Slow growth in wages and a recovery based on running down savings is cause for concern

Latest projections suggest that wages of the typical worker will broadly flat-line over the next four years despite official projections of stronger economic growth released alongside the Budget.

Today’s OBR projections have average pay recovering to its pre-crisis level by 2018. (This projection is based on the mean and uses the CPI measure of inflation). Analysis  by the independent think tank the Resolution Foundation suggests that median weekly wages will remain broadly flat in real terms, standing at just £427 in 2018, at almost precisely the same level as in 2013 (at today’s prices and using the RPIJ measure of inflation that takes account of housing costs). [1]

The sluggish recovery in wages helps explain the continued reliance on drawing down savings to sustain consumer spending. The OBR now projects that the household savings ratio will stand at 3.2% in 2018, compared with 5.0% today. Back in November 2011 it projected that it would be 6.2% today and fall to a low of 5.7% by 2016. The reliance on running down savings raises questions about the sustainability of the recovery.

Despite an improved forecast for business investment growth in the coming years, the rebalancing of the economy promised at the start of the parliament also looks some way off. In its first fiscal outlook in 2010, the OBR projected that business investment would return to its pre-crisis level by 2012 and would be 28% above that level by the end of its forecast horizon. Instead, business investment remains 13% below the 2008 benchmark and is now forecast to rise to 30% above that point by 2018.

In relation to specific measures announced, RF analysis shows that three quarters of the gains from the increased personal tax allowance will flow to households in the top half of the income distribution. About 1% of the cost of the policy is actually spent on lifting people out of income tax. Those below the personal tax allowance will continue to pay National Insurance.

Matthew Whittaker, senior economist at the Resolution Foundation, said: “In spite of stronger growth, the prospects for typical wages are not encouraging – showing no signs of a rise over the forecast period to 2018 when we take account of inflation and housing costs. For many people, a meaningful recovery still seems a long way off.

”The large projected fall in the UK’s savings to income ratio is also cause for concern. It calls into question the prospects for a balanced and sustainable recovery. We need to see a stronger performance in wages, investment, employment – or a combination of all three – to secure a shared recovery. ”

Gavin Kelly, chief executive of the Resolution Foundation, said:  “The clear majority of gains from raising the personal tax allowance, a policy continued in this budget, go to better-off households and only a tiny proportion of the cost of the policy is actually spent lifting people out of income tax.

“It’s also wrong to suggest that someone on £8,500 has been ‘taken out of tax’ when they are still paying National Insurance contributions. There is no good argument for raising the income tax threshold but ignoring the NICs one.

“And it’s regrettable that at the same time as the government is increasing the tax threshold it has chosen to freeze the ‘work allowance’ within Universal Credit which will discourage work and worsen the problem of punitive effective tax rates hitting the working poor. There are better ways of spending £1.4bn”.

[1] The Resolution Foundation analysis converts the OBR projection for average pay into a median, by applying the ratio between growth in mean and median pay that held in the decade prior to the financial crisis (1997 – 2007). Real-terms figures are estimated using a constructed RPIJ measure of inflation. The RPIJ better captures the full range of cost of living pressures (including mortgage interest costs) facing households than the CPI does.