What a drag: The chilling impact of unemployment on real wages

It is clear that the relationship between unemployment and real wages looks different in the current period than it did coming out of previous recessions. This has several important implications going forward:

• First, if the same real wage-unemployment relationship remain in place, higher paid workers are likely to continue to see a modest upward trend in real wage growth with flat unemployment, but real wage growth for low and middle earners will not return to significant positive territory until unemployment starts to fall significantly – probably below the levels (of between 4 and 6 per cent) recorded in the period from 1999 to 2007.
• Secondly, in contrast to the view that there has been a large degree of labour hoarding that can generate a productivity boost when growth returns, any economic recovery will need to feed through into jobs growth before it boosts wages. Higher pay will only be generated when and if unemployment falls significantly.
• Thirdly, while pay will respond if and when unemployment falls significantly, especially for low to middle paid workers, the kind of sustained real wage growth recorded through the 1980s and 1990s will not return if unemployment simply falls back to its pre-recession norm. This is likely to allow policy makers to keep interest rates lower than in the past for similar levels of unemployment without fear of an inflationary wage-price spiral.
• Finally, if government wishes to boost the earnings of low and middle earners it must focus not just on policies that influence pay directly, but also on driving down levels of unemployment. The increased sensitivity of real wages to unemployment means that such a focus becomes even more important than it has been in previous years.