Unemployment is dragging down wages more steeply than in previous recessions

Typical workers have lost an extra £800 in annual pay over recent years because unemployment has begun to drive down wages much more strongly than had previously been observed, a new study for independent think-tank the Resolution Foundation has discovered.

The study, What a Drag, shows that the relationship between pay and unemployment shifted during the last decade, with wages becoming much more sensitive to unemployment from 2003. This meant that while a doubling of unemployment between 1986 and 2002 would have been expected to depress real wages by seven per cent for someone on median earnings, the same rise in unemployment would have pushed down those wages by 12 per cent between 2003 and 2010.

With unemployment almost doubling in recent years, the study’s authors Professor Paul Gregg and Professor Steve Machin were able to show how the effect on the pay of workers on low to middle earnings was significantly more severe than in previous recessions.

The increase in unemployment from 4.6 per cent in 2005 to 8.3 per cent in 2011 led to a reduction of £2,100 in the annual earnings of a full-time worker at median pay rates. The same rise in unemployment in previous years would have reduced those earnings by only £1,300 – a difference of £800 a year.

The report identifies that wages across the earnings spectrum have become more sensitive to unemployment in the period after 2003. However, both before and after 2003 the impact of unemployment on real wages is far more pronounced for low to middle earners than for those in the top half of the distribution. For example, while a doubling of unemployment would reduce real wages for a typical worker by 12 per cent between 2003 and 2010, the effect for the lower-paid would be 17 per cent (but just 11 per cent for the more well-paid). [1]

The research has notable implications for policies to manage Britain’s emergence from recession:

• Real wage growth for low to middle earners is unlikely to happen until unemployment (currently eight per cent) falls significantly – probably to below levels seen during the growth years before 2007 (when it fell as low as 4. 6 per cent). Any economic recovery needs to feed through into job growth before it will boost wages
• If unemployment falls significantly, policy makers will be able to keep interest rates lower than in the past for similar levels of unemployment without fear of wage-driven inflation
• If government wishes to boost the wages of low and middle earners it must focus on driving down unemployment as well as policies that influence pay directly

Gavin Kelly, chief executive of the Resolution Foundation, said: “This timely study reveals the extent to which unemployment is having a chilling effect on wages.  It shines a new light on the extent of wage stagnation over the last decade and makes clear that driving down unemployment is an essential pre-condition to securing wage-growth. The sensitivity of wages to unemployment affects everyone but it hits those on low to middle earnings the hardest.”

“Policy makers need to bear in mind that the relationship between unemployment and wages appears to have changed compared to previous recessions – this could have significant implications for the future path of monetary policy, with interest rates able to stay lower for longer than would have been the case in the past without sparking wage inflation.”

Professor Machin said: “The reasons behind this increase in the sensitivity of real wages to unemployment will be complex but it may well, at least in part, be a consequence of the weakening of labour market institutions such as the coverage of trade unions as well as the success of active welfare policies which have made the unemployed better able to compete for jobs.”

The research forms an important part of the evidence being gathered by the Resolution Foundation’s Commission on Living Standards, an independent and wide ranging investigation into the pressures facing people on low to middle incomes, which will be published in the autumn.

Notes to editors

1. A “typical” worker is defined as one on median wages (that is at the mid-point of the earnings distribution). Here “lower-paid” refers to someone at the 20^th percentile of earnings and “better-paid” to the 70^th percentile.
    
2. What a Drag: the changing relationship between unemployment and real wage growth is written by Professor Paul Gregg of the Department of Social and Policy Sciences at the University of Bath and Professor Steve Machin of the Department of Economics at University College London. It is available in advance from the Resolution Foundation press office and will be available for download on publication at www.resolutionfoundation.org
3. The study used wages data reported by employers from the New Earnings Survey/Annual Survey of Hours and Earnings
4. Between 1986 and 2003, real wage growth at the middle (median) of the income distribution rose on average by 1.6 per cent a year. Since 2003, median real wages have fallen on average by 0.3 per cent a year.