Next month we will be treated to the familiar spate of end of year reviews. Amid all that copy we can expect a regular theme to be that this was (another) year in which all the forecasts of a rise in earnings for workers were proved wrong.
Inaccurate economic forecasts, especially when it comes to wages, are so common as to not merit much attention. But this year was supposed to be different – and there were reasonable grounds for thinking it would be.
Unlike other years, the wider economic context has been highly propitious for pay. Growth has been strong, outperforming expectations. Employment levels have reached their pre-crisis levels and unemployment has plummeted. Inflation has fallen below target. Business investment has been on the rise. Yet real wages have continued their relentless six year slide.
There are many fashionable views on why this might be the case. Some point to secular stagnation, others think that the robots have started eating our pay rises. Another view is that the ‘natural’ rate of unemployment has fallen far further than we’d realised.
Yet for all the speculation we haven’t, until now, had an authoritative answer to a relatively straightforward question about the fall in wages: how much of it can be directly attributed to the changing make-up of the UK’s workforce? Has the balance of the workforce shifted – whether in terms of demographics, skill-levels, occupational structure or migrant status – in a way that has dragged down wages? Or has lower pay been driven by the same sort of employees doing the same sort of work but getting paid less for it?
This isn’t a new question and there’s been plenty of speculation about it. Since the financial crisis something of a conventional wisdom emerged among some economic commentators that much of the bad news on wages has been overblown. According to this view, what’s been dragging down the official wage figures has been exactly these shifts in the composition of the workforce. The implication being that the underlying trend in individuals’ wages hasn’t been anything like as poor as the headlines suggest.
Research out today suggests this view was very significantly, though not completely, wrong. During the years since the financial crisis, changes in the make-up of the UK’s workforce actually propped up wages. Take out these so-called compositional effects and the underlying pay squeeze would have been far worse: 11 per cent rather than the 8 per cent fall we’ve actually seen.
This isn’t entirely surprising. It’s what we would expect given long-term trends like the persistent upward drift in qualification levels. As lower-qualified workers retire and are replaced by more highly-qualified new starters, so a compositional boost to pay might be regarded as a normal state of affairs. Meanwhile, the research shows that other much-hyped factors like an increased number of migrants in the workforce have had next to no direct impact on average wages.
The received wisdom isn’t, however, completely wrong for two reasons. First, the wage-pain hasn’t been evenly spread across existing workers. The young and those who have spent time any time out of work have been hammered, job-stickers – especially those in full-time work – less so. Second, and crucially, the idea that shifts in the make-up of the workforce are what is dragging down wages has, belatedly, come true. This year, unlike others since 2008, compositional changes reduced average pay. Put differently: if it wasn’t for the changing make-up of the workforce, 2014 would indeed have been the year of the pay rise.
So what’s changed? Partly there has been a small but significant downward shift in the occupational structure – this year we’ve seen a 140,000 rise in the number of poorly paid “elementary” jobs like cleaning and a 130,000 fall in the number of (well-paid) managers. Both drag down the average.
Click on graph to enlarge.
There’s also been a welcome boost in the numbers of young people who are finding work (up 270,000 year-on-year) and let’s not forget that young people’s pay has actually plummeted by 13 per cent since 2007. More twenty-somethings in work, again, drags down the average.
But it’s important to keep this in proportion. Even if we completely strip out these compositional effects from pay, the underlying wage figures would still be anaemic: real pay growth would stand at 0.1 per cent over the first six months of this year. Not exactly a rebound after the biggest wage falls in modern history (and if inflation returned to target levels that growth would be wiped out).
What does any of this mean for the living standards debate in the run up to the election? Those in the coalition who are tempted to try and stretch the pay figures in order to somehow imply that headline wages aren’t really falling should change tack. Far better to be candid: yes, headline pay is still falling which is troubling and unprecedented. But in 2014, at least, that’s partly because more young people, as well as more of the unemployed, are moving into work. More worrying for ministers is whether the downward occupational shift we’ve seen over the last year, which is increasing our already high share of low paid work, will prove to be a blip or a permanent feature of our new jobs market.
As for Labour, they need to bear in mind that the underlying wage trend that hitherto has been responsible for the squeeze has, for now at least, turned positive. If – and it is still a big if – we move into a phase where pay is clearly rising for the majority but the average wage figures flat-line due to compositional changes that hit the minority, that will greatly alter the politics of pay over the next few years.
So when it comes to predictions as to whether 2015 will turn out to be the year of the pay rise, you can rest assured they will be a cut and paste of last year’s. But when you read them bear this in mind: in a buoyant labour market with rising productivity we’d want to see nominal wages rising by around 4 per cent across the board (with inflation of 2 per cent). We’re currently miles away from that. Even if wages do sneak into positive territory next year, we will still be a very long way from returning to normal.
Gavin Kelly is chief executive of Resolution Foundation