The Treasury has a point on living standards — but it ignores the role of inequality

Inequality is a more important explanation than rising employer costs for why the wages of the typical worker have fallen behind GDP.

One of the big surprises in today’s Autumn Statement lies in the new OBR projections. Growth has been revised up as expected—at least in the short-term. But wage forecasts are down. Amazingly, after today’s largely positive economic news, the squeeze on wages is now going to be even longer than the OBR thought in March. The updates reflect the OBR’s revised view that the crisis has caused a larger and more permanent hit to productivity than previously thought. They will also add momentum to a debate that was already gaining pace before today’s announcement: is the link between economic growth and wage growth weakening? And how soon will a recovery bring an end to the squeeze?

Earlier this week, the Treasury entered this debate by briefing its own new analysis of how the link between economic growth and living standards has changed over the longer term. Their top-line message was clear: there’s been no fundamental shift in the relationship between growth and pay. Instead, wages have simply been squeezed by rising employer costs — both pension contributions and, more pointedly, the increases in employer National Insurance introduced under Labour. But how adequate an explanation do employer costs really provide for the changing link between GDP and pay?

We can answer this by looking at a report written for the Resolution Foundation by Professor John van Reenen and Joao Paulo Pessoa. Although the paper is referenced in HMT’s briefing, they have not gone as far as replicating the wider analysis the paper covered.

In the fuller analysis we see that there are three potential culprits for why the link between GDP growth and wage growth has weakened over time. First there’s the question of whether the share of national income going into workers’ compensation has been falling, and the share going to profits rising. If so, the compensation workers receive will have lagged growth in GDP. Second, there’s the fact that not all compensation goes into wages—some goes into pension contributions and some goes into employer National Insurance. This is HMT’s focus. Third, there’s the fact that wages are not distributed evenly across the economy. If those at the top get a growing share of wages over time, wages for typical workers in the middle— at the median —are likely to lag behind.

So here, in three simple charts, is the story of how much each of these things have mattered in the last 30 years.Chart 1 shows how trends in GDP compare to trends in average worker compensation since 1972. If the share of national income going to labour was falling, we’d see a growing gap between the two. We don’t see much of this. At the start of the crisis in 2008, overall compensation had only fallen slightly behind GDP. This suggests that changes in the share of GDP going to labour don’t account for much of what’s going on.

Chart 1: The role of a falling labour share—GDP and average total compensation

What about the non-wage costs that the Treasury focuses on? Chart 2 shows that a gap has indeed opened up between a measure of average compensation, which includes these costs, and average wages, which doesn’t. This confirms HMT's basic claim that non-wage employer costs have risen, squeezing the amount left over for pay. Not all of this change is about employer NICs —rising pension contributions have played a bigger role. This is of course no bad thing in itself, although its generational implications are harsh for the young people taking a hit to their pay to fill historic pension fund deficits. Either way, the trade-off between these costs and wages is clear.

Chart 2: The role of employer costs — average total compensation and average wages

That leaves the question of how wages are distributed by the labour market. Chart 3 shows how trends in median wages—the pay of the worker in the middle of the distribution—compare to trends in average (mean) wages, which also capture growth in wages at the very top. The gap between the two shows the extent to which inequality accounts for the typical worker falling behind economic growth. As we can see, this gap is the biggest of the three. Inequality is a more important explanation than rising employer costs for why the wages of the typical worker have fallen behind GDP.

Chart 3: The role of inequality—mean wages and median wages

What should we make of all this? There’s no disguising the fact that it makes for a lousy whodunit; no single factor is to blame. And of course today’s new OBR forecasts for wages owe as much to the unusual dynamics of our post-crisis labour market as they do to the longer-term story we see in these charts.

But the findings also show how much we need a more serious, less partisan debate about these fundamental changes in how our economy works. There will be those on both sides of the political aisle that don’t much like the implication of these findings. For some on the left, it is appealing to turn to a falling labour share as an explanation for wages falling behind. They see the owners of capital hoarding ever more profits, squeezing out workers. But in 2008, such changes only accounted for around a fifth of the gap that had opened up between GDP and median pay since 1972. On the other hand, non-wage costs accounted for more than a quarter (27 per cent). That means accepting the basic truth in the Treasury account: rising employer costs put pressure on pay.

But we also need to challenge the temptation, more common on the right, to say that high or rising employer costs are a simple cause of the weakening link between growth and wages. This is inexcusably partial. Inequality accounted more than half (53 per cent) of the gap that had opened up between GDP growth and median wage growth from 1972 to 2008. Yet inequality has so far been missing entirely from government briefing on this issue. If there are still those who think high levels of inequality aren’t relevant to the living standards of ordinary workers, they too need to wake up.

A block of flats is seen on January 2, 2012 in Bath, England. Photograph: Getty Images.

James Plunkett is director of policy and development at the Resolution Foundation

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David Davis interview: The next Conservative leader will be someone nobody expects

The man David Cameron beat on why we should bet on a surprise candidate and what the PM needs to do after the referendum. 

“I’m tired,” says David Davis when I greet him. The former Conservative leadership candidate is running on three hours’ sleep after a Question Time appearance the night before. He is cheered, however, by the coverage of his exchange with Ed Miliband. “Which country would it be be like?” the former Labour leader asked of a post-EU UK. “The country we’re going to be like is Great Britain,” the pro-Brexit Davis retorted

The 67-year-old Haltemprice and Howden MP is at Hull University to debate constituency neighbour Alan Johnson, the head of the Labour In campaign. “As far as you can tell, it’s near to a dead heat,” Davis said of the referendum. “I think the run of events will favour Brexit but if I had to bet your salary, I wouldn’t bet mine, I’d place it on a very narrow victory for Brexit.”

Most economists differ only on how much harm a Leave vote would do. Does Davis believe withdrawal is justified even if it reduces growth? “Well, I think that’s a hypothetical question based on something that’s not going to happen ... One of the arguments for Brexit is that it will actually improve our longer-run economic position. In the short-run, I think Stuart Rose, the head of Remain, had a point when he said there would be very small challenges. In a few years probably nothing.

“The most immediate thing would likely be wage increases at the bottom end, which is very important. The people in my view who suffer from the immigration issue are those at the bottom of society, the working poor, which is why I bridle when people ‘oh, it’s a racist issue’. It’s not, it’s about people’s lives.”

More than a decade has passed since David Cameron defeated Davis by 68-32 in the 2005 Conservative leadership contest. The referendum has pitted the two men against each other once more. I asked Davis whether he agreed with the prime minister’s former strategist, Steve Hilton, that Cameron would be a Brexiter were he not in No.10.

“I think it might be true, I think it might be. When you are in that position you’re surrounded by lot of people: there’s the political establishment, the Whitehall establishment, the business establishment, most of who, in economic parlance, have a ‘sunk cost’ in the current set-up. If changes they stand to lose things rather than gain things, or that’s how they see it.

“Take big business. Big business typically gets markets on the continent, maybe distribution networks, supply networks. They’re going to think they’re all at risk and they’re not going to see the big opportunities that exist in terms of new markets in Brazil, new markets in China and so on, they’re naturally very small-C Conservative. Whitehall the same but for different reasons. If you’re a fast-track civil servant probably part of your career will be through the Commission or maybe the end of your career. Certainly in the Foreign Office. When I ran the European Union department in the Foreign Office, everybody wanted a job on the continent somewhere. They were all slanted that way. If all your advice comes from people like that, that’s what happens.”

Davis told me that he did not believe a vote to Leave would force Cameron’s resignation. “If it’s Brexit and he is sensible and appoints somebody who is clearly not in his little group but who is well-equipped to run the Brexit negotiations and has basically got a free hand, there’s an argument to say stability at home is an important part of making it work.”

He added: “I think in some senses the narrow Remain is more difficult for him than the narrow Brexit. You may get resentment. It’s hard to make a call about people’s emotional judgements under those circumstances.”

As a former leadership frontrunner, Davis avoids easy predictions about the coming contest. Indeed, he believes the victor will be a candidate few expect. “If it’s in a couple of years that’s quite a long time. The half life of people’s memories in this business ... The truth of the matter is, we almost certainly don’t know who the next Tory leader is. The old story I tell is nobody saw Thatcher coming a year in advance, nobody saw Major coming a year in advance, nobody saw Hague coming a year in advance, nobody saw Cameron coming a year in advance.

“Why should we know two years in advance who it’s going to be? The odds are that it’ll be a Brexiter but it’s not impossible the other way.”

Does Davis, like many of his colleagues, believe that Boris Johnson is having a bad war? “The polls say no, the polls say his standing has gone up. That being said, he’s had few scrapes but then Boris always has scrapes. One of the natures of Boris is that he’s a little bit teflon.”

He added: “One thing about Boris is that he attracts the cameras and he attracts the crowds ... What he says when the crowd gets there almost doesn’t matter.”

Of Johnson’s comparison of the EU to Hitler, he said: “Well, if you read it it’s not quite as stern as the headline. It’s always a hazardous thing to do in politics. I think the point he was trying to make is that there’s a long-running set of serial attempts to try and unify Europe not always by what you might term civilised methods. It would be perfectly possible for a German audience to turn that argument on its head and say isn’t it better whether we do it this way.”

Davis rejected the view that George Osborne’s leadership hopes were over (“it’s never all over”) but added: “Under modern turbulent conditions, with pressure for austerity and so on, the simple truth is being a chancellor is quite a chancy business ... The kindest thing for Dave to do to George would be to move him on and give him a bit of time away from the dangerous front.”

He suggested that it was wrong to assume the leadership contest would be viewed through the prism of the EU. “In two years’ time this may all be wholly irrelevant - and probably will be. We’ll be on to some other big subject. It’’ll be terrorism or foreign wars or a world financial crash, which I think is on the cards.”

One of those spoken of as a dark horse candidate is Dominic Raab, the pro-Brexit justice minister and Davis’s former chief of staff. “You know what, if I want to kill somebody’s chances the thing I would do is talk them up right now, so forgive me if I pass on that question,” Davis diplomatically replied. “The reason people come out at the last minute in these battles is that if you come out early you acquire enemies and rivals. Talking someone up today is not a friendly thing to do.” But Davis went on to note: “They’re a few out there: you’ve got Priti [Patel], you’ve got Andrea [Leadsom]”.

Since resigning as shadow home secretary in 2008 in order to fight a by-election over the issue of 42-day detention, Davis has earned renown as one of parliament’s most redoubtable defenders of civil liberties. He was also, as he proudly reminded me, one of just two Tory MPs to originally vote against tax credit cuts (a record of rebellion that also includes tuition fees, capital gains tax, child benefit cuts, House of Lords reform, boundary changes and Syria).

Davis warned that that any attempt to withdraw the UK from the European Convention on Human Rights would be defeated by himself and “a dozen” other Conservatives (a group known as the “Runnymede Tories” after the meadow where Magna Carta was sealed).

“They’ve promised to consult on it [a British Bill of Rights], rather than bring it back. The reason they did that is because it’s incredibly difficult. They’ve got a conundrum: if they make it non-compliant with the ECHR, it won’t last and some of us will vote against it.

“If they make it compliant with the ECHR it is in essence a rebranding exercise, it’s not really a change. I’d go along with that ... But the idea of a significant change is very difficult to pull off. Dominic Raab, who is working on this, is a very clever man. I would say that, wouldn’t I? But I think even his brain will be tested by finding the eye of the needle to go through.”

Davis is hopeful of winning a case before the European Court of Justice challenging the legality of the bulk retention of communications data. “It’s a court case, court cases have a random element to them. But I think we’ve got a very strong case. It was quite funny theatre when the ECJ met in Luxembourg, an individual vs. 15 governments, very symbolic. But I didn’t think any of the governments made good arguments. I’m lucky I had a very good QC. Our argument was pretty simple: if you have bulk data collected universally you’ve absolutely got to have an incredibly independent and tough authority confirming this. I would be surprised if the ECJ doesn’t find in my favour and that will have big implications for the IP [Investigatory Powers] bill.”

Davis launched the legal challenge in collaboration with Labour’s deputy leader Tom Watson. He has also campaigned alongside Jeremy Corbyn, last year travelling to Washington D.C. with him to campaign successfully for the release of Shaker Aamer, the final Briton to be held in Guantanamo Bay.

“I like Jeremy,” Davis told me, “but the long and the short of it is that not having been on the frontbench at all shows. I’m not even sure that Jeremy wanted to win the thing. He’s never been at the Despatch Box. He’s up against a PM who’s pretty good at it and who’s been there for quite a long time. He’s playing out of his division at the moment. Now, he may get better. But he’s also got an incredibly schismatic party behind him, nearly all of his own MPs didn’t vote for him. We had a situation a bit like that with Iain Duncan Smith. Because we’re a party given to regicide he didn’t survive it. Because the Labour Party’s not so given to regicide and because he’d be re-elected under the system he can survive it.”

At the close of our conversation, I returned to the subject of the EU, asking Davis what Cameron needed to do to pacify his opponents in the event of a narrow Remain vote.

“He probably needs to open the government up a bit, bring in more people. He can’t take a vengeful attitude, it’s got to be a heal and mend process and that may involve bringing in some of the Brexiters into the system and perhaps recognising that, if it’s a very narrow outcome, half of the population are worried about our status. If I was his policy adviser I’d say it’s time to go back and have another go at reform.”

Davis believes that the UK should demand a “permanent opt-out” from EU laws “both because occasionally we’ll use it but also because it will make the [European] Commission more sensitive to the interests of individual member states. That’s the fundamental constitutional issue that I would go for.”

He ended with some rare praise for the man who denied him the crown.

“The thing about David Cameron, one of the great virtues of his premiership, is that he faces up to problems and deals with them. Sometimes he gets teased for doing too many U-turns - but that does at least indicate that he’s listening.”

George Eaton is political editor of the New Statesman.