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The record pay squeeze is over – but maybe not for long

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The record pay squeeze is over - but maybe not for long Posted by David Smith at 09:00 AMCategory: David Smith's other articles My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt. Plenty of crazy and alarming things are happening in British politics but, leaving those to others for now, and turning to a slightly happier story, we are on the cusp of a rather different and significant moment, and it has been a long time coming. Within the next few weeks regular pay in Britain, in real terms, should finally move above pre-crisis levels. The longest pay squeeze in modern times – even exceeding one during the Victorian era - will be over. Bring out the bunting. Currently, regular pay in Britain, adjusted for inflation. Is just 0.8% below the

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The record pay squeeze is over - but maybe not for long

Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Plenty of crazy and alarming things are happening in British politics but, leaving those to others for now, and turning to a slightly happier story, we are on the cusp of a rather different and significant moment, and it has been a long time coming. Within the next few weeks regular pay in Britain, in real terms, should finally move above pre-crisis levels. The longest pay squeeze in modern times – even exceeding one during the Victorian era - will be over. Bring out the bunting.

Currently, regular pay in Britain, adjusted for inflation. Is just 0.8% below the level established in April 2008, more than 11 years ago. It has been a lost decade and more for pay and, as I say, we have not seen anything like this in modern times. Nobody back then could have imagined that the hangover from the crisis would last so long.

The reason we can expect this milestone to be passed is that we have returned, decisively, to meaningful increases in real wages. Regular pay is currently rising by 3.9% a year in cash, or nominal, terms, against an inflation rate of 2.1%, making for real wage rises of nearly 2% a year.

Though you would not know it from the gloomy noises coming from Britain’s high streets, some of which verge on the suicidal, this is good news for consumer-facing businesses. It helps explain why official retail sales figures show a 3.3% increase on a year earlier while, even in a slow-growing economy, consumer spending in the second quarter was up by 1.8% on a year earlier. Along with government spending, the consumer is what is keeping the economy going. If it were not for weak Brexit-related consumer confidence, lower now than in the immediate aftermath of the referendum according to Gfk, the consumer would be keeping the economy going more.

That 3.9% figure is shared by the public and private sectors, which is also worth noting. Part of the reason for the lost pay decade was the austerity-driven squeeze on the public sector, which included periods both of pay freezes and below-inflation settlements for public employees. Now, partly helped by the timing of the latest National Health Service pay settlement, public sector sector pay is rising at its fastest rate since May 2010, the dawn of the coalition government’s age of austerity under David Cameron and George Osborne.

It has been anything but a tea party for private sector workers during this period, of course. Pay settlements lurched downwards in the wake of the financial crisis and have taken years to recover to anything like pre-crisis norms. People chose the security of a job over above-inflation pay awards, collectively pricing themselves into work, until the labour market became tight enough to force the hand of employers.

Many economists expected that hand to be forced well before this, and that the traditional Phillips curve relationship between unemployment and wage rises would have kicked in before now to give us 4%-plus wage rises. The lower the unemployment rate, the greater the upward pressure on pay, in normal circumstances.

The circumstances of the past decade have not, of course been normal. Apart from unemployment and a tight labour market, the other moving part in this is productivity. Broadly speaking, firms can afford real wages of 2% a year if productivity is rising at a similar rate, which is its historic average. Productivity is the route to rising prosperity.

But productivity, as you will know, has not been rising. The main measure, output per hour, was only 0.5% higher in the first quarter of this year, the latest figure, than at the end of 2007. It has fallen fractionally over the past year and looks to have suffered a bigger drop in the second quarter of this year. It is going nowhere fast.

That is one reason to be cautious about the extent to which the current pay revival can be maintained. Pay rises that are not matched by productivity gains are unlikely to be sustainable, and have already got the Bank of England twitchy about their inflationary consequences. At some stage there will be a productivity revival and, as far as the outlook for pay is concerned, it cannot come soon enough. But it is not there yet, and is not in sight.

It is only fair, too, to point out that while regular pay is closing in on pre-crisis levels, there is some way to go before that is true of total pay, including bonuses. Average total pay still has some way to go before it catches up with the previous peak, achieved in February 2008. It is still 5% below what it was then and the clue to why it is still lagging may be in the name. Total pay includes bonuses and they are a lot lower than they were in the heady days leading up to the worst of the financial crisis, and not just in financial services.

Going back to regular pay, where there is a much smaller gap to make up, the concern about whether this is a steady march towards the sunlit uplands, and years ahead of near-normal real wage rises, lies with that familiar elephant in the room, the threat of a no-deal Brexit.

A promising outlook for real wages was snuffed out three years ago by the pound’s sharp fall as a result of the referendum. This had the effect, through higher import prices, of pushing up inflation, putting the squeeze back on real take-home pay. It is a straightforward relationship.

A no-deal Brexit would see another big sterling fall from the pound’s already weak position, as everybody in the markets knows, possibly a bigger one than in 2016. Inflation would rise again, through the import price route.

This time, however, it would be compounded by the impact of tariffs and shortages on prices, including food prices. Ministers have already warned that food prices would be likely to rise in the event of a no-deal Brexit. The National Institute of Economic and Social Research (Niesr) has said that inflation could rise to more than 4% even in the event of what it describes as an “orderly” no-deal Brexit.

If such a Brexit would be very likely to push inflation up, for a variety of reasons, it would also be likely to push wage growth lower. Niesr’s projections are that it would snuff out growth and push up unemployment, the response of business to which would be to rein back pay increases.

There are plenty of reasons to avoid a no-deal Brexit, of course, beyond the fact that it would mean that the current recovery in real wages was likely to prove to be another false dawn. It is the most damaging form of Brexit ad we are in great danger of lurching into it. But we should add this to the collection of reasons for steering clear of it. It would be a great pity if, after more than lost decade for pay, we were to retreat back into the gloom again.

The record pay squeeze is over - but maybe not for long
David Smith
David Smith is economics editor of The Sunday Times. His website is http://economicsuk.com . His latest book is Something Will Turn Up.

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