilisations, societies, systems, ideas etc… rising and dying… always been that way!

    And still posting as Neil ??? (sorry Neil) Here is Justathought

  • Paul C

    Shaun,

    It is always worth raising the “real income” issue, just so as to make it clear to readers that compound statistics can explain a large portion of pain we suffer everyday but it is a symptom not the cause. To somehow tie together the decision of QE and artificially low central bank rates as part of a coherent remedy for recovery is we all know by now, simply wishful thinking.

    Low interest rates, bank bailouts and Q.E. are desperate measures to keep the UK system from catastrophic failure, they are not a well thought out or long term policy solutions. Each incremental desperate measure takes us even further from a financially sustainable solution (see also Greece bailouts).

    It has been impressive to see how these preventative measures have got us from 2007 to 2013 though, even commendable given the iterative rig-up of each measure. I’ll even remark that pop-corn is the way forward as one of your other commenters often alludes).

    After giving cheap money to first time home buyers we should be in for another impressive measure come 2014. Now let me suggest some ideas….How about we give “free money” to large and trustworthy Corporates to renew our UK infrastructure whilst at the same time promising over the future “tolls” to incentivize them to run them for 50 years:

    Network Rail – Print £35Bn and let them build HS2

    BAA – Print £25Bn and let them build Heathrow2

    MorganSIndall – Print £100Bn and let them resurface the M1 and M6

    Hitachi – Print £150Bn and let them build 1 or 2 Nuclear Power Stations

    Maybe others can add to the list, I may not get all of the plans right first time.

  • Anonymous

    How about we print enough to build 10 British AGRs ? – 1 or 2 reactors aren’t enough to replace the generating capacity.

  • Anonymous

    Shaun – good article and some very interesting comments by folk on discus which is why it is all essential reading! It makes my day that common sense and well argued opinions are ‘out there’ – in contrast to the drivel in most of the media.

  • Anonymous

    Hi Anteos

    Thanks for the link which is interesting. As you know inflation (miss)measurement is one of my interests and themes.

  • Anonymous

    Hi James

    I am sure that you are right about that and the TUC should have made it clearer what they meant as otherwise it might mislead.

  • Anonymous

    Hi Neil and welcome to my part of the blogosphere

    I can see that Expat has already replied but would add that in my opinion we need to reinstate shareholders authority over the company. Somewhere on the journey to remuneration committees and the like shareholders lost control and directors in effect set their own terms.

  • Anonymous

    Hi Abune and welcome to my part of the blogosphere.

    I see you already have some replies but we have pretty much concluded on here in the past that we have had crony capitalism which has elements of a feudal structure about it. The real question in my opinion is does human nature always push us that way?

  • Anonymous

    Hi Jimbob

    We come to the same answer time after time which is that our banks are hindering any real economic recovery. Instead of reform we are dangled a carrot of maybe some cheap shares in Lloyds TSB and RBS. I guess they are playing to greed rather than intelligence.

  • Anonymous

    Hi Ian

    Yes plenty of empires have fallen before usually with very unpleasant results.

  • James

    The trouble is (and I have sat on many of these committees):

    1. All consultants know that they won’t get reappointed if they don’t recommend rises;

    2. You have executives keen on pay and with full-time resources to devote to the issue, whereas non-execs are just part-timers

    3. High executive pay rarely comes back to haunt non-execs

    4. Once the comparative game starts, everyone thinks that, because they are exceptional talent, they deserve upper quartile rewards
    One thing that I would say, however, in favour of high CEO pay is that ludicsrous city pay is a much greater problem. First, it isn’t public in general. Secondly, it is draining off talent from useful bits of the economy.
    I tell you that I’d much rather anonymously pick up my millions in the city than pick up less as a publicly harassed CEO.

  • Patrick

    A system based entirely on ‘self’ interest was only ever going to result in croney capitalism, as those who gain an advantage, do everything in their power, sometime outside of the law to protect what they have. Nine times out of ten, the most ruthless will be the ones that survive and thrive, creating a moral vacuum at the top. Warren Buffet is an anomaly, the exception that proves the rule.

    The ‘invisible hand’ is all too invisible.

  • Patrick

    …but regulation is supposedly what prevents ‘true’ capitalism from working…

    Is there a type of regulation that free market capitalism can exist with, or are the two things mutually exclusive. If they’re mutually exclusive, then don’t we have to assume that Capitalism just cannot work?

    It often seems that when real world capitalism gets critiqued, it immediately turns into a political, rather than economic argument, linking supposedly intrinsic left centric policy to its failings.

    Seems to me that basic corporate laws have a much bigger part to play in the failings of contemporary capitalism. Both in terms of corporate entity rights, and the enforced pursuit of profit at any/all costs.

  • Anonymous

    I know we get lots of “free market deregulation” hype from lobbyists and the mainstream press. We get bank bosses complaining about cost of implementing new laws. It’s media hype.

    Britain has acquired a checkbox culture, where many silly rules are codified and complied with but they cannot cover everything dubious.

    An alternative has a lightweight regulatory code with the emphasis complying with the spirit of the law. Eg, we expect you to behave ethically and will take action if we feel you are not.

    Rules and order are needed – good roads and honest traffic police both save lives and make travel quicker. German shareholders appear better rewarded and protected than English shareholders – English regulation allows company directors to overpay themselves while losing money. I might ask if German businesses are reaping a benefit of treating shareholders fairly ….

  • Anonymous

    Love point 1. That’s exactly the kind of realpolitic that utterly escapes somewhere like FTAlphaville who would start banging on about free markets being efficient!

  • Kev

    The Data Protection act is an excellent example of this. Much blamed by incompetent investigators and the like, all you have to do to side step it is to include the relevant caveat in your terms and conditions.

  • Kev

    The planet is finite, but the universe is infinite. Spreading human life through the universe may appear fanciful, but the alternative is a cull.