Weak pay growth could leave Britain waiting until the end of the century for real wages to double – and our disastrous productivity record is to blame

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 Resolution Foundation report published today (Tuesday).

Count the pennies – funded by the Nuffield Foundation – 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 per cent.

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 per cent since 2014, down from a pre-crisis average of 4 per cent, and is only just above the Bank of England’s 2 per cent 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. But the Foundation notes that many popular explanations of the recent wage slowdown – such as workers receiving a falling share of national income because of reduced bargaining power or rising inequality – are wide of the mark.

Instead 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.

The shifting characteristics of Britain’s workforce – such as it becoming more educated over time – tended to boost pay by an average of 0.7 per cent a year pre-crisis. However, the levelling off of the increase in the number of new graduates entering the labour market in recent years has muted this longstanding ‘skills tailwind’. Alongside a slowing in the process by which better paid jobs replace lower paid ones, this shift accounts for a further fifth of the overall slowdown in pay.

Beyond the skills of the workforce the Foundation finds that 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 Foundation says 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:

“Britain is living through a painful pay puzzle, where earnings growth remains rooted below 3 per cent even while unemployment has fallen to a 40-year low.

“Understanding the real reasons why pay is performing so badly is one of the biggest challenges we face because, unless we fix it, it could take until the end of the century for real wages to double.

“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.”