Pay growth slowed by UK's poor productivity record and high underemployment

08 October 2018

If the slow pace of Britain’s post-crisis pay growth were to continue indefinitely it will take until 2099 for real wages today to double in value – compared to the pre-crisis average when wages doubled every 29 years – according to a new Nuffield-funded report published by the Resolution Foundation

Count the pennies explores the puzzle of why pay growth has not recovered to pre-crisis levels, despite unemployment not only recovering but falling further to a 40-year low of 4%.

Historically, low levels of unemployment have driven faster wage rises as firms are forced to pay more to attract scarce workers. However, nominal pay growth has averaged just 2.2% since 2014, down from a pre-crisis average of 4%, and is only just above the Bank of England’s 2% inflation target.

The failure of pay to respond to falling unemployment has led many economists to conclude that the relationship between the two has broken down. 

However, the report shows how levels of underemployment and insecure work also need to be included alongside unemployment when measuring labour market slack, to recognise that many workers want to take on more hours or find more secure work. It finds that there are 700,000 people who’d like to do more hours and who, like the unemployed, are actively searching for work, up from 500,000 before the crisis.

By including these people, the report shows that the relationship between a tighter labour market and stronger pay growth is alive and well. This broader measure of slack accounts for a fifth of the slowdown in pay between 2014 and 2018. However, the report notes that this broader measure of slack has now all but recovered to pre-crisis levels, so that while it helps explain weak wage growth in recent years that effect should now fade.

Counting the pennies warns that this reduced slack does not mean pay growth will return to pre-crisis levels for two related reasons – a diminishing ‘skills tailwind’ and weak productivity growth.

Beyond the skills of the workforce, poor pay growth is explained by ongoing weak productivity growth, which accounts for almost half of the slowdown. Productivity has grown by an average of just 0.8 per cent per year since 2014, down from 2 per cent in the early 2000s.

The researchers argue that identifying the real reasons behind Britain’s pay crisis is vital if we’re to make the right interventions to tackle it, and get wages growing at a healthy rate again. 

Stephen Clarke, Senior Economic Analyst at the Resolution Foundation, said: 

“Our work has shown that there are three core factors behind Britain’s pay problems – people wanting more hours or secure work, a diminishing ‘skills tailwind’, and terrible productivity growth. 

“While the first trend is now fading, tackling the other two related problems isn’t easy. But that shouldn’t stop policy makers doing everything they can to address them as the strength of all our pay rises in the future will ultimately depend on Britain solving its current pay puzzle.”