Why has UK real wage growth been so low?

Some people have
expressed surprise that UK real wages have recently fallen during a
period when the UK labour market was pretty tight. (That tight labour
market may be coming to an end as unemployment has begun to rise).
Here is the real (in terms of consumer prices) level of the monthly
average earnings data for regular pay (excluding bonuses) ending in
April this year.

Levels of this
measure are a little messed up in 2020 because of the pandemic, but
the recent fall in real wages is real enough, reflecting consumer
price inflation rising more rapidly than regular pay. In April
consumer price inflation was over 3% above the increase in regular

That real wages
should be falling even though the labour market is tight is no
surprise when we recognise that a key reason why inflation is rising
so rapidly is a huge hike in the price of energy. Higher energy
prices represent a transfer from consumers of energy to producers of
energy. Unless you can stop that transfer happening by some means
(by, for example, taxing
energy producers
making unusually large profits), then
consumers have to pick up the tab.

That in turn must
mean a reduction in real consumer wages (nominal wages less consumer
price inflation). That is likely to happen because in most cases firms
set wages, and in looking at what they can afford to pay they will
not look at consumer prices, but at the prices of the products they
produce, which are rising less rapidly than consumer prices. They may
be forced to raise wages above this and productivity growth in a tight labour market, but
they have absolutely no reason to compensate workers for a rise in
energy prices. Equally, to argue that workers on average do not have
to take a real (consumer) wage cut in these circumstances is at best
wishful thinking, which is why I didn’t sign this

Does this reflect
weak union power?

But why should
workers shoulder all the higher costs of energy? What about those
living off rents or dividends, or pensioners? Well landlords and
shareholders consume energy as well, so they will pay, although as
they tend to be richer than average they will feel it less. In the
UK, however, the government has said that state pensions will be protected from higher energy
prices (with a delay) because pensions are indexed to either earnings
or consumer prices, whichever is the higher. This illustrates a more
general point, which is that the government can (and indeed should)
adjust who pays for higher energy prices among the population by
altering taxes or benefits. [1]

What would happen if
some or all workers did manage to persuade companies to keep nominal
wages at the level of consumer price inflation? Consider the case
where only some rather than all workers did this first. It is just
possible that the companies they work for would absorb higher wages
through lower profits, but the more likely outcome is that their
prices would rise by more than other firms. Consumers would pay those
higher prices, so this is another way besides government action of
redistributing the cost of higher energy among consumers. (Workers
who get a high pay rise gain, those that don’t lose.)

But belonging to a
union is not the only way some workers can transfer real income falls
due to higher energy prices to others. In terms of the current
situation it also matters how much personal bargaining power they
have, which in turn depends on how tight particular labour markets
are, how much money their employers are making or whether their
employer is the state. This last factor is particularly important at
the moment, as the following chart shows (from

Currently it is
public sector workers who are really being hit by higher energy
prices, while workers in finance are (on average) getting wage rises
that are at least keeping pace with inflation. 
The former is untenable if we want good public services, and the government can hardly argue that bringing public sector pay in line with the private sector will be inflationary (although that probably won’t stop them trying!). The latter raises a question over why financial firms think they can afford such pay rises, and
whether recent fiscal transfers from the government to banks (
have been wise.

Now consider what
would happen if all workers managed to emulate their comrades working
in finance? Would all workers avoid an immediate fall in real wages?
In this situation it is then even more likely that firms would raise
their prices to protect profits, producing a wage price spiral. [2]
The Bank of England would raise interest rates sufficiently high such
that unemployment rose, and aggregate demand fell, substantially,
persuading enough workers to accept lower real wages and some firms
to accept lower profits. This 1970s scenario will not happen today,
because unions are not nearly as strong now as they were then.

While the reduction
in union power since the 1970s will help avoid the kind of wage-price
spiral we saw then, it is also reasonable to suppose that a tight
labour market will have some effect on nominal wage inflation. This
in turn could lead to higher domestically generated excess inflation
(threatening the inflation targets of central banks). In addition
when inflation is high firms may find it easier to raise profit
margins. Arguments
about whether its wages or profits being too high that is risking
persistent excess inflation are not very helpful when the only
solution we currently have to reduce inflation from either source is
to reduce the aggregate demand for goods and services. [3] Equally,
arguments that generally higher wages or profits will have no
consequence for the economy are simply false. [4]

This is why in the
US and UK short term interest rates are rising. In general it is hard
trying to decide how far interest rates need to rise (and economic
activity to be correspondingly lower) to avoid a large temporary
energy price shock and temporary supply side shock (and temporary
Brexit inflationary shock in the UK) leading to permanently excess
inflation. That also means it is possible to make big mistakes,
allowing either inflation to persist or creating an unnecessary
recession. Given the mandates of most central banks, the latter is more likely than the former.

So why have real
wages grown so little over the last 15 years?

If we return to the
first chart, we can see that basic real pay is now around where it
was before the Global Financial Crisis. (Total pay, including
bonuses, would be a little higher.) Does this reflect a general shift
in GDP from labour to profits?

Here is the share of
corporate income in GDP since 1970 (source ONS).

There has been no
trend rise in the share of GDP going to profits since 1970, so rising
profits are not why real wages have grown so little over the last
decade and a half. Where there is a problem is that this steady
profit share has been accompanied by a recent slump in business

By far the most
important reason for stagnant real wages can be seen by looking at an
old favourite, real GDP per capita, over the same period as the first

You can see from
this that there just has not been much growth in national output per
head after the GFC. GDP per head was about 6% higher in the first
quarter of this year than at its pre-GFC peak, which is pretty
pathetic over a 14 year period. The UK economy has been hit by one
disaster after another: the GFC, then the austerity period that
squashed growth during what should have been the recovery period 2010-2013, a certain vote in 2016, and then Brexit and the pandemic.

Why is GDP per
capita 6% higher since the GFC compared to no growth for average real
earnings? The most obvious reason is the decline in the terms of
trade caused by higher energy prices at the end of the period, which
reduces the real wage when deflated by consumer prices but does not
reduce the amount produced in the UK to the same extent. Other
reasons include a slight fall in the share of wages in income caused
by a rise in indirect taxes (e.g. the 2010 increase in VAT). In
addition I have already noted that there is some small positive
growth in total real earnings once we include bonus payments.

The main message is
that a lack of growth in real wages over the last 15 years reflects a
lack of growth in the economy as a whole. The current cost of living
crisis is all the more painful because of this lack of real growth
over the last decade and a half. No one should be fooled by
government ministers talking about ‘a strong economy’: on this
like much else they are lying. Furthermore we know why the UK economy
has been so weak since the GFC. First austerity severely limited our
ability to recover from the GFC recession, and then Brexit has cut UK
growth and increased UK inflation.


David Edgerton wrote
in the Observer about the dangers of
declinism (in short, the UK economy has suffered because of deep
longstanding and particular problems that we have never solved) and
its opposite, revivalism (from cool Britannia to Brexiter hype). Both
as generalities are nonsense, and as he points out there is a danger
of looking at the UK independently of trends in other major
economies, particularly those we trade a great deal with.

So, for example, our
economic performance after the GFC crisis was terrible because of
austerity, but austerity also happened in the US and was perhaps more
severe in the Eurozone, where it generated a second recession. As I
, since the pandemic the US has grown more
rapidly than Europe (including the UK) in part because of a fiscal
stimulus that spurred the post-vaccine recovery.

Declinism stems in
part from not seeing the UK in an international context. Of course
the UK has many deep seated problems, but the same is true in most
other countries. This chart, from
, can perhaps make this point more clearly than
any words.

Compared to the
original EU countries, UK growth was lower before we joined the EU,
but since we joined the EU it has at least kept pace with those
countries. I suspect this overstates the beneficial impact of joining
the EU, as the EU5 were recovering from a much lower base after WWII
and therefore could grow faster. But what it does show is that from
the 1980s onwards, for whatever reasons (and there were probably
many) the UK was actually doing rather well compared to our European
neighbours. As I
, the same was true relative to the US. So stories
about some unique UK national economic decline that starts well
before 2010 are simply wrong. It is why we should not regard
like this
as applying to the UK alone.

But while this chart
may exaggerate the beneficial impact of EU membership, those benefits
are real enough, and what we may already be seeing since the GFC and
particularly Brexit is the beginning of another period of relative UK
decline. Italy may save us from being the sick
man of Europe
once again, but if we want to see
reasonable real wage growth again we have to do something about
improving trade with our neighbours, which means getting rid of a
hard Brexit, which in turn inevitably means removing from power the
political party that delivered Brexit.

(23/06/22) The key difference between public and private sector pay

From comments I
think it is worth expanding on a point I made briefly in the main
post. I suggested that while high (i.e. matching inflation) private
sector pay awards would generate domestically generated inflation,
and therefore prompt yet higher interest rates and increase the
probability of a recession, this was not true for higher public
sector pay awards.

The intuition is
very straightforward. Widespread private sector pay awards that
matched inflation would prompt firms to raise their prices by a lot
more than the inflation target of 2%. In contrast, if most public
sector pay goes up, there are no prices to increase. In that very
simple sense you just cannot get a public sector wage-price spiral.

Of course higher public sector pay will increase aggregate demand, which adds to inflation. But keeping public sector pay well below inflation should never be a demand reduction tool. That is the job of interest rate and fiscal policy. It is totally inappropriate to hold public sector pay well below both private sector pay and inflation as a means of regulating aggregate demand.   

In different
situations it might be the case that high public sector pay awards
might encourage those in the private sector to seek matching
increases. But that will not happen this year, because public sector
wage increases have been so much lower than private sector wage
increases. Most of the public sector is playing catch-up, or to put
it differently, the public sector is currently being asked to
shoulder much more of the energy price hike than those in the private
sector. As a result, the knock-on effect of higher public sector pay
awards on private sector pay, and therefore inflation and interest
rates, is likely to be minimal.

What will happen if
public sector pay awards begin to match those in the private sector
is that the government will need to find the extra cash. But we know
that it has the money, without having to increase taxes, because the
Chancellor has made no secret that he is assembling a large sum of
money for additional tax cuts before the next election. So the choice
is in many ways a very simple one. Do we want public sector workers 
to be paid more,
like nurses and doctors where there is a current chronic shortage of
staff, or do we prefer tax cuts to help the Conservative party win the next election?


[1] It could also
shield all consumers by borrowing, transferring some of the cost of
higher energy into the future, although that would make no sense if
higher energy prices were permanent.

[2] The employment
contract is not symmetric in terms of power between employee and
employer, which is why trade unions are important in improving terms
and conditions, preventing exploitation etc. However if union
membership was widespread, the ability of unions to improve the real
wages of workers as a whole is severely constrained by the fact that
firms set prices.

[3] What about
passing laws to prevent excessive increases in profits or wages? They
were tried in the 1960s and 1970s, and they failed because they
require the state to work out, product by product or worker by worker, what reasonable
profits or wage increases are. Over the longer term it is better to
ensure excessive profits are controlled through competition
(enforced, if necessary, by breaking up monopolies) or, when
competition is impossible, through forms of regulation.

[4] If the aim is to
reduce the proportion of profits going to dividends, or share buy
backs, high nominal wage demands is a very uncertain method of
achieving this (as firms set prices). A more inevitable outcome is
widespread unemployment as the central bank attempts to control