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

Photo: Getty
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Like it or hate it, it doesn't matter: Brexit is happening, and we've got to make a success of it

It's time to stop complaining and start campaigning, says Stella Creasy.

A shortage of Marmite, arguments over exporting jam and angry Belgians. And that’s just this month.  As the Canadian trade deal stalls, and the government decides which cottage industry its will pick next as saviour for the nation, the British people are still no clearer getting an answer to what Brexit actually means. And they are also no clearer as to how they can have a say in how that question is answered.

To date there have been three stages to Brexit. The first was ideological: an ever-rising euroscepticism, rooted in a feeling that the costs the compromises working with others require were not comparable to the benefits. It oozed out, almost unnoticed, from its dormant home deep in the Labour left and the Tory right, stoked by Ukip to devastating effect.

The second stage was the campaign of that referendum itself: a focus on immigration over-riding a wider debate about free trade, and underpinned by the tempting and vague claim that, in an unstable, unfair world, control could be taken back. With any deal dependent on the agreement of twenty eight other countries, it has already proved a hollow victory.

For the last few months, these consequences of these two stages have dominated discussion, generating heat, but not light about what happens next. Neither has anything helped to bring back together those who feel their lives are increasingly at the mercy of a political and economic elite and those who fear Britain is retreating from being a world leader to a back water.

Little wonder the analogy most commonly and easily reached for by commentators has been that of a divorce. They speculate our coming separation from our EU partners is going to be messy, combative and rancorous. Trash talk from some - including those in charge of negotiating -  further feeds this perception. That’s why it is time for all sides to push onto Brexit part three: the practical stage. How and when is it actually going to happen?

A more constructive framework to use than marriage is one of a changing business, rather than a changing relationship. Whatever the solid economic benefits of EU membership, the British people decided the social and democratic costs had become too great. So now we must adapt.

Brexit should be as much about innovating in what we make and create as it is about seeking to renew our trading deals with the world. New products must be sought alongside new markets. This doesn’t have to mean cutting corners or cutting jobs, but it does mean being prepared to learn new skills and invest in helping those in industries that are struggling to make this leap to move on. The UK has an incredible and varied set of services and products to offer the world, but will need to focus on what we do well and uniquely here to thrive. This is easier said than done, but can also offer hope. Specialising and skilling up also means we can resist those who want us to jettison hard-won environmental and social protections as an alternative. 

Most accept such a transition will take time. But what is contested is that it will require openness. However, handing the public a done deal - however well mediated - will do little to address the division within our country. Ensuring the best deal in a way that can garner the public support it needs to work requires strong feedback channels. That is why transparency about the government's plans for Brexit is so important. Of course, a balance needs to be struck with the need to protect negotiating positions, but scrutiny by parliament- and by extension the public- will be vital. With so many differing factors at stake and choices to be made, MPs have to be able and willing to bring their constituents into the discussion not just about what Brexit actually entails, but also what kind of country Britain will be during and after the result - and their role in making it happen. 

Those who want to claim the engagement of parliament and the public undermines the referendum result are still in stages one and two of this debate, looking for someone to blame for past injustices, not building a better future for all. Our Marmite may be safe for the moment, but Brexit can’t remain a love it or hate it phenomenon. It’s time for everyone to get practical.