What is happening with UK wages? - Economics Observatory

While headline figures for wages have recently suggested rapid growth, average settlements are 2-3% – and pay is certainly not going up as fast as consumer prices. Real wages are only likely to rise if either productivity growth accelerates or workers have greater bargaining power.

Wage growth has varied dramatically during the pandemic. Low-wage sectors such as hospitality and retail have been particularly affected by Covid-19 and large numbers of workers have had to take temporary pay cuts while furloughed. These effects have given rise to year-on-year earnings increases as high as 8.8% in the second quarter of 2021.

But we know that this measure is distorted. The most recent data suggest that earnings are increasing by around 4% annually – below the current rate of consumer price index (CPI) inflation. This indicates that real wages (which takes inflation into account) are falling, as people’s pay is growing more slowly than prices are increasing.

While there have been large wage increases in some shortage sectors (such as haulage and logistics), in other parts of the labour market, wages are stagnant or rising very slowly. Real wages are only likely to rise faster if either productivity growth accelerates or workers have greater bargaining power.

What do the latest data reveal?

The latest earnings data from the Office for National Statistics (ONS) suggest that average earnings in the UK were 4.2% higher in the period from September to November 2021 than in the same period of 2020. Regular earnings (which exclude bonuses) rose by 3.8%.

The ONS has suggested that headline figures should be interpreted with caution for a number of reasons. First, in the first year of the pandemic, many people were furloughed on the Coronavirus Job Retention Scheme (CJRS) and had taken wage reductions of up to 20%. Their return to full-time work and pay since then is likely to have contributed significantly to fast headline earnings growth, especially in the private sector where furlough was concentrated.

Second, the composition of those in work may have changed over the same period. When low-paid workers lose their jobs it raises average earnings (as this leaves more highly paid workers in the workforce proportionately). There is evidence that this was the case in the early months of the pandemic. As Figure 1 shows, the large fall in earnings in 2020 led to a large upward spike in annual growth in 2021.

Figure 1: Great Britain average weekly earnings annual growth rates (seasonally adjusted)

Source: ONS Monthly Wages and Salaries Survey

But in recent months, the ONS estimate that these temporary factors have now largely worked their way out of the latest figures.

Are lots of people actually getting pay rises of over 4%?

For many workers, growth in earnings over the past year will be equal to the size of any pay increase their employer has granted, either individually or collectively. Several organisations monitor pay settlements. Preliminary analysis by XpertHR suggests that average basic pay settlements picked up to around 2.5% at the start of 2022, having finished 2021 at around 2%. But many settlements take place in April, so the picture will be clearer in a few months’ time.

Figure 2: Median pay settlements and growth in average earnings before Covid-19 (percentage change)

Source: ONS and Incomes Data Research

The difference between total earnings growth and pay settlements is generally described as ‘pay drift’ and was typically between 0.5% and 1% in the years before the pandemic (Figure 2). Positive pay drift may reflect several factors, including:

Compositional shifts: The shift to a higher-wage economy – for example, through the automation of low-paid jobs and a rise in the proportion of jobs that require longer periods of training.
Increases in hours: If the number of hours worked by the average worker increases, their total earnings will increase more quickly than their hourly rate.
Bonuses: Some employers pay staff outside their contractual pay and – at times of large profits or labour shortages – they may increase bonuses to attract and retain staff.
Starting salaries: If wages for new starters rise more quickly than for existing staff, this can lead to positive pay drift. In the long run, there is unlikely to be a significant difference between wage increases of existing and new workers (or workers would always be better off seeking a similar job elsewhere), but new starters may be the first to benefit from generalised wage increases that feed into settlements for existing staff with a lag.

Why are wage increases watched so carefully by the Bank of England?

The Monetary Policy Committee (MPC) of the Bank of England has a target of 2% for CPI inflation. While many economists believe that the factors that have driven CPI inflation well above target are temporary ones, the MPC may be concerned that temporary factors could lead to rising inflation expectations and what’s known as a ‘wage-price spiral’.

In this scenario, workers who are facing higher prices demand and receive higher pay rises, which in turn increases firms’ costs, leading them to raise prices further. This then leads to higher wage demands, and so on.

Many economists believe that a wage-price spiral was a factor in the persistently high inflation seen in the UK in the 1970s (see Figure 3), when global oil price shocks were followed by higher pay increases to compensate for higher inflation.

But MPC member Jonathan Haskel recently highlighted changes in the UK labour market as one potentially significant difference between the 1970s and now, along with greater international capital mobility and greater policy credibility (via inflation targeting and central bank independence). Achieving inflation-proofed pay increases was easier at a time when a larger proportion of the working population were members of trade unions and covered by collective bargaining agreements.

Figure 3: Average earnings and consumer price inflation (spliced estimates)

Source: Bank of England

Should the Bank of England be worried about wage increases?

There have been high-profile stories about large wage rises in some sectors. Annual earnings growth in the finance and business services sectors was over 7% in the year to November and IDR suggested in late 2021 that rapid growth in these areas had more to do with the resumption of bonuses than any base or compositional effects. This compares with 2.1% increases in manufacturing and 2.6% in the public sector, where much of the workforce had its pay frozen last year by the government.

There have also been widespread reports of rising pay for HGV drivers. They are in short supply as a combined result of Brexit, changes to rules around self-employment, years of low pay, more online shopping and a general shift in demand from services towards goods consumption.

According to Indeed, a job search website, advertised pay (starting salaries) grew by nearly 9% between January and October 2021 for driving jobs and 6% for construction jobs. On a comparable basis, however, they calculate that the equivalent growth in posted wages for the economy as a whole was around 2% over the same period (2.3% annualised). This suggests that rapid growth in starting salaries for particularly in-demand occupations is compatible with much less dramatic growth in wages across the wider workforce.

With nominal wage growth now slightly above pre-Covid-19 levels, so far there appears to be little sign of a wage-price spiral taking hold. But those concerned about the potential of rising wages to keep inflation above target will be waiting to see whether there are signs of ‘contagion’ from HGV driving, construction and other sectors to the rest of the labour market.

It also remains to be seen whether pay settlements in the first half of 2022 show material rises from their present 2-3% level, and whether these then feed into firms not badly affected by supply disruptions raising their prices.

Are rising wages a sign of the UK shifting to being a high-pay economy?

The prime minister has spoken of a desire to turn the UK into a ‘high-wage, high-skill economy‘. This comes after one of the worst decades for real wages in recent centuries and, as yet, there is little evidence of a shift to an economy in which real wages may be significantly higher than in the past: indeed, Brexit is widely expected to have a negative effect on wages in at least some sectors.

In the private sector, faster real wage growth requires either workers being able to capture a greater share of value added by the firm at the expense of employers or productivity increases that increase the value of firm products. The first may be achieved through tighter labour markets (when the economy is close to ‘full employment’), greater bargaining power for workers or stronger trade unions.

The second – greater productivity, a prerequisite for sustained annual wage growth over a longer period without reduced company profitability – would require an increase in the UK’s productivity growth rate, which has followed a significantly slower trend since the global financial crisis of 2007-09.

The long-term effect of Covid-19 on productivity may be positive, through increased automation, but this is still highly uncertain. Many studies have suggested a negative productivity effect from Brexit arising from additional trade barriers, stricter migration policies and lower foreign direct investment, although disentangling these from the effects of Covid-19 is likely to take several years.

The picture for real wages does not look promising at the start of 2022. Rising national insurance contributions from April may act to induce employers to hold down pay awards to control their wage bills. The possibility of further major Covid-19 lockdowns remains, with likely negative consequences for wages, with or without the reintroduction of furlough. The most important question overall this year will be whether nominal wages respond to rising inflation.