Wages have not risen above inflation for three decades—but that may changeby Hamish McRae / February 20, 2014 / Leave a comment
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Will 2014 be the year of the pay rise? There are signs that it just might. In Britain in January, job vacancies grew at their fastest for more than 15 years. Salaries for permanent staff rose, according to a survey by the Recruitment and Employment Federation and KPMG, while the Office for Budget Responsibility predicted that real wages—taking account of inflation— will finally begin to rise after five years of stagnation.
If so, that would shatter the pattern that has held in Britain, the United States and much of the developed world for an astonishingly long time—almost three decades—in which wages did not rise faster than inflation. Economists have clashed over the reasons for this phenomenon, which is one of the most studied and most controversial of recent times. This is inevitably a debate that begins with numbers, but it is also a debate about changing structures of employment—about the way we live and work today, which extends to sweeping predictions about the impact of technology and globalisation. Politicians, meanwhile, have found it fertile ground: anxious to respond to widespread distress and alarm, and hopeful that they can do something about it (although it is not clear they always can—see p32).
It’s already evident that wages and living standards will be one of the battlegrounds of the 2015 general election, with fistfuls of recent statistics invoked on either side of the argument. Matthew Hancock, the Skills Minister and former Chief of Staff for George Osborne, seized on the January figures, arguing in an article in the Times that Britons are indeed better off than a year earlier. “Last year,” he wrote, “take-home pay grew faster than inflation for every group of earners except the top 10 per cent.” But others retorted that data recently provided by the Office for National Statistics (ONS) suggested the opposite: that, depending on what measure you use, earnings are still lagging behind inflation.
So, what has been going on? And why? The roots stretch back before the 2008 financial crisis and recession that followed. Britain has been stuck in a spiral of declining wage growth for over three decades. According to the ONS, real wages grew 2.9 per cent in the 1970s and 80s, 1.5 per cent in the 90s, 1.2 per cent in the 2000s and fell by 2.2 per cent since the first quarter of 2010.
This is not just an issue for Britain. The west as a whole has endured three decades during which wages have barely risen ahead of inflation and in some places not at all. In Germany, for example, wages have been stagnant for 10 years. EU data published in 2012 showed that the numbers of “working poor” had Hamish McRae is an Associate Editor of the Independent grown faster in Germany than anywhere else in the eurozone. In the US, average weekly earnings, adjusted for inflation, failed to reach their 1972 peak of $342 for 39 years in a row—in 2011, the figure was just $295.
Of course, at least some of this is the result of the recession, although its effects have been mixed. In Britain, as in just about every major developed country, real incomes are lower than they were at their 2007-8 peak. Some analysts predict that they will begin to rise again in the near future and that the economic recovery already underway will shortly translate into rising productivity and real wages. But others are less optimistic, and argue that the labour market has undergone structural changes that will delay the point at which productivity (output per person) and wages start to rise—perhaps indefinitely.
Optimists will point out that past recessions have led to changes in economic structure that have increased growth. It is always easier to spot the negatives than the positives, but we can already see a number of changes that have taken place in Britain over the past five years that should improve performance. Take what is happening in the public sector. Productivity is rising, the only large part of the economy where this is happening. This is the result of the rather crude mathematical way we measure productivity. There are fewer people working in public services, many fewer in the departments that are not protected, but there seems to be no fall in their output. It follows that productivity has risen; nor does there seem to have been a decline in the quality of the output. One can have doubts about the scale of the spending squeeze still ahead and criticise the way the cuts have been imposed, but it is hard to deny that the efficiency of the public sector has improved.
Another example is the labour market. There are now more than one million people over the age of 65 at work, double the number of 10 years ago and the largest single increase of “new” workers since the recession. They are not new at all, of course; the increase has come from people staying on at work or becoming self-employed. Some of this may have been driven by inadequate pensions, some by employers actively seeking to create posts for older staff; better health is a factor, too. This recession, far from pushing older people out of the workforce through early retirement, as happened in previous downswings, seems to have had quite the opposite effect of keeping them at work.
This is part of a wider revolution taking place in employment, with more part-time workers and larger numbers of selfemployed. This seems to have been driven by the harsher climate of recession, but in Britain and Germany it shows how more flexible labour markets are one way not just of responding to recession, but of improving the structural efficiency of the economy.
What effect are these changes having on wages? Simon Ward, an economist at Henderson Global Investors, notes that in the recession and early stages of recovery, earnings on a wide measure which includes self-employment lagged behind earnings on the narrower measure used in the official figures. Now, as things have picked up, they have surged ahead. Ward argues that “divergences between the series can be significant but temporary… The expectation here is that the current gap will be closed by a pick-up in the official earnings measure during 2014.”
If this argument is right, and common sense suggests that to some extent it must be, working people will start to feel somewhat richer as the year progresses—assuming that inflation remains at or close to the target of 2 per cent, an assumption that seems reasonable enough. However, not only are real incomes still well below their peak, the increases that do come through are the result of people working beyond 65, taking a second job and so on.
Can all the ground that has been lost be recovered? Growth in most of the major developed economies is so far below previous trends that it would be highly optimistic to assert that it will. For that to happen, a decade of above-trend growth would be required. But it would also be too pessimistic to suppose that none of the losses will be recouped.
The greater uncertainty about future growth prospects stems from deeper structural changes, however. The fiercest economic battles are now being fought over the role of technology and globalisation. Economists such as Robert Gordon and Tyler Cowen have raised the possibility that the great engine of growth that has been humming since the Industrial Revolution has started to slow down as the rate of technological innovation has declined. China, India and other emerging economies are able to increase living standards by applying technologies developed in the west. But can we advance further?
There are reasons for cautious optimism. In the US, the share of employment in manufacturing has fallen from nearly 30 per cent in the 1950s to less than 10 per cent today. Jobs in services, meanwhile, now account for 70 per cent of employment. The US and other advanced economies have discovered that it is harder to increase productivity in service industries than it is to do so in manufacturing. Manufacturing manages to achieve increases of output per person (or productivity) of between 2 and 3 per cent a year. In services, the increase is around 1 per cent. Crudely put: it is easier to automate the making of car than it is the running of a hospital. Emerging economies are able to achieve huge increases in productivity as they play “catch up.” But the key to increasing the overall productivity of a developed economy lies with the 70 per cent or so of jobs that are in services.
Though the evidence is still patchy, it looks as if progress may be being made. Go back 20 years and we were stuck. Computers had enabled the automation of some service functions—managing bank accounts, for example—but it seemed impossible to go much further. Efficiency could be improved by applying production line techniques to some services, but you ended up with fast food instead of proper restaurants. Production line efficiency improves quality in manufacturing, but does the reverse in services. It is easy to see why. A BMW in the US, say, is virtually identical to one in Europe or China. A pension is not. Pensions differ from country to country and have to be tailored to the age and circumstances of the buyer.
Then came the internet. It has the potential to do for services what Henry Ford’s moving production line did for manufacturing. However, it takes time to learn how best to exploit new technology. Take airline bookings, for example, which have been utterly transformed by the internet. It took time for airlines to develop booking systems for general use, and they had the advantage of already having computerised reservation systems used by travel agents. It also took time for customers to learn how to use the systems. But there is nothing new about this. Ford not only had to contend with the fact that unmade roads were often impassable for his vehicles; his customers also didn’t know how to drive.
The application of new technologies to services has been uneven because we are learning as we go. Progress has been dramatic in some areas—online shopping and news, for example—and halting in others. We have no idea, for instance, whether “Moocs” (massive open online courses) will transform higher education or turn out to be nothing more than a cheap marketing device for universities seeking to attract larger numbers of foreign students. What we do know is that there has, as yet, been no sustained surge in the efficiency and productivity of service industries. But, as the economist Alfred Marshall observed 130 years ago, it takes time for the full impact of any invention on the economy to be felt, since other smaller developments must occur before it can be properly exploited. The smartphone revolution has only just begun.
Technological change has already had an impact on clerical jobs. An entire stratum of middle-skilled, middle-income jobs has disappeared. The question that some commentators are asking is whether this technological hollowing-out will move up the skill chain. Will artificial intelligence replace human intelligence? In The Second Machine Age, MIT professors Erik Brynjoolfsson and Andrew McAfee argue that it will. Others, such as Harvard’s Ed Glaeser, believe that as we become richer we will figure out new ways of spending our money which will generate new service jobs requiring new skills that cannot be mastered by machines.
The second big structural factor to consider is globalisation, and here there is evidence to suggest that the pressure may be decreasing. The exporting of manufacturing jobs “off-shore” to low-wage economies is slowing. This is partly because the jobs that were going to go have gone, partly because of rising wages in the emerging economies and partly because the growth in manufacturing in the developed world has been at the top end. The evidence so far is thin, but it looks as if some jobs are being “reshored” or brought back. A common complaint from UK manufacturers is that they cannot find people with the requisite skills here, not that workers are too expensive compared to their Asian counterparts. In services, too, the flow of jobs overseas appears to be slackening. And the very technologies that allow an operative in Bangalore to fix our computers also enable British service industries to sell their services worldwide.
However, anyone who believes we can advance further has to acknowledge that we face two headwinds that will inevitably slow us down. One is demography, the other the environment.
Up to now demography has worked in our favour. In most developed countries, each generation of working people has been larger than the previous one. That is why the maths of state pension schemes, which rely on the contributions of one generation of workers to pay the pensions of the previous one, have added up. That is no longer the case. All western economies are seeing a rise in the proportion of retirees and some are already seeing a fall in the workforce. In Italy, for example, projections suggest that by 2050 there will be more retired people than those in work.
The shifting ratio of workers to dependents inevitably bears down on the standard of living of both. The challenge is to adapt to this shift in a way that does the least damage to those living standards. Countries that adapt, for example by enabling and encouraging older people to stay in some form of work, will deal better than those that don’t.
Much the same point applies to environmental concerns. The countries that industrialised first were largely indifferent to the burden they were placing on the planet. Part of the wealth we generated imposed external costs we never paid. But that is less true now. Western Europe, at least, has been able to increase GDP without increasing energy use. This progress has to be paid for. In Britain, roughly one-third of the increase in inflation over the past two years can be attributed to green levies on public utilities. In Germany, supposedly green policies have had the perverse effect of shifting the country to coal and lignite for electricity generation.
Both demography and environmental factors will make it harder to increase real earnings and living standards, but betterconceived policies could reduce the burdens significantly.
Putting all this together, there is room for optimism that 2014 will bring modest wage growth. Skills shortages, together with falling unemployment, trade unions negotiating better terms for members and increasing business confidence, all play a part in that. But the longer term remains uncertain. Only when the puzzle of sluggish productivity in service industries is solved can we expect to return to the kind of wage rises—of around 2 per cent a year—that we used to take for granted.