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More work, less pay: Is the UK's low-wage economy working?

Jo Harper
October 19, 2017

UK unemployment has sunk to a 42-year low, but rising prices mean lower real incomes. The labor market is good at creating jobs, but not so much at raising pay. And just when you thought Brexit couldn't get any better.

Image: Getty Images

UK unemployment held at 4.3 percent in the third quarter — maintaining its joint lowest level since 1975, the year of "Brentry." 

There were officially 1.44 million unemployed, down 215,000 in the last 12 months, with an extra 420,000 jobs created, according to the Office for National Statistics (ONS).

The jobless rate hasn't been this low since Harold Wilson was prime minister and Britain entered the European Economic Community (EEC), a forerunner of the EU, 42 years ago.

But there is a snag in the beautiful story. Official figures this week also showed a sixth straight month of negative real earnings, posing a dilemma for the central bank as it ponders a change in its medium-term monetary policy stance and a hike in interest rates in November to dampen inflation.

Wages grew 2.2 percent in the three months to August, the same level recorded in the three months to July, the ONS said. After taking into account the Consumer Prices Index (CPI) 12-month inflation rate of 3.0 percent — the highest level for more than five years, as a Brexit-hit pound raises the cost of imported goods — real wages fell 0.4 percent from 2016.

In a rational open economy high employment should drive up wages as workers' bargaining power improves, but average earnings are no higher than they were in February 2006, despite the economy being 4.4 percent per capita larger. This means Britons need an average 18-euro- ($21-) per-week pay rise just to get back to the levels before the financial crisis of 2007-8.

"Many labor market measures continue to strengthen," said ONS statistician Matt Hughes. "On the other hand, total earnings in cash terms grew slower than prices over the last year, meaning the real value continues to fall."

This lack of real wage gains in turn undermines consumers' ability to spend, the main driver of growth in the UK for several years.

A report by the ratings agency Standard & Poor's in May highlighted the impact of Brexit on living standards. The primary impact, it said, has been to lower the value of the pound, making imports more expensive and helping to drive up inflation. S&P said it expected this to continue and noted that the government would have to boost spending on infrastructure to improve productivity.

Others even see real wages shrinking over the next few months and wage growth is not expected to go much above 2.1 percent or 2.2 percent before summer 2018. Headline inflation is seen peaking at 3.1 percent in November and the gap between CPI and wage growth is likely to stay fairly wide for some time to come.

Some fear that UK unemployment will even soon start to rise as the wage squeeze hits consumer spending.

Controversial zero-hour contracts

Zero hours, minimal thought

The main factor behind the rise in inflation was the Brexit vote, S&P said, and noted that other reasons behind weak wage growth were the rise of the ‘gig' economy and zero hour-contracts.

An S&P report in May noted from official figures that in the fourth quarter of last year about 900,000 jobs were based on zero-hour contracts.

As Kevin Gardiner, global investment strategist at Rothschild, told the Financial Times this means zero-hours contracts are a mere 3 percent of the record 27 million jobs in Britain. However, holding down the lowest rung of the wage ladder also depresses the wages of workers in more secure work positions, others argue.

"These types of jobs, often in consumer-facing services where relatively low skill levels are required, made up almost one-quarter of all employment created since 2010 when the recovery started, and this seems to be part of a broader trend," S&P said.

"Jobs created since the global financial crisis have tended to be in occupations with relatively low productivity and less secure, including low paid self-employment and part-time employment."

Restraining factors

Others note that organized labor is, well, not very well organized and decidedly less militant than in the past mainly due to government legislation making joining unions and going on strike more difficult.

"There's no way for labor to push up wages since no one goes on strike anymore and the unions are weak,” Mark Blyth, professor of international political economy at Brown University in the US state of Rhode Island, told DW.

"Profits are high without investment in productivity, while inflation is coming only through the import channel and will level off. The presumption that wages should rise as markets tighten presumes labor has bargaining power. With a rise in part time work where employers dictate the terms and labor accepts this is not true. What puzzle?," Blyth says.

On the systemic level, a lack of investment, either public or private, in training and adjusting or upgrading of workers' skills to meet changing labor market realities also holds back external investment as international capital looks for cheap and reliable labor rather than well-organized potentially militant workers.

Others note the government's public sector pay cap, which is widely seen as squeezing wages.

Brexit puts the pinch on UK businesses

Under-productivity a systemic problem

The key underlying issue and one that has bedeviled the UK economy for decades is how to improve productivity, which in the UK lags well (over 20 percent) behind that of Germany and France and about 10 percent behind that of Italy. Britain's bosses argue of course that productivity needs to rise so they can afford wage increases.

"Output per unit of labor employed (output per hour worked) has been stagnant. This means that pay has also been stagnant in real terms. This shortfall in productivity has meant two things — firms need to employ more workers to get the job done, and (because pay is low) they can afford to do so," Geraint Johnes, professor of economics at Lancaster University Management School, told DW.

What little improvement there has been in productivity has not been fully passed on to workers in higher wages, S&P said.

"While GDP has been growing in the UK at what appears to be a healthy rate since the recession, much of this growth has been due to an increase in the working population," Johnes said.

"Leading firms appear to perform quite well, but other firms lag behind. The problem has got worse over the last 8-10 years, partly because of a deficiency of business investment, partly because the returns to investment in research and development have fallen (with less successful innovation in key areas such as pharma and IT), partly because people who lost their jobs have gone back to work in positions that don't fully utilize their skills, partly because the recession didn't shake out particularly unproductive businesses. The point about business investment is critical."

"A number of UK businesses held onto workers during the recession and that partly explains the weak wage growth since productivity was low as a result of keeping workers on even as demand for output was low," Adjunct Professor of Economics at London Business School, Linda Yueh, told DW. "This flexibility in the British labor market also explains why it was possible for self-employment to increase over the past few years, which in turn has also contributed to a low unemployment rate," Yueh said.

To hike interest rates or not to hike?

Most analysts expect the Bank of England to respond to rising inflation by hiking interest rates in November. However, it will want to see signs that robust economic growth has fed into pay sufficient to fund a trade-off between supporting jobs and the economy with low rates and stemming price growth and there is no decisive evidence either way to change the cost of borrowing from 0.25 percent.

All are equal, but some are more than others, with workers in the financial sector getting decent pay rises, up 2.2 percent over the last year. But in many industries — including the public sector, manufacturing, construction and distribution — pay growth is still below 2 percent. This does not suggest that it is yet time for the Bank of England to be hiking interest rates.

Matthew Percival, CBI Head of Employment, told The Guardian that the government can — and must — help.  "Persistently weak productivity, coupled with falling real wages, continues to hit living standards, underlining the need for the Chancellor to bold in his Budget," Percival said. "Delivering urgent progress on large and small infrastructure projects, addressing underfunding in education and providing practical support for innovators are all steps the government can take as part of a meaningful Industrial strategy to boost productivity, the only sustainable route to improving people's pay."