Britain’s unemployment is ultra-low, but its wages are ultra-measly

BRITAIN is enjoying a jobs miracle. Its rate of unemployment is one of the lowest in Europe. Before long, and possibly as soon as the next release of data on September 11th, it could fall below 4%, a level not breached since 1974. The ruling Conservative Party is rightly proud of its record on jobs. Yet the economy that has got so many people into work has proved incapable of generating pay rises. Real wages are lower than a decade ago. The government may crow about unemployment being at its lowest since the 1970s, but pay growth is at its weakest since the Napoleonic wars.

A few factors help to explain why Britain enjoys such little unemployment. The OECD, a club of mostly rich countries, says the country has the least-regulated labour market in Europe. Hiring and firing staff is easier than in countries such as France, where the hassle of getting rid of bad employees makes bosses think twice about taking someone on in the first place. (France’s unemployment rate is more than twice Britain’s.) Policy measures have made Britons more employable. Since the 1980s governments have more closely supervised jobseekers’ efforts, which some research has associated with lower long-term unemployment.

In the past, low unemployment went hand in hand with juicy pay rises. The fewer the number of people looking for work, the harder employers had to compete for staff. The inverse relationship between unemployment and wage growth is summed up by the Phillips curve, named after William Phillips, who first plotted it in 1958. Yet in recent years the relationship has become much weaker. Economists in many rich countries, including America and Germany, have noticed that low unemployment is not generating the high wage-growth that might be expected. Britain’s ultra-low rate of joblessness, coupled with particularly weedy wages, makes it perhaps the biggest Phillips-buster of all.

As Britain’s unemployment rate has fallen, economists have been stumped time and again by the failure of pay to respond. In 2013 calculations from the Bank of England suggested that 6.5% was as low as unemployment could go without wages beginning to push inflation above its target rate. Within a few months that estimate had edged down to 5.5%. Then 5% or so. Now that rate is thought to be just over 4%.

Yet even as unemployment heads below that level, there is little sign of pay pressure. If the relationship seen during the 2000s held today, workers would be enjoying nominal wage rises of some 5% a year (see chart 1). Instead, the most recent official reading shows annual nominal wage growth of just 2.7% in June. Data from Adzuna, a job-search website, show that advertised salaries fell from June to July. The upshot is that wages have done worse in Britain lately than almost anywhere in the rich world (see chart 2). To explain this unusually poor performance, consider three factors.
First, productivity. In the long run, changes in real wages depend on how much workers produce per hour. Since the financial crisis, productivity growth has stagnated. Low government and business investment may be in part to blame. Britain’s manufacturing industry uses fewer robots per worker than Slovakia’s. Moreover, in recent years Britain has seen the rapid growth of low-productivity jobs in industries such as hospitality. The number of hairdressers has risen by 50% since 2010. The growth of such jobs has dragged down average productivity. Our analysis suggests that the changing composition of jobs in the British labour market has pushed down the average real wage by more than 2%.

Yet productivity is not the whole story. Pay per person has deviated further from its pre-crisis trend than productivity growth. In the past year output per hour has at last picked up, but wages have not. This points to a second reason for Britain’s weak wage-growth: workers’ diminished bargaining power.

The decline of unionisation is commonly blamed for this. In the 1960s, when unions were mightier, the share of GDP accruing to workers was far higher. But the kneecapping of the unions in the 1980s predates the recent stagnation in pay. Perhaps a more important reason is the government’s cap on public-sector pay rises. Since 2011 salaries for most public employees have increased by no more than 1% a year in nominal terms (though in recent months the cap has been raised). The pay premium typically enjoyed by public-sector workers has diminished. This also affects the private sector. If bosses are less fearful of losing workers to the state, they will be less inclined to offer pay rises.

Changes to welfare policy from 2010, including tougher rules on who gets benefits, and declines in their value, have also played a role. Cross-country analysis of welfare policy is scanty, but it suggests that the reforms in Britain have been especially hard-nosed. As losing a job becomes a scarier prospect, workers may not bargain so hard for better pay.

In trying to puzzle out the breakdown of the relationship between unemployment and pay observed by Phillips, economists are increasingly asking themselves whether the labour market is really as tight as the headline unemployment rate suggests. Few Britons are out of work altogether, but 8% say they would like to work more hours than they do, a higher share than before the financial crisis. A delivery driver, for instance, might want more errands than he is offered. Such workers may be more concerned about securing extra hours than demanding higher pay.

All this means that the labour market may need to tighten even more before wage growth improves substantially. Yet with inflation above the official 2% target, the Bank of England’s monetary-policy committee has lately taken a hawkish turn, raising interest rates in an effort to dampen the spending and investment that would raise demand for labour. Meanwhile, with Brexit six months away, the outlook for economic growth is poor. It may be some time before Britain’s miraculous unemployment figures are matched by equally impressive wage growth.

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