Britain’s £1bn crisis pay squeeze helped save 800,000 jobs – but the next recession could be different

The trade-off for Britain experiencing the sharpest real pay fall of any major advanced economy in the immediate wake of the financial crisis was a smaller than expected rise in unemployment that helped save up to 800,000 jobs. This is according to a new Resolution Foundation report, funded by the Nuffield Foundation, to be published later this week looking into the causes and consequences of Britain’s decade-long pay crisis, and what it means for future pay prospects.

The report notes that the scale and length of Britain’s post-crisis pay squeeze was unprecedented, with real average earnings falling by around 7 per cent between 2009 and 2014 – equivalent to a £1bn weekly wage loss across the workforce. This squeeze was strongest for those in professional occupations such as software developers, engineers and teachers, where real pay fell by 14.5 per cent, and for those aged 22-29 where pay fell by 11 per cent. Older workers and those working in low paying roles such as sales and customer experienced a more modest pay squeeze.

The report finds that the main reason for the speed and depth of the squeeze, on top of the sheer scale of Britain’s recession, was that the country adjusted to the financial crisis through an inflation shock. This was driven by increases in the price of imports, following a huge 27 per cent depreciation of sterling in 2009.

The Foundation notes that this inflation shock – in which CPI inflation rose to 4.8 per cent in 2008 and to 4.5 per cent in 2011 – allowed firms to adjust to the recession through real wage cuts, rather than by cutting jobs.

New analysis by the Foundation – which models comparable data on GDP per capita, pay, employment and prices across all major advanced economies between 2010 and 2014 – finds that had Britain’s inflation rate tracked the OECD average, Britain’s pay squeeze would have been far more modest at just -1.4 per cent, rather than -7 per cent. This would have meant Britain experiencing one of the smallest pay squeezes in Europe, in line with Italy and smaller than Germany’s, rather than the second biggest.

However, the analysis also finds that the alternative to adjusting to the financial crisis through real wage cuts would have been a much faster rise in unemployment. The Foundation’s modelling finds that in the absence of an inflation shock, unemployment would have increased by 5.1 percentage points, rather than 2.7 per cent. Although over a million people lost their jobs between 2007 and 2012, such a rise would have left a further 800,000 people out of work.

The Foundation argues that while the post-crisis pay squeeze was painful, the pain was at least shared across the workforce, rather than concentrated on those losing their jobs. It notes however that while lower unemployment was a silver lining to the post-crisis pay squeeze, this does not apply to the ongoing weak wage growth we see today.

Looking to the future, the Foundation warns that just because the last crisis led to a pay squeeze, it does not mean that the next one will – and that should sterling not fall in response to the next recession, Britain would be far more likely to experience a sharp rise in unemployment than another deep pay squeeze.

The Foundation says that policymakers must therefore be prepared for experiencing either a pay squeeze or unemployment-led recession next time around – for example by ensuring our welfare system is fit to cope with growing unemployment pressures if they materialise.

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

“Britain experienced an unprecedented pay squeeze in the wake of the financial crisis, with millions of workers suffering years of shrinking pay packets.

“The scale of the pay squeeze took everyone by surprise, with most economists predicting far higher unemployment instead. But while absorbing the impact of the financial crisis through our pay packets was painful, it did at least share the pain of the crisis and keep unemployment in check, with 800,000 more people keeping their jobs as a result.

“But we shouldn’t assume workers will all be in it together when the next recession comes. There’s a good chance instead of more modest pay falls and bigger increases in unemployment. This kind of recession will require a different kind of response from policy makers and it’s important we start thinking about those responses now.”