Three reasons pay might be falling

Good unemployment figures but stagnant pay have been the story about each month’s jobs figures for a year now.

Good unemployment figures but stagnant pay have been the story about each month’s jobs figures for a year now

I had an unfair advantage, writing this post, because I knew pretty much what I was going to say – that the employment and unemployment figures were very good but that pay was going up by so much less than inflation that it overshadowed the employment figures.

I knew that because it has been the essence of the story about each month’s figures for a year now.

We’ve been saying that for some time, but we can be sure it’s going to be the focus for wider media responses today, because Peter Patterson, the deputy chief economist at the Office for National Statistics, released a comment on the figures:

“The striking divergence between employment and pay continues. While the employment rate has never been higher, the average weekly earnings of employees excluding bonuses have risen by only 0.7 per cent over the past year. The latest Consumer Price Index shows inflation running at 1.9 per cent.”

ONS don’t put out comments like that every month. It’s important to recognise the truth in both sides of this conundrum, because today’s headline employment figures are unusually good. Employment in the three months from March to May was a quarter of a million higher than in the previous three month period and 929,000 higher than a year ago.

Of course, the working age population is growing, but the employment rate is going up too: it is now 73.1 per cent, equal to the highest rate since records began in 1971 (achieved in 2005).

Unemployment is not improving quite as quickly, but it is 121,000 down on the quarter, 383,000 down on the year – at this rate, unemployment may fall below 2 million later this summer. The unemployment rate is not yet down to the figure of about 5 per cent that we had between 2000 and 2008, but the reduction in the past year from 7.8 to 6.5 per cent is respectable.

Youth unemployment is down 64,000, unemployment over 6 months is down 81,000 and the ratio of unemployed people to job vacancies is down from 3.8 to 3.3 – on all these, we still have a little way to go before we get back to pre-recession levels, but progress is being made.

The other half of the conundrum is pay. Regular pay (excluding bonuses) in May was just 0.7 per cent higher than it was in May 2013. If we confine ourselves to workers in finance and business services (probably the most significant sector for pay), regular pay is lower than it was in October 2011.

Average bonuses are down 9.3 per cent on a year ago, 19.6 per cent [!] in finance and business services. This isn’t just a problem for people in the City – many private service sector workers rely on their bonuses these days. As a result, total pay (regular pay plus bonuses) is just 0.3 per cent higher than it was a year ago, the worst figure since the recession. In finance and business services the annual increase in total pay is negative for the second month running: – 2.3 per cent.

First-year economics will teach you that there is a link between pay and productivity and this is borne out by the figures: looking back over the past 20 years, output per worker grew by, on average, 2.3 per cent a year between Q1 1994 and Q1 2008; between Q2 2008 and Q1 2014, on average it fell 0.6 per cent a year. More accurately, output per worker fell like a stone during the recession and has stagnated since then (click to zoom):

Output per workerj

Essentially there are three explanations for why pay and output per worker may be falling. One is that existing businesses are becoming less productive, another is that in the churn of businesses, the new businesses being created are less productive than the businesses that are disappearing and the third is that both are happening to some extent.

Why would any of these be associated with rising employment? If existing companies or entrepreneurs contemplating new establishments have noted the stagnation of wages and decided to take advantage by substituting labour for capital, we would expect to see more jobs, lower pay and lower productivity for any given level of output. Low productivity and wages would be compatible with both the stagnating GDP we had a couple of years ago or the recovery we’re experiencing at present.

It’s also possible that entrepreneurs would see opportunities in industries that had previously been unattractive because their lower typical productivity meant that it was difficult to make a profit, given UK wage levels. Rising self-employment, which tends to have lower productivity, may also be part of this story.

If what we’re seeing is existing firms using labour instead of capital the situation may be remediable. As unemployment falls (more slowly than employment is rising, but falling nonetheless) we can hope that pay stagnation will end too. We may even be able to think about recovering lost ground – and as that happens, the labour/capital trade off will look less attractive to business people.

At the same time, people who have become self-employed as a last resort will return to higher productivity employee employment. In this scenario, the recovery has the potential to become self-sustaining, eventually repairing wages and productivity.

This is the hopeful possibility – though note that an early or too steep interest rate rise could kill off the recovery before it matures.

But if what has been happening is a shift to a low pay/low productivity/low skills/low commitment/low security model then things could be more difficult. Then the impact of rising wages would not be met by rising investment and a transition to higher productivity and higher wages would involve business closures and job losses. The inability to meet demands for higher wages could lead to a wages/prices spiral, with interest rates then being raised too fast and too soon for many families to cope.

If substantial capacity has been lost in the recession (workers’ skills becoming out-of-date, equipment outmoded, markets lost to competitors) the ability to compensate for the loss of low productivity jobs with high productivity replacements may be impaired

Like this article? Sign up to Left Foot Forward's weekday email for the latest progressive news and comment - and support campaigning journalism by making a donation today.