Are workers’ wages really likely to begin growing again any time soon?

The Office for Budget Responsibility looks to be overly optimistic once again

The Friday before last, I set my smart Dartmouth students in my Financial Crisis class the task of examining the December jobs report released by the US Bureau of Labor Statistics. In class the day before, I wrote the word SURPRISE in large capital letters on the blackboard, and told them to determine whether there was anything surprising in the report.

I explained that the consensus was expecting private non-farm payrolls to be about 200,000, with many suggesting they might be as high as 234,000. Over the past 18 months, payrolls were up by more than 100,000 every month except one (89,000 in July 2012) and up over 200,000 in three of the previous four months. Employment has risen for 39 months in a row, but is still one and a quarter million lower than it was in February 2008, at the start of the recession.

But I warned that this might well be a strange month, as we have had a couple of months of data impacted by the government shutdown, and so it turned out. We got 74,000, which was a big surprise, although it was tempered a little with upward revisions to the October numbers of 38,000 and reports that it was weather-related. The unemployment rate dropped from 7 per cent to 6.7 per cent, but the drop in unemployment of 490,000 was less than the 525,000 who withdrew from the labour force.

Most commentators didn’t spot that average private-sector weekly earnings fell on the month from $833.18 (£506) to $831.45.

On the same day, a report on the Canadian labour market showed a big drop in employment. Two nasty surprises.

In contrast, UK employment is now three quarters of a million higher today  (2.7 percentage points) than it was at the start of the recession. In the UK and the US, the 16+ employment rate (employment/population) still hasn’t recovered to its pre-recession levels. The 16+ employment rate in the US was 62.9 per cent in January 2008, and is 58.6 per cent today. In the UK it was 60.3 per cent in January 2008 and is 59.3 per cent today.

What has been really different is the recent path of real earnings, which have fallen much more in the UK than in the US. The first chart illustrates the path of median usual weekly earnings in the US. In constant (1982-84) dollars, they have shown little or no change from Q1 2008. They were $335 in Q1 1979 as well as in Q1 2008, compared with $333 in Q3 2013. So the story from the US is that median real wages haven’t risen in 35 years. No kidding. The concern is that as a result of Coalition policies, the UK labour market has now become like the US, and real wage growth for the typical median worker is a thing of the past. In contrast to flat real wage growth in the US, real full-time weekly earnings in the UK in the period 1998-2008, according to the Labour Force Survey, rose by about a quarter, over the same period. But it has been a very different story since 2010, when the Coalition took office, as the second chart shows. At the median, real wages were down by 9.6 per cent alone between 2011 and 2013 and by 4.6 per cent at the mean. Over the last quarter, median weekly and hourly earnings of full-time workers earnings also fell, in the case  of weekly earnings from £481 to  £462 and for hourly earnings from  £10.59 to £10.43.

This amount of downward wage flexibility is likely a major part of the explanation for the UK’s better job performance, even though the US has grown much faster. This contrasts sharply with the recession of the 1980s, when 10 per cent of the population were unemployed all the time – the Full Monty generation – and 90 per cent were never unemployed and enjoyed substantial real wage growth. This has been a nasty surprise for workers. The question is whether this is about to change. That seems unlikely.

According to the most recent forecasts of the Office for Budget Responsibility (OBR), they expect good surprises to be headed workers’ way, and soon. As ever, they are projecting real earnings growth, which I calculate as their forecast of average earnings growth minus their projection for the CPI. They are expecting real earnings to rise, by 0.3 per cent in 2014 and four times that in 2015, just in time for the election. The only basis for this seems to be mean reversion: it was like this over the past 30 years so must be so again, even though the chart shows that the trend over the past decade or so was down. In their Budget forecast of June 2010 they were forecasting real earnings growth would have been 1.8 per cent in 2013 and 2.4 per cent in both 2014 and 2015. Now they are less optimistic, but still expect a swift turnaround from negative in 2013 to positive growth in 2014 and beyond. The OBR looks to be overly optimistic again.

We have known for a long time, following the work of Sumner Slichter, that wage growth is determined by a blend of “insider” and “outsider” forces. By insider forces we mean the ability and willingness to pay, so when profits rise the ability to pay rises, but it seems as if bosses are happy to keep any gains to themselves rather than sharing them with the workers.

Outsider forces refer to the slack that exists in the labour market. As the unemployment rate rises, worker bargaining power weakens. Bargaining power is held down by the presence of highly productive and cheap migrant workers, but also by the possibility that more migrants could come. But this doesn’t mean the blame for weaker bargaining power is the fault of migrants, as UKIP claims. Globalisation means firms could always relocate and move their offices or factories to Bulgaria or Germany or China. None of these forces has suddenly changed and inflation seems unlikely to collapse. My fingers and toes are crossed hoping for a big positive surprise on the wage front.  My brain says something else.