The Independent View: Will 2015 be the turning point on wage growth?

image001Another Bank of England inflation report, another set of rosy forecasts for earnings next year. Just as 2014 was supposed to be the year of the pay rise, now it seems 2015 will be the year when things turn positive.

And, according to the Bank, wages won’t just creep into positive territory next year, they are going to take something of a jump upwards. In the last quarter of 2015 the Bank expects nominal wage growth of 3.25% at a time of inflation of 1.4% – so a gear shift from the current position of at best flat-lining real pay to healthy growth of roughly 1.8% in a year’s time.

How sceptical should we be?  The Bank’s Chief Economist has been admirably forthright in highlighting his organisation’s own habit of promising sunshine tomorrow, with spring always just around the corner but never coming to pass, as the chart below from his recent speech illustrates. At some point, though, things have to brighten. And every passing month in which unemployment continues its fall and GDP continue to rise makes a degree of optimism about the following year that bit more plausible.

Of course, no-one knows whether wage growth of over 3% in 2015 is likely to come good. But we can identify some of the things you’d need to believe about the jobs market to make this forecast feel achievable. Our reading is that you’d need to put reasonable faith in the following:

  • That the current downward shift in the make-up of the workforce towards lower-paid groups and roles is a blip not a trend.We’ve recently arrived at some clarity on the much-speculated question of how the employee mix affects average pay. In contrast to most of the decade prior, the first half of 2014 was one in which the changing composition of the workforce caused a significant wage drag rather than a boost, as recent Resolution Foundation analysis has uncovered. A return to strong wage growth next year rests on this drag dissipating swiftly. One of the main drivers has been the entry and re-entry of younger and less experienced workers, reflecting rapid employment growth and falling youth unemployment. We might reasonably expect this to fall out. But the biggest drag has come from shifts away from managerial occupations and towards lower-paid caring, labouring and cleaning jobs. Whether this trend will dissipate remains much less clear.
  • That spare capacity is bottoming out. An often-cited explanation for real wage falls having persisted is that there is more slack in the labour market than was expected, boosting supply and therefore giving employers little impetus to raise pay. With the headline unemployment rate proving an imperfect indicator, factors such as underemployment and cumulative welfare reforms pushing the unemployed to intensify their search for work have prompted the Bank to revise upwards estimates of spare capacity in previous Inflation Reports. Today’s report suggests that slack has started to narrow (though it highlights considerable uncertainty over this). An imminent up-tick in pay growth rests partly on this tentative judgement proving accurate.
  • That job turnover continues to pick up. Many, including the Bank and the ONS, view employees moving from job to job as a leading indicator of wage pressure, reflecting peoples’ confidence about their labour market prospects. Although still far from the pre-crisis peak, this indicator has started to pick up. To be optimistic about wages you need also to be optimistic that this trend will continue, and that the expected relationship between churn and pay bears out. Again, we just don’t know.
  • That the low-earning self-employed stay put. A group of workers not accounted for in any of the above is the self-employed. They are not measured in the official earnings data but have accounted for two thirds of the employment growth since 2008. The data we do have suggest self-employed earnings are low and have been squeezed even harder than those of employees. If – and it is an if – some of the post-crisis growth in self-employment growth is a response to higher unemployment and lower vacancies then we may expect their number to fall as some of move into employee roles (over recent months their number have tailed off slightly). Recall that a significant minority of the self-employed appear to make less than the minimum wage, so for this group an employee job would represent a pay rise. While this would mean an improvement in their personal prospects, it would also drag down the official employee pay figures. If the self-employment surge starts to unwind it could also be a drag on pay.
  • That pay settlements continue to improve. Data from other surveys that more closely reflect settlements within firms or sectors has been much stronger than official earnings measures of late. Prospects for average pay rest on this trend continuing and feeding though to the average. One factor that might prompt optimism in this regard is the first real-terms increase in the National Minimum Wage in six years. If this becomes a widely referred to benchmark for pay settlements in 2015, this would raise the average wage growth even further.

* Laura Gardiner is a Senior Research and Policy Analyst at the Resolution Foundation

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17 Comments

  • It will be a growth for just long enough for the Tories to claim all the credit for the economy in the 2015 election.

    As for the impact of the minimum wage, I know several self employed people who have paid themselves less than the minimum wage for many years. They are the new deprived underclass in many rural areas where there is a dearth of waged jobs.

  • In answer too your Question my thought is No

    It’s fair to say why
    Employers have an unlimited source of labour from the EU

    While wages are kept low they sell abroad with more ease and increase their own pocket books

    They will argue that a raise will increase inflation which in moderation I think is good

    The larger companies have one interest only the shareholders

    Even today Ed Milliband is arguing for minimum wage of £8 an hour in 2020 must be music to the ears as its likely less than inflation and takes no account of terrible wage growth for 5 years

    Even the CBI expect the government to reduce tax and NIS instead of not as well as a living wage

    So sorry no 2015 will not be the end how I wish it would

  • Sorry but I just cannot see it. In my business, as with many other service providers, we have suppressed wages due to suppressed contract values many of which are public sector or otherwise publicly funded. As most are obtained through tender, and as most tenders are decided on a 60% + cost basis, companies do not risk putting higher rates into their submissions and therefore cannot afford to dramatically increase wages. Some contracts are pegged to CPI/RPI and this is generally passed on, but if this drops it will further restrict the ability to increase wages.

  • I think that one reason for the failure of wages to return to strong growth is the fact that the sheer quantity of “disguised” unemployment has been so high in our current flexible labour market.

    Everyone was surprised earlier in the recession when the headline unemployment figure peaked at around 8% rather than 11% or even 13%. But this ignored the levels of under-employment. It has taken a long period of very strong labour market demand and job creation to absorb this under-employment and reach a point where the market tightens and wage settlements start to creep upwards.

    The other side of the living standards equation has been inflation, which has constantly surprised on the upside due to high world market prices for energy and other commodities including foodstuffs like wheat. The failure of these commodity prices to fall as they did during other developed world recessions was due to higher demand in other countries like China and Brazil sustaining prices. This too has put unprecedented pressure on UK living standards since the start of the economic crisis, but is now thankfully abating and even going into reverse. It will be this factor, rather than booming nominal wage rises, which help to start to lift living standards in the near future.

    One question to ask is why there have been so many low paid jobs created recently, pushing down average weekly pay. I hate to have to say it, but Lib Dem policy may have a role here, since implementing the £10,000 personal allowance has meant that more people are incentivised to enter the workforce at a lower level of gross wages. Basically, if you tax something less, you get more of it. This is a good thing, in that it means there is more employment and perhaps lower skilled people are absorbed into the workforce when previously they might not have been. However, in the longer run, we should be asking ourselves whether pushing up the personal allowance even further might intensify this trend towards growing low-paid employment and whether this is what we really want.

  • @ Steve Way

    “Sorry but I just cannot see it.” That is because, as you say, you are in the public sector, where the state acts as a monopsonist (monopoly buyer). In the private sector, many jobs in building, transport etc. are now seeing significant labour shortages and wages are beginning to respond accordingly. As I said above, the reason they haven’t done so earlier has been down to the hidden level of underemployment (e.g. self-(un)employment) that has not been picked up by the headline jobless figure.

  • @RC
    I’m not in the public sector I am a part owner and director of a private company. We provide some services to the public sector but also have contracts in the private and third sectors. Most significant contracts, whether public or private are tendered and most have a minimum of 60% cost bias. I just cannot see a longer term move of wage increases exceeding inflation.

  • Sorry, my mistake, but you did say that many of your contracts were public sector or otherwise public funded. That is likely to be true of your competitors and so is likely to set the basic demand levels for your sector. But what is true of one area of the economy where the public sector is a major customer is not necessarily true of other sectors where it isn’t. I don’t think the sector you work in is likely to be typical of the economy as a whole.

    And like I said, it is more likely to be falling inflation than large rises in nominal wages that lead to the rise in real earnings.

  • The unstated question and hence unanswered question is whether wage growth and the inflation that will naturally follow is what our economy actually needs…

  • Er, yes we do need wage growth, because otherwise people’s living standards will keep on falling and we won’t have the tax revenue to sustain public services and reduce the deficit.

    Next question, please.

  • Bill le Breton 13th Nov '14 - 3:03pm

    Roland, I am worried that you don’t understand the meaning of inflation.

  • It’s amazing that we have found ourselves in a situation where people actually question the economic merit of rising wages. On paper wage growth of 3% and inflation of 3% is no different to wage growth of 1% and inflation of 1%. However given the levels of debt we have, the former would be far preferable. We simply have to inflate some of it or endure years of pain. Why oh why are we still targeting 2% inflation. A 5% nominal GDP target would be better.

    It really doesn’t matter what happens. A global crash, the Eurozone crisis, ‘secular stagnation’ – we remain stuck in the thinking of the 70s and 80s, no doubt when messers Cameron, Osborne and Clegg made their minds up politically.

  • Richard Dean 13th Nov '14 - 3:28pm

    @Bill le Breton
    I am worried that you might not understand the meaning of the Phillips curve

  • Bill le Breton 13th Nov '14 - 7:44pm

    Richard, are you worried that I don’t understand the difference between a move along a Philips curve or a shift of the Philips curve?

  • David Evershed 13th Nov '14 - 7:48pm

    As the proportion of unemployed youths and older workers reduces, they move into the earning statistics. As these will on average be low wage earners they will bring down the average earnings figure. The National Statistics Office does not seem to adjust for this change in mix.

    So many of those who have remained in work may well have been receiving a bigger increase in pay than the statistics show.

    Those who have moved from being unemplyed to employed will also have received a decent increase in earnings which is also not reflected in the statistics.

  • Sometimes it is good to question basic assumptions, particularly those arising from orthodox thinking…

    I wasn’t questioning the merits of wage increases per say, only whether the economy (as a whole) and envisaged economic conditions were such that a jump in wages wouldn’t have negative effects…

    We shouldn’t forget that the Bank of England report is a forecast, so whilst it may be wrong (given past performance there is a strong likelihood of this being so), some will use it as the basis for demands for larger increases than they would otherwise demanded. But this also omits the feel good factor that such positive reports also generate…

    Also as David Evershed points out there are trends that aren’t reflected in the figures.

  • Richard Dean 13th Nov '14 - 10:11pm

    @Bill le Breton
    I was, but now I’m not, thanks. Though I have reservations about the reliability of using curves that shift in response to changing “expectations”. Partly because it’s perfectly possible to second guess how expectations will change.

  • Old prices are falling so the prices of everything is falling, that’s all this is.

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