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Posts Tagged ‘real wages’

Falling UK real wages – comparison with other OECD countries

In the last blog post, As UK inflation rises, so real wages begin to fall, we showed how the rise in inflation following the Brexit vote is causing real wages in the UK to fall once more, after a few months of modest rises, which were largely due to very low price inflation. But how does this compare with other OECD countries?

In an article by Rui Costa and Stephen Machin from the LSE, the authors show how, from the start of the financial crisis in 2007 to 2015 (the latest year for which figures are available), real hourly wages fell further in the UK than in all the other 27 OECD countries, except Greece (see the chart below, which is Figure 5 from their article). Indeed, only in Greece, the UK and Portugal were real wages lower in 2015 than in 2007.

The authors examine a number of aspects of real wages in the UK, including the rise in self employment, differences by age and sex, and for different percentiles in the income distribution. They also look at how family incomes have suffered less than real wages, thanks to the tax and benefit system.

The authors also look at what the different political parties have been saying about the issues during their election campaigns and what they plan to do to address the problem of falling, or only slowly rising, real wages.

Articles
Real Wages and Living Standards in the UK LSE – Centre for Economic Performance, Rui Costa and Stephen Machin (May 2017)
The Return of Falling Real Wages LSE – Centre for Economic Performance, David Blanchflower, Rui Costa and Stephen Machin (May 2017)
The chart that shows UK workers have had the worst wage performance in the OECD except Greece Independent, Ben Chu (5/6/17)

Data
Earnings and working hours ONS
OECD.Stat OECD
International comparisons of productivity ONS

Questions

  1. Why have real wages fallen more in the UK than in all OECD countries except Greece?
  2. Which groups have seen the biggest fall in real wages? Explain why.
  3. What policies are proposed by the different parties for raising real wages (a) generally; (b) for the poorest workers?
  4. How has UK productivity growth compared with that in other developed countries? What explanations can you offer?
  5. What is the relationship between productivity growth and the growth in real wages?
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As UK inflation rises, so real wages begin to fall

With the effects of the depreciation of sterling feeding through into higher prices, so the rate of inflation has risen. The latest figures from the ONS show that in the year to April 2017, CPI inflation was 2.7% – up from 2.3% in the year to March. The largest contributors to higher prices were transport costs and housing and household services.

But wage increases are not keeping up with price increases. In 2017 Q1, the average annual growth rate in regular pay (i.e. excluding bonuses) was 2.1%. In other words, real pay is falling. And this is despite the fact that the unemployment rate, at 4.6%, is the lowest since 1975.

The fall in real wages is likely to act as a brake on consumption and the resulting dampening of aggregate demand could result in lower economic growth. On the other hand, the more buoyant world economy, plus the lower sterling exchange rate is helping to boost exports and investment and this could go some way to offsetting the effects on consumption. As Mark Carney stated in his introductory remarks to the May 2017 Bank of England Inflation Report:

The combination of the stronger global outlook and sterling’s past depreciation is likely to support UK net trade. And together with somewhat lower uncertainty, stronger global growth is also likely to encourage investment as exporters renew and increase capacity.

According to the Bank of England, the net effect will be modest economic growth, despite the fall in real wages.

In the MPC’s central forecast, quarterly growth is forecast to stabilise around its current rate, resulting in growth of 1.9% in 2017 and around 1¾% in each of the next two years.

But forecasting is dependent on a range of assumptions, not least of which are assumptions about consumer and business expectations. These, in turn, depend on a whole range of factors, such as the outcome of the UK election, the Brexit negotiations, commodity prices, world growth rates and international events, such as the actions of Donald Trump. Because of the uncertainty surrounding forecasts, the Bank of England uses fan charts. In the two fan charts illustrated below (from the May 2017 Inflation Report), the bands on constructed on the following assumptions:

If economic circumstances identical to today’s were to prevail on 100 occasions, the MPC’s best collective judgement is that CPI inflation or the mature estimate of GDP growth would lie within the darkest central band on only 30 of those occasions and within each pair of the lighter coloured areas on 30 occasions.

The charts and tables showing the May 2017 projections have been conditioned on the assumptions that the stock of purchased gilts remains at £435 billion and the stock of purchased corporate bonds remains at £10 billion throughout the forecast period, and on the Term Funding Scheme (TFS); all three of which are financed by the issuance of central bank reserves. They have also been conditioned on market interest rates, unless otherwise stated.

The wider the fan, the greater the degree of uncertainty. These fan charts are wide by historical standards, reflecting the particularly uncertain future for the UK economy.

But one thing is clear from the latest data: real incomes are falling. This is likely to dampen consumer spending, but just how much this will impact on aggregate demand over the coming months remains to be seen.

Articles
UK real wages drop for first time in three years Financial Times, Sarah O’Connor (17/5/17)
Bank of England warns Brexit vote will damage living standards The Guardian, Katie Allen (11/5/17)
UK wage growth lags inflation for first time since mid-2014 BBC News (17/5/17)
Britons’ Falling Real Wages Show Challenging Times Have Arrived Bloomberg, Scott Hamilton and Lucy Meakin (17/5/17)
Jobs market will suffer a Brexit slowdown, say experts The Guardian, Angela Monaghan and Phillip Inman (15/5/17)
Pay will continue to be squeezed, employers’ survey suggests BBC News, Kamal Ahmed (15/5/17)
Brexit latest: Real wages falling, Office for National Statistics reveals Independent, Ben Chu (17/5/17)
UK inflation climbs to four-year high, beating forecasts Financial Times, Gavin Jackson (16/5/17)
Why is UK inflation at a four-year high? Financial Times, Gavin Jackson (19/5/17)
A blip, or a test of hawks’ patience? Economists respond to high UK inflation data Financial Times, Nicholas Megaw (16/5/17)
UK inflation rate at highest level since September 2013 BBC News (16/5/17)
Inflation jumps to its highest level since 2013 as Brexit continues to bite Business Insider, Will Martin (16/5/17)
UK GDP growth weaker than expected as inflation hits spending The Guardian, Katie Allen (25/5/17)
UK economic growth estimate revised down BBC News (25/5/17)

Reports
Inflation Report, May 2017 Bank of England (11/5/17)
Labour Market Outlook, Sping 2017 Chartered Institute of Personnel and Development (May 2017)

Data
Statistical Interactive Database – interest & exchange rates data Bank of England
Inflation and price indices ONS
Earnings and working hours ONS
Second estimate of GDP: Jan to Mar 2017 ONS Statistical Bulletin (25/5/17)

Questions

  1. Find out what has happened to the dollar/sterling and the euro/sterling exchange rate and the sterling exchange rate index over the past 24 months. Plot the data on a graph.
  2. Explain the changes in these exchange rates.
  3. Why is there negative real wage growth in the UK when the rate of unemployment is the lowest it’s been for more than 40 years?
  4. Find out what proportion of aggregate demand is accounted for by household consumption. Why is this significant in understanding the likely drivers of economic growth over the coming months?
  5. Why is uncertainty over future UK growth rates relatively high at present?
  6. Why is inflation likely to peak later this year and then fall?
  7. What determines the size and shape of the fan in a fan chart?
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Return of the political business cycle?

According to the theory of the political business cycle, governments call elections at the point in the business cycle that gives them the greatest likelihood of winning. This is normally near the peak of the cycle, when the economic news is currently good but likely to get worse in the medium term. With fixed-term governments, this makes it harder for governments as, unless they are lucky, they have to use demand management policies to engineer a boom as an election approaches. It is much easier if they can choose when to call an election.

In the UK, under the Fixed-term Parliaments Act of 2011, the next election must be five years after the previous one. This means that the next election in the UK must be the first Thursday in May 2020. The only exception is if at least two-thirds of all MPs vote for a motion ‘That there shall be an early parliamentary general election’ or ‘That this House has no confidence in Her Majesty’s Government.’

The former motion was put in the House of Commons on 19 April and was carried by 522 votes to 13 – considerably more than two-thirds of the 650 seats in Parliament. The next election will therefore take place on the government’s chosen date of 8 June 2017.

Part of the reason for the government calling an election is to give it a stronger mandate for its Brexit negotiations. Part is to take advantage of its currently strong opinion poll ratings, which, if correct, will mean that it will gain a substantially larger majority. But part could be to take advantage of the current state of the business cycle.

Although the economy is currently growing quite strongly (1.9% in 2016) and although forecasts for economic growth this year are around 2%, buoyed partly by a strongly growing world economy, beyond that things look less good. Indeed, there are a number of headwinds facing the economy.

First there are the Brexit negotiations, which are likely to prove long and difficult and could damage confidence in the economy. There may be adverse effects on both inward and domestic investment and possible increased capital outflows. At the press conference to the Bank of England’s February 2017 Inflation Report, the governor stated that “investment is expected to be around a quarter lower in three years’ time than projected prior to the referendum, with material consequences for productivity, wages and incomes”.

Second, the fall in the sterling exchange rate is putting upward pressure on inflation. The Bank of England forecasts that CPI inflation will peak at around 2.8% in early 2018. With nominal real wages lagging behind prices, real wages are falling and will continue to do so. As well as from putting downward pressure on living standards, it will tend to reduce consumption and the rate of economic growth.

Consumer debt has been rising rapidly in recent months, with credit-card debt reaching an 11-year high in February. This has helped to support growth. However, with falling real incomes, a lack of confidence may encourage people to cut back on new borrowing and hence on spending. What is more, concerns about the unsustainability of some consumer debt has encouraged the FCA (the financial sector regulator) to review the whole consumer credit industry. In addition, many banks are tightening up on their criteria for granting credit.

Retail spending, although rising in February itself, fell in the three months to February – the largest fall for nearly seven years. Such falls are likely to continue.

So if the current boom in the economy will soon end, then, according to political business cycle theory, the government is right to have called a snap election.

Articles
Gloomy economic outlook is why Theresa May was forced to call a snap election The Conversation, Richard Murphy (18/4/17)
What does Theresa May’s general election U-turn mean for the economy? Independent, Ben Chu (18/4/17)
It’s not the economy, stupid – is it? BBC News Scotland, Douglas Fraser (18/4/17)
Biggest fall in UK retail sales in seven years BBC News (21/4/17)
Sharp drop in UK retail sales blamed on higher prices Financial Times, Gavin Jackson (21/4/17)
Shoppers cut back as inflation kicks in – and top Bank of England official says it will get worse The Telegraph, Tim Wallace Szu Ping Chan (21/4/17)
Retail sales volumes fall at fastest quarterly rate in seven years Independent, Ben Chu (21/4/17)

Statistical Bulletin
Retail sales in Great Britain: Mar 2017 ONS (21/4/17)

Questions

  1. For what reasons might economic growth in the UK slow over the next two to three years?
  2. For what reasons might economic growth increase over the next two to three years?
  3. Why is forecasting UK economic growth particularly difficult at the present time?
  4. What does political business cycle theory predict about the behaviour of governments (a) with fixed terms between elections; (b) if they can choose when to call an election?
  5. How well timed is the government’s decision to call an election?
  6. If retail sales are falling, what other element(s) of aggregate demand may support economic growth in the coming months?
  7. How does UK productivity compare with that in other developed countries? Explain why.
  8. What possible trading arrangements with the EU could the UK have in a post-Brexit deal? Discuss their likelihood and their impact on economic growth?
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Rising inflation

The latest figures from the ONS show that UK inflation rose to 2.3% for the 12 months to February 2017 – up from 1.9% for the 12 months to January. The rate is the highest since September 2013 and has steadily increased since late 2015.

The main price index used to measure inflation is now CPIH, as opposed to CPI. CPIH is the consumer prices index (CPI) adjusted for housing costs and is thus a more realsitic measure of the cost pressures facing households. As the ONS states:

CPIH extends the consumer prices index (CPI) to include a measure of the costs associated with owning, maintaining and living in one’s own home, known as owner occupiers’ housing costs (OOH), along with Council Tax. Both of these are significant expenses for many households and are not included in the CPI.

But why has inflation risen so significantly? There are a number of reasons.

The first is a rise in transport costs (contributing 0.15 percentage points to the overall inflation rate increase of 0.4 percentage points). Fuel prices rose especially rapidly, reflecting both the rise in the dollar price of oil and the depreciation of the pound. In February 2016 the oil price was $32.18; in February 2017 it was $54.87 – a rise of 70.5%. In February 2016 the exchange rate was £1 = $1.43; in February 2017 it was £1 = $1.25 – a depreciation of 12.6%.

The second biggest contributor to the rise in inflation was recreation and culture (contributing 0.08 percentage points). A wide range of items in this sector, including both goods and services, rose in price. ‘Notably, the price of personal computers (including laptops and tablets) increased by 2.3% between January 2017 and February 2017.’ Again, a large contributing factor has been the fall in the value of the pound. Apple, for example, raised its UK app store prices by a quarter in January, having raised prices for iPhones, iPads and Mac computers significantly last autumn. Microsoft has raised its prices by more than 20% this year for software services such as Office and Azure. Dell, HP and Tesla have also significantly raised their prices.

The third biggest was food and non-alcoholic beverages (contributing 0.06 percentage points). ‘Food prices, overall, rose by 0.8% between January 2017 and February 2017, compared with a smaller rise of 0.1% a year earlier.’ Part of the reason has been the fall in the pound, but part has been poor harvests in southern Europe putting up euro prices. This is the first time that overall food prices have risen for more than two-and-a-half years.

It is expected that inflation will continue to rise over the coming months as the effect of the weaker pound and higher raw material and food prices filter though. The current set of pressures could see inflation peaking at around 3%. If there is a futher fall in the pound or further international price increases, inflation could be pushed higher still – well above the Bank of England’s 2% target. (Click here for a PowerPoint of the chart.)

The higher inflation means that firms are facing a squeeze on their profits from two directions.

First, wage rises have been slowing and are now on a level with consumer price rises. It is likely that wage rises will soon drop below price rises, meaning that real wages will fall, putting downward pressure on spending and squeezing firms’ revenue.

Second, input prices are rising faster than consumer prices. In the 12 months to February 2017, input prices (materials and fuels) rose by 19.1%, putting a squeeze on producers. Producer prices (‘factory gate prices’), by contrast, rose by 3.7%. Even though input prices are only part of the costs of production, the much smaller rise of 3.7% reflects the fact that producer’s margins have been squeezed. Retailers too are facing upward pressure on costs from this 3.7% rise in the prices of products they buy from producers.

One of the worries about the squeeze on real wages and the squeeze on profits is that this could dampen investment and slow both actual and potential growth.

So will the Bank of England respond by raising interest rates? The answer is probably no – at least not for a few months. The reason is that the higher inflation is not the result of excess demand and the economy ‘overheating’. In other words, the higher inflation is not from demand-pull pressures. Instead, it is from higher costs, which are in themselves likely to dampen demand and contribute to a slowdown. Raising interest rates would cause the economy to slow further.

Videos
UK inflation shoots above two percent, adding to Bank of England conundrum Reuters, William Schomberg, David Milliken and Richard Hunter (21/3/17)
Bank target exceeded as inflation rate rises to 2.3% ITV News, Chris Choi (21/3/17)
Steep rise in inflation Channel 4 News, Siobhan Kennedy (21/3/17)
U.K. Inflation Gains More Than Forecast, Breaching BOE Goal Bloomberg, Dan Hanson and Fergal O’Brien (21/3/17)

Articles
Inflation leaps in February raising prospect of interest rate rise The Telegraph, Julia Bradshaw (21/3/17)
Brexit latest: Inflation jumps to 2.3 per cent in February Independent, Ben Chu (21/3/17)
UK inflation rate leaps to 2.3% BBC News (21/3/17)
UK inflation: does it matter for your income, debts and savings? Financial Times, Chris Giles (21/3/17)
Rising food and fuel prices hoist UK inflation rate to 2.3% The Guardian, Katie Allen (21/3/17)
Reality Check: What’s this new measure of inflation? BBC News (21/3/17)

Data
UK consumer price inflation: Feb 2017 ONS Statistical Bulletin (21/3/17)
UK producer price inflation: Feb 2017 ONS Statistical Bulletin (21/3/17)
Inflation and price indices ONS datasets
Consumer Price Inflation time series dataset ONS datasets
Producer Price Index time series dataset ONS datasets
European Brent Spot Price US Energy Information Administration
Statistical Interactive Database – interest & exchange rates data Bank of England

Questions

  1. If pries rise by 10% and then stay at the higher level, what will happen to inflation (a) over the next 12 months; (b) in 13 months’ time?
  2. Distinguish between demand-pull and cost-push inflation. Why are they associated with different effects on output?
  3. If producers face rising costs, what determines their ability to pass them on to retailers?
  4. Why is the rate of real-wage increase falling, and why may it beome negative over the coming months?
  5. What categories of people are likely to lose the most from inflation?
  6. What is the Bank of England’s remit in terms of setting interest rates?
  7. What is likely to affect the sterling exchange rate over the coming months?
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UK productivity: a constraint on long-term growth

‘Employment has been strong, but productivity and real wages have been flat.’ This is one of the key observations in a new OECD report on the state of the UK economy. If real incomes for the majority of people are to be raised, then labour productivity must rise.

For many years, the UK has had a lower productivity (in terms of output per hour worked) than most other developed countries, with the exception of Japan. But from 1980 to the mid 2000s, the gap was gradually narrowing. Since then, however, the gap has been widening again. This is illustrated in Chart 1, which shows countries’ productivity relative to the UK’s (with the UK set at 100). (Click here for a PowerPoint.)

Compared with the UK, GDP per hour worked in 2013 (the latest data available) was 28% higher in France, 29% higher in Germany and 30% higher in the USA. What is more, GDP per hour worked and GDP per capita in the UK fell by 3.8% and 6.1% respectively after the financial crisis of 2007/8 (see the green and grey lines in Chart 2). And while both indicators began rising after 2009, they were still both below their 2007 levels in 2013. Average real wages also fell after 2007 but, unlike the other two indicators, kept on falling and by 2013 were 4% below their 2007 levels, as the red line in Chart 2 shows. (Click here for a PowerPoint.)

Although productivity and even real wages are rising again, the rate of increase is slow. If productivity is to rise, there must be investment. This could be in physical capital, human capital or, preferably, both. But for many years the UK has had a lower rate of investment than other countries, as Chart 3 shows. (Click here for a PowerPoint.) This chart measures investment in fixed capital as a percentage of GDP.

So how can investment be encouraged? Faster growth will encourage greater investment through the accelerator effect, but such an effect could well be short-lived as firms seek to re-equip but may be cautious about committing to increasing capacity. What is crucial here is maintaining high degrees of business confidence over an extended period of time.

More fundamentally, there are structural problems that need tackling. One is the poor state of infrastructure. This is a problem not just in the UK, but in many developed countries, which cut back on public and private investment in transport, communications and energy infrastructure in an attempt to reduce government deficits after the financial crisis. Another is the low level of skills of many workers. Greater investment in training and apprenticeships would help here.

Then there is the question of access to finance. Although interest rates are very low, banks are cautious about granting long-term loans to business. Since the financial crisis banks have become much more risk averse and long-term loans, by their nature, are relatively risky. Government initiatives to provide finance to private companies may help here. For example the government has just announced a Help to Grow scheme which will provide support for 500 small firms each year through the new British Business Bank, which will provide investment loans and also grants on a match funding basis for new investment.

Articles
OECD: UK must fix productivity Economia, Oliver Griffin (25/2/15)
The UK’s productivity puzzle BBC News, Lina Yueh (24/2/15)
OECD warns UK must fix productivity problem to raise living standards The Guardian, Katie Allen (24/2/15)
Britain must boost productivity to complete post-crisis recovery, says OECD International Business Times, Ian Silvera (24/2/15)
OECD urges UK to loosen immigration controls on skilled workers Financial Times, Emily Cadman and Helen Warrell (24/2/15)

Report
OECD Economic Surveys, United Kingdom: Overview OECD (February 2015)
OECD Economic Surveys, United Kingdom: Full report OECD (February 2015)

Questions

  1. In what ways can productivity be measured? What are the relative merits of using the different measures?
  2. Why has the UK’s productivity lagged behind other industrialised countries?
  3. What is the relationship between income inequality and labour productivity?
  4. Why has UK investment been lower than in other industrialised countries?
  5. What are zombie firms? How does the problem of zombie firms in the UK compare with that in other countries? Explain the differences.
  6. What policies can be pursued to increased labour productivity?
  7. What difficulties are there in introducing effective policies to tackle low productivity?
  8. Should immigration controls be lifted to tackle the problem of a shortage of skilled workers?
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Making economic sense of politicians’ statements

Politicians often make use of economic statistics to promote their point of view. A good example is a claim made by the UK Prime Minister on 23 January 2014. According to the latest statistics, he said, most British workers have seen their take-home pay rise in real terms. The Labour party countered this by arguing that incomes are not keeping up with prices.

So who is right? Studying economics and being familiar with analysing economic data should help you answer this question. Not surprisingly, the answer depends on just how you define the issue and what datasets you use.

The Prime Minister was referring to National Statistics’ Annual Survey of Hours and Earnings (ASHE). This shows that in April 2013 median gross weekly earnings for full-time employees were £517.5, up 2.25% from £506.10 in 2012, and mean gross weekly earnings for full-time employees were £620.30, up 2.06% from £607.80 in 2012 (see Table 1.1a in the dataset). CPI inflation over this period was 2.4%, representing a real fall in median gross weekly earnings of 0.15% and mean gross weekly earnings of 0.34%.

But when adjustments are made for increases in personal income tax allowances, then, according to the government, except for the richest 10% of the working population, people had an average increase in real take-home pay of 1.1%.

But does this paint the complete picture? Critics of the government’s claim that people are ‘better off’, make the following points.

First, the ASHE dataset is for the year ending April 2013. The ONS publishes other datasets that show that real wages have fallen faster since then. The Earnings and Working Hours datasets, published monthly, currently go up to November 2013. The chart shows real wages from January 2005 to November 2013 (with CPI = 100 in December 2013). You can see that the downward trend resumed after mid 2013. In the year to November 2013, nominal average weekly earnings rose by 0.9%, while CPI inflation was 2.1%. Thus real weekly earnings fell by 1.2% over the period (click here for a PowerPoint of the chart).

Second, there is the question of whether CPI or RPI inflation should be used in calculating real wages. RPI inflation was 2.9% (compared to CPI inflation of 2.4%) in the year to April 2013. The chart shows weekly earnings adjusted for both CPI and RPI.

Third, if, instead of looking at gross real wages, the effect of income tax and national insurance changes are taken into account, then benefit changes ought also to be taken into account. Some benefits, such as tax credits and child benefit were cut in the year to April 2013.

Fourth, looking at just one year (and not even the latest 12 months) gives a very partial picture. It is better to look at a longer period and see what the trends are. The chart shows the period from 2005. Real wages (CPI adjusted) are 8.0% lower than at the peak (at the beginning of 2009) and 5.0% lower than at the time of the election in 2010. The differences are even greater if RPI-adjusted wages are used.

But even if the claim that real incomes are rising is open to a number of objections, it may be that as the recovery begins to gather pace, real incomes will indeed begin to rise. But to assess whether this is so will require a careful analysis of the statistics when they become available.

Articles
UK pay rising in real terms, says coalition BBC News (24/1/14)
Are we really any better off than we were? BBC News, Brian Milligan (24/1/14)
Government take-home pay figures ‘perfectly sensible’ BBC Today Programme, Paul Johnson (24/1/14)
Take-Home Pay ‘Rising Faster Than Prices’ Sky News, Darren McCaffrey (25/1/14)
David Cameron hails the start of ‘recovery for all’ The Telegraph, Peter Dominiczak (23/1/14)
Is take-home pay improving? The answer is anything but simple The Guardian, Phillip Inman and Katie Allen (24/1/14)
Cameron’s ‘good news’ about rising incomes is misleading says Labour The Guardian, Rowena Mason (24/1/14)
The Tories’ claim that living standards have risen is nonsense on stilts New Statesman, George Eaton (24/1/14)
FactCheck: Conservative claims on rising living standards Channel 4 News, Patrick Worrall (25/1/14)
Living standards squeeze continues in UK, says IFS BBC News (31/1/14)
Richest have seen biggest cash income squeeze but poorest have faced higher inflation IFS Press Release (31/1/14)

Data
Average Weekly Earnings dataset ONS (22/1/14)
Annual Survey of Hours and Earnings, 2013 Provisional Results ONS (12/12/13)
Consumer Price Inflation, December 2013 ONS (14/1/14)
Inequality and Poverty Spreadsheet Institute for Fiscal Studies
An Examination of Falling Real Wages, 2010 to 2013 ONS (31/1/14)

Questions

  1. Why are mean weekly earnings higher than median weekly earnings?
  2. Explain the difference between RPI and CPI. Which is the more appropriate index for determining changes in real incomes?
  3. Find out what benefit changes have taken place over the past two years and how they have affected household incomes.
  4. How have gross weekly earnings changed for the different income groups? (The ASHE gives figures for decile groups.)
  5. Which is better for assessing changes in incomes: weekly earnings or hourly earnings?
  6. How would you define a change in living standards? What data would you need to be able to assess whether living standards have increased or decreased?
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Good news and bad news on the labour market front

First the good news. Employment is rising and unemployment is falling. Both claimant count rates and Labour Force Survey rates are down. Compared with a year ago, employment is up 279,092 to 29,869,489; LFS unemployment is down from 7.87% to 7.69%; and the claimant count rate is down from 4.7% to 4.0%.

Now the bad news. Even though more people are in employment, real wages have fallen. In other words, nominal wages have risen less fast than prices. Since 2009, real wages have fallen by 7.6% and have continued to fall throughout this period. The first chart illustrates this. It shows average weekly wage rates in 2005 prices. (Click here for a PowerPoint of the chart.)

The fall in real wages is an average for the whole country. Many people, especially those on low incomes, have seen their real wages fall much faster than the average. For many there is a real ‘cost of living’ crisis.

But why have real wages fallen despite the rise in employment? The answer is that output per hour worked has declined. This is illustrated in the second chart, which compares UK output per worker with that of other G7 countries. UK productivity has fallen both absolutely and relative to other G7 countries, most of which have had higher rates of investment.

The falling productivity in the UK requires more people to be employed to produce the same level of output. Part of what seems to be happening is that many employers have been prepared to keep workers on in return for lower real wages, even if demand from their customers is falling. And many workers have been prepared to accept real wage cuts in return for keeping their jobs.

Another part of the explanation is that the jobs that have been created have been largely in low-skilled, low-wage sectors of the economy, such as retailing and other parts of the service sector.

But falling productivity is only part of the reason for falling real wages. The other part is rising prices. A number of factors have contributed to this. These include a depreciation of the exchange rate back in 2008, the effects of which took some time to filter through into higher prices in the shops; a large rise in various commodity prices; and a rise in VAT and various other administered prices.

So what is the answer to falling real wages? The articles below consider the problem and some of the possible policy alternatives.

Articles
Inflation, unemployment and UK ‘misery’ BBC News, Linda Yueh (16/10/13)
Employment is growing, but so are the wage slaves The Guardian, Larry Elliott (16/10/13)
Living standards – going down and, er, up BBC News, Nick Robinson (26/7/13)
Revealed: The cost of living is rising faster in the UK than anywhere in Europe, with soaring food and energy bills blamed Mail Online, Matt Chorley (16/10/13)
Cutting prices to raise living standards is just a waste of energy The Telegraph, Roger Bootle (6/10/13)
Downturn sees average real wages collapse to a record low Independent, Ben Chu (17/10/13)
Why living standards and public finances matter Financial Times, Gavin Kelly (29/9/13)
Social Mobility Tsar Alan Milburn Calls on Government to Boost Wages to End UK Child Poverty International Business Times, Ian Silvera (17/10/13)
Do incorrect employment growth figures explain low UK productivity? The Guardian, Katie Allen (23/10/13)

Data
Unemployment data ONS
Average Weekly Earnings dataset ONS
Consumer Prices Index ONS
International Comparison of Productivity ONS

Questions

  1. How are real wages measured?
  2. Why have real wage rates fallen in the UK since 2009?
  3. What factors should be included when measuring living standards?
  4. Why has employment risen and unemployment fallen over the past two years?
  5. What factors could lead to a rise in real wages in the future?
  6. What government policies could be adopted to raise real wages?
  7. Assess these policies in terms of their likely short-term success and long-term sustainability.
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The political dynamite of calm economic reflection

In a carefully argued article in the New Statesman, the UK Business Secretary, Vince Cable, considers the slow recovery in the economy and whether additional measures should be adopted. He sums up the current state of the economy as follows:

The British economy is still operating at levels around or below those before the 2008 financial crisis and roughly 15 per cent below an albeit unsustainable pre-crisis trend. There was next to no growth during 2012 and the prospect for 2013 is of very modest recovery.

Unsurprisingly there is vigorous debate as to what has gone wrong. And also what has gone right; unemployment has fallen as a result of a million (net) new jobs in the private sector and there is vigorous growth of new enterprises. Optimistic official growth forecasts and prophets of mass unemployment have both been confounded.

He argues that supply-side policies involving “a major and sustained commitment to skills, innovation and infrastructure investment” are essential if more rapid long-term growth is to be achieved. This is relatively uncontroversial.

But he also considers the claim that austerity has kept the economy from recovering and whether policies to tackle the negative output gap should be adopted, even if this means a short-term increase in government borrowing.

But crude Keynesian policies of expanding aggregate demand are both difficult to implement and may not take into account the particular circumstance of the current extended recession – or depression – in the UK and in many eurozone countries. World aggregate demand, however, is not deficient. In fact it is expanding quite rapidly, and with the sterling exchange rate index some 20% lower than before the financial crisis, this should give plenty of opportunity for UK exporters.

Yet expanding UK aggregate demand is proving difficult to achieve. Consumers, worried about falling real wages and large debts accumulated in the years of expansion, are reluctant to increase consumption and take on more debts, despite low interest rates. In the light of dampened consumer demand, firms are reluctant to invest. This makes monetary policy particularly ineffective, especially when banks have become more risk averse and wish to hold higher reserves, and indeed are under pressure to do so.

So what can be done? He argues that there is “some scope for more demand to boost output, particularly if the stimulus is targeted on supply bottlenecks such as infrastructure and skills.” In other words, he advocates policies that will simultaneously increase both aggregate demand and aggregate supply. Monetary policy, involving negative real interest rates and quantitative easing, has helped to prevent a larger fall in real aggregate demand and a deeper dive into recession, but the dampened demand for money and the desire by banks to build their reserves has meant a massive fall in the money multiplier. Perhaps monetary policy needs to be more aggressive still (see the blog post, Doves from above), but this may not be sufficient.

Which brings Dr Cable to the political dynamite! He advocates an increase in public investment on infrastructure (schools and colleges, hospitals, road and rail projects and housing, and considers whether this should be financed, not by switching government expenditure away from current spending, but by borrowing more.

Such a strategy does not undermine the central objective of reducing the structural deficit, and may assist it by reviving growth. It may complicate the secondary objective of reducing government debt relative to GDP because it entails more state borrowing; but in a weak economy, more public investment increases the numerator and the denominator.

He raises the question of whether the balance of risks has changed: away from the risk of increased short-term borrowing causing a collapse of confidence to the risk of lack of growth causing a deterioration in public finances and this causing a fall in confidence. As we saw in the blog post Moody Blues, the lack of growth has already caused one ratings agency (Moody’s) to downgrade the UK’s credit rating. The other two major agencies, Standard & Poor’s and Fitch may well follow suit.

The day after Dr Cable’s article was published, David Cameron gave a speech saying that the government would stick to its plan of deficit reduction. Not surprisingly commentators interpreted this as a split in the Coalition. Carefully argued economics from Dr Cable it might have been, but political analysts have seen it as a hand grenade, as you will see from some of the articles below.

When the facts change, should I change my mind? New Statesman, Vince Cable (6/3/13)
Keynes would be on our side New Statesman, Vince Cable (12/1/11)
Exclusive: Vince Cable calls on Osborne to change direction New Statesman, George Eaton (67/3/13)
Vince Cable: Borrowing may not be as bad as slow growth BBC News (7/3/13)
Vince Cable makes direct challenge to Cameron over economic programme The Guardian, Nicholas Watt (7/3/13)
Vince Cable Says George Osborne Must Change Course And Borrow More To Revive Growth Huffington Post, Ned Simons (6/3/13)
David Cameron and Vince Cable at war over route to recovery Independent, Andrew Grice (6/3/13)
Vince Cable: Borrowing may not be as bad as slow growth BBC News, James Landale (6/3/13)
David Cameron: We will hold firm on economy BBC News (7/3/13)
David Cameron: We will hold firm on economy BBC News (7/3/13)
Clegg Backs Cable Over Controversial Economy Comments LBC Radio, Nick Clegg (7/3/13)
It’s plain what George Osborne needs to do – so just get on and do it The Telegraph, Jeremy Warner (6/3/13)
Vince Cable’s plan B: a “matter of judgement” BBC News, Stephanie Flanders (7/3/13)
George Osborne needs to turn on the spending taps The Guardian, Phillip Inman (12/3/13)

Questions

  1. Why has monetary policy proved ineffective in achieving a rapid recovery from recession?
  2. Distinguish between discretionary fiscal policy and automatic fiscal stabilisers.
  3. Why has the existence of automatic fiscal stabilisers meant that the public-sector deficit has been difficult to bring down?
  4. In what ways has the balance of risks in using discretionary fiscal policy changed over the past three years?
  5. In what ways is the depression of the late 2000s/early 2010s (a) similar to and (b) different from the Great Depression of the early 1930s?
  6. In what ways is the structure of public-sector debt in the UK different from that in many countries in the eurozone? Why does this give the government more scope for expansionary fiscal policy?
  7. Why does the Office of Budget Responsibility’s estimates of the tax and government expenditure multipliers suggest that “if fiscal policy is to work in a Keynesian manner, it needs to be targeted carefully, concentrating on capital projects”?
  8. Why did Keynes argue that monetary policy is ineffective at the zero bound (to use Dr Cable’s terminology)? Are we currently at the zero bound? If so what can be done?
  9. Has fiscal tightening more than offset loose monetary policy?
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The puzzling case of falling unemployment

UK Unemployment figures for the July to September period have just been published. Perhaps surprisingly, the rate has fallen to 7.8% from 8.0% in the previous 3-month period. What is more, there have been similar 0.2 percentage-point falls in each of the two 3-month periods prior to that (see chart below).

This would normally suggest that the economy has been growing strongly and faster than the growth in potential output. But, despite positive economic growth in quarter 3 (see A positive turn of events?), the economy has been experiencing a prolonged period of low or negative growth.

So what is the explanation for the fall in unemployment? (For a PowerPoint of the chart, click here)

One reason is a greater flexibility in the labour market than in previous recessions. People are more willing to accept below inflation wage increases, or even nominal wage cuts, in return for greater job security. Others are prepared to reduce their hours.

The other reason is a fall in productivity (i.e. output per hour worked). One explanation is that people are not working so hard because, with a lack of demand, there is less pressure on them to be productive; a similar explanation is that firms are ‘hoarding’ labour in the hope that the market will pick up again.

Another explanation is that employment growth has often occurred in the low productivity industries, such as labour-intensive service industries; another is that when people leave their jobs they are replace by less productive workers on lower wages; another is that workers are making do with ageing equipment, whose productivity is falling, because firms cannot afford to invest in new equipment. An range of possible explanations is given on page 33 of the Bank of England’s November 2012 Inflation Report.

But with many predicting that growth will be negative again in 2012 quarter 4, the fall in unemployment may not continue. Britain may join many other countries in Europe and experience rising unemployment as well as falling output.

Articles
Government hails fall in jobless total The Guardian, Hélène Mulholland (14/11/12)
UK unemployment figures: analysis The Guardian, Larry Elliott (14/11/12)
Jobless claims rise as Olympics effect wanes The Telegraph, Rachel Cooper and Louisa Peacock (14/11/12)
UK unemployment falls to 2.51 million, ONS says BBC News (14/11/12)
Unemployment continuing to fall BBC News, Stephanie Flanders (14/11/12)
Britain’s recession: Harsh but fair? BBC News, Stephanie Flanders (17/10/12)
The UK productivity puzzle (cont’d) BBC News, Stephanie Flanders (20/9/12)
UK jobs: The plot thickens BBC News, Stephanie Flanders (15/8/12)

Data
Unemployment: the key UK data and benefit claimants for every constituency Guardian Data Blog
Labour Market Statistics, November 2012 ONS
Video Summary: Latest on the Labour Market, November 2012 ONS
Labour Productivity, Q2 2012 ONS
International Comparisons of Productivity, First estimates for 2011 ONS

Questions

  1. What possible explanation are there for the latest fall in unemployment?
  2. What has been happening to employment, both full time and part time?
  3. What are the different ways of measuring productivity? Why will they be affected differently by a fall in the average number of hours worked?
  4. Why might it be in firms’ interests to maintain the level of their workforce despite falling sales?
  5. Assume that there has been a fall in aggregate demand. Compare the resulting effect on consumption of (a) a fall in wages rates; (b) a rise in unemployment. How might the design of the benefit system affect the answer?
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Flexible labour markets and flexible firms

Over recent years, labour markets have become more flexible. Both firms and workers have been much more adaptable to changing market conditions.

This has been illustrated by responses to the 2008/9 recession and the minimal recovery since then. Many firms have seen a drop in demand for their products and have responded by producing less. But this has not necessarily meant laying off workers. But why not? The following include some of the reasons:

• greater flexibility in hours worked: thus hours can be reduced;
• reduction in real wages because of wages not keeping up with inflation;
• many workers receiving part of their income in the form of profit sharing: when profits fall, employees’ income automatically falls;
• a general reduction in unionisation in the private sector;
• in firms where workers are still unionised, unions and management increasingly seeing themselves to be on the ‘same side’: thus unions more willing to explore flexibility;
• less support from state if people are unemployed;
• greater flexibility from the use of temporary or agency staff: these can be reduced in a recession, thus helping to protect the jobs of established workers.

The following podcast looks at this growing flexibility and why it has helped to restrict the rise in unemployment.

Podcast
The real economy: Labour market BBC Today Programme, Evan Davis (24/8/11)

Articles
Agencies placing more in new jobs Western Mail (4/8/11)
Staff appointments increase at subdued pace in July, according to latest Report on Jobs The Recruitment & Employment Federation, News Release (4/8/11)
Manufacturing week: How we got here The Telegraph, Roland Gribben (27/8/11)
Jobless figures show the real risk of creating a lost generation London Evening Standard, Jonathan Portes, Director, National Institute of Economic and Social Research (17/8/11)
Flexible working: is more legislation needed? Personnel Today, Laura Chamberlain (1/9/11)
Recruitment agencies ‘play a big part’ in flexible working The Sales Director, John Oak (10/8/11)

Questions

  1. Find out what has happened to real GDP, employment and unemployment over the past four years. (Try searching Reference Tables for GDP and Labour Market Statistics on the National Statistics site at http://www.ons.gov.uk/ons/datasets-and-tables/index.html.)
  2. Distinguish between ‘insiders’ and ‘outsiders’ in the labour market? How has the relationship between the two groups changed in recent years?
  3. Distinguish between functional, numerical and financial flexibility of firms? (See Box 9.8 in Economics (7th ed), Web Case 6.2 in Essentials of Economics (5th ed), section 18.7 in Economics for Business (5th ed) or section 8.5 in Economics and the Business Environment (3rd ed).)
  4. Examine the effects of wage rises being less than the rate of inflation on the profit-maximising number of full-time equivalent people employed. How is this influenced by the rate of increase in the price of other inputs and the ability of the firm to raise prices in line with inflation?
  5. Should firms be required by law to allow workers to demand flexible working conditions? What forms might such flexibility take?
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