Continuing wage falls this year caused by rising youth employment and decline in managers

A downward shift in the mix of occupations across the workforce towards lower-paying roles, along with a welcome return of younger and less experienced workers to the labour market, has prevented 2014 from being the year of the pay rise, according to a major new report published today (Friday) by the independent think-tank the Resolution Foundation.

Changes in the characteristics of the workforce over time – such as age, gender, sector, occupation, migrant status and skill level – tend to pull wage growth in different directions. The Resolution Foundation study shows that in most years since the financial crisis the overall effect of these changes in the workforce has been to prop up wages. Without them Britain’s pay squeeze would have been a third deeper – with real wages falling by 10.8 per cent since 2007, rather than 8 per cent.

However in its latest Inflation Report, the Bank of England suggested that changes in the make-up of the workforce may have started depressing pay growth during 2014. The Resolution Foundation report is the first attempt to fully analyse the impact of these changes – the so called ‘compositional effect’ – in order to establish the extent to which it is now acting as a drag on wages and to pin-point the specific impact of different factors.

It shows that the overall ‘compositional effect’ has turned what would have been positive real wage growth of 0.1 per cent during the first half of 2014 into a fall of 0.8 per cent. Without these changes in the workforce, wage growth would have turned positive – if only very modestly so.

The analysis highlights key changes in the composition of the workforce that have all reduced earnings growth in 2014:

• Decline of managerial jobs and rise in lower paying roles. While overall employment has surged in 2014, there has been a fall in the proportion of managerial roles, which are typically high paying, among employees. The fastest growing jobs have been caring roles and elementary occupations such as cleaning, both of which are low paid. This downward shift in the mix of occupations across the workforce has been the single biggest drag on wage growth this year.
• Rising youth employment. Employment has risen fastest among 20-29 year olds this year, who are the lowest paid adults. With young people currently earning 13 per cent less in real terms since 2007 (the biggest pay squeeze of any age group), their entry into the workforce has been a significant drag in wages.
• New job starts. The fastest growing group of workers in the labour market this year are those that have been employed for less than a year in their current role. They are also the lowest paid. In previous years, rising employment among older workers meant that growth was fastest among people with longer-held jobs.

The growth in the number of full-time jobs, relative to part-time ones, has provided the biggest single boost to wage growth so far this year.

The ‘wage drag’ created by the entry and re-entry of younger and less experienced workers reflects the surge in employment this year. With the UK’s employment rate already having returned to its pre-crisis level, the effects of this increase may weaken in 2015, increasing the chances wages will start to rise in real terms.  However, the wage drag created by the change in the mix of occupations across the workforce is more worrying, says the Resolution Foundation, particularly if it represents a longer-term shift in the labour market.

Despite the importance of the compositional effect in explaining why wages are still falling in 2014 the report highlights that a generalised and dramatic slowdown in pay growth within sectors and different groups of workers has been by far the biggest factor explaining falling wages since the financial crisis.  The average year-on-year change in individuals’ wages across the economy has plummeted from around 4 per cent before the downturn to between 0 and 1 per cent in the last two years.

The report also shows that the longer term trend towards an upgrading of skill levels across the workforce helped to support pay throughout the years of the wage-squeeze while the increasing size of the migrant workforce had a negligible compositional effect on wages over the period analysed (2006-2014).

Matthew Whittaker, Chief Economist at the Resolution Foundation, said:

“Many people predicted that 2014 would be the year of the pay rise. In fact, earnings growth reached a record low earlier this year and is not set to overtake inflation until 2015. This stubbornness of pay falls is a worry to all of us.

“We are beginning to get a clearer picture of what underpins these terrible wage figures. Some factors are more benign, while others are a cause for concern. The speed up in the entry of younger and less experienced employees into the workforce, who are invariably lower paid than average, has been an important drag on wages. This downward pressure on wage growth should dissipate next year and hopefully open the way for a long overdue return to positive wage growth.

“What’s more worrying however is how the mix of occupations – particularly the decline in managerial roles and the rise of low-skilled occupations – is dragging down wage growth. It’s not yet clear whether this is a temporary blip or the start of a new shift in patterns of UK employment.

“We shouldn’t forget that underlying pay growth within different sectors and groups of workers remains very subdued, despite the reports of strong growth in some firms. Ultimately the prospects for pay rest on employers’ willingness and ability to reintroduce above-inflation pay increases. If the recent minimum wage rise of three per cent can set a benchmark, then there are reasons to be optimistic that 2015 could finally be the year of the pay rise.”

Ends

• One of the reasons for the decline in managerial roles among employees has been the shift towards self-employment among managers. However, this shift is impossible to model as the earnings of the self-employed are not captured in the ONS’ main pay surveys. With around one in seven workers across the UK now self-employed, the Resolution Foundation wants to see a new ‘all-worker’ earnings measure that captures the pay of everyone, rather than just employees. Our case for an ‘all-worker’ measure is available here.
• Real wage growth is calculated using CPI inflation.
• The size of the pay squeeze since 2007 in the absence of compositional changes is calculated by removing compositional effects from annual real wage growth from 2008 onwards, and recalculating post-2007 Average Weekly Earnings on this basis. Due to a change in variable coding it has not been possible to calculate compositional effects during 2011, so for this year we revert to overall real wage growth. This is likely to understate the size of the wage fall in the absence of compositional effects. Our calculation of the size of the pay squeeze since 2007 compares average real pay in July 2013-June 2014 (with post-2007 compositional effects removed) to average real pay in the 2007 calendar year.
• The overall compositional effect on wage growth has changed from +0.6 percentage points in the first half of 2013 to -0.3 percentage points in the first half of 2014 (as shown in the chart above). This reversal has reduced real wage growth by 0.9 percentage points in the first half of the year.
• References to the ‘compositional effect’ on earnings growth can be found in Section 4.3 of the Bank’s Quarterly Inflation Report (page 33 onwards), published in August.