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
- Why have real wages fallen more in the UK than in all OECD countries except Greece?
- Which groups have seen the biggest fall in real wages? Explain why.
- What policies are proposed by the different parties for raising real wages (a) generally; (b) for the poorest workers?
- How has UK productivity growth compared with that in other developed countries? What explanations can you offer?
- What is the relationship between productivity growth and the growth in real wages?
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
- 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.
- Explain the changes in these exchange rates.
- 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?
- 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?
- Why is uncertainty over future UK growth rates relatively high at present?
- Why is inflation likely to peak later this year and then fall?
- What determines the size and shape of the fan in a fan chart?
One of President Trump’s main policy slogans has been ‘America first’. As Trump sees it, a manifestation of a country’s economic strength is its current account balance. He would love the USA to have a current account surplus. As it is, it has the largest current account deficit in the world (in absolute terms) of $481 billion in 2016 or 2.6% of GDP. This compares with the UK’s $115bn or 4.4% of GDP. Germany, by contrast, had a surplus in 2016 of $294bn or 8.5% of GDP.
However, he looks at other countries’ current account surpluses suspiciously – they may be a sign, he suspects, of ‘unfair play’. Germany’s surplus of over $50bn with the USA is particularly in his sights. Back in January, as President-elect, he threatened to put a 35% tariff on imports of German cars.
In practice, Germany is governed by eurozone rules, which prevent it from subsidising exports. And it does not have its own currency to manipulate. What is more, it is relatively open to imports from the USA. The EU imposes an average tariff of just 3% on US imports and importers also have to add VAT (19% in the case of Germany) to make them comparably priced with goods produced within the EU.
So why does Germany have such a large current account surplus? The article below explores the question and dismisses the claim that it’s the result of currency manipulation or discrimination against imports. The article states that the reason for the German surplus is that:
… it saves more than it invests. The correspondence of savings minus investment with exports minus imports is not an economic theory; it’s an accounting identity. Germans collectively spend less than they produce, and the difference necessarily shows up as net exports.
But why do the Germans save so much? The answer given is that, with an aging population, Germans are sensibly saving now to support themselves in old age. If Germany were to reduce its current account surplus, this would entail either the government reducing its budget surplus, or people reducing the amount they save, or some combination of the two. This is because a current account surplus, which consists of exports and other incomes from abroad (X) minus imports and any other income flowing abroad (M), must equal the surplus of saving (S) plus taxation (T) over investment (I) plus government expenditure (G). In terms of withdrawals and injections, given that:
I + G + X = S + T + M
then, rearranging the terms,
X – M = (S + T) – (I + G).
If German people are reluctant to reduce the amount they save, then an alternative is for the German government to reduce taxation or increase government expenditure. In the run-up to the forthcoming election on 24 September, Chancellor Merkel’s centre-right CDU party advocates cutting taxes, while the main opposition party, the SPD, advocates increasing government expenditure, especially on infrastructure. The article considers the arguments for these two approaches.
Article
The German economy is unbalanced – but Trump has the wrong answer The Guardian, Barry Eichengreen (12/5/17)
Data
German economic data (in English) Statistisches Bundesamt (Federal Statistical Office)
World Economic Outlook Databases IMF
Questions
- Why does Germany have such a large current account surplus?
- What are the costs and benefits to Germany of having a large current account surplus?
- What is meant by ‘mercantilism’? Why is its justification fallacious?
- If Germany had its own currency, would it be a good idea for it to let that currency appreciate?
- What are meant by ‘resource crowding out’ and ‘financial crowding out’? Why might the policies of tax cuts advocated by the CDU result in crowding out? What form would it take and why?
- Compare the relative benefits of the policies advocated by the CDU and SPD to reduce Germany’s budget surplus.
- Would other countries, such as the USA, benefit from a reduction in Germany’s current account surplus?
- Is what ways would the USA gain and lose from restricting imports from Germany? Would it be a net gain or loss? Explain.
According to the Halifax house price index, house prices fell in the UK in the three months to April. This is the first quarterly fall since 2012. The Nationwide index (see below), shows that prices in April were 0.4% lower than in March (although the 3-month rate was still slightly positive).
The fall in house prices reflects a cooling in demand. This, in turn, reflects a squeeze on household incomes as price rises begin to overtake wage rises. It also reflects buyers becoming more cautious given the uncertainty over the nature of the Brexit deal and its effects on the economy and people’s incomes.
The fall in demand is also driven by recent Bank of England rules which require mortgage lenders to limit the proportion of mortgages with a mortgage/income ratio of 4.5 or above to no more than 15% of their new mortgages. It is also affected by a rise in stamp duty, especially on buy-to-let properties.
Despite the fall in prices, this may understate the fall in demand relative to supply. House price movements often lag behind changes in demand and supply as people are reluctant to adjust to equilibrium prices. In the case of a falling market, sellers may be unwilling to sell at the lower equilibrium price, believing that a lower price ‘undervalues’ their property. Indeed, they may not even put their houses on the market. This makes prices ‘sticky’ downwards. The result is a fall in sales.
Eventually, such people will reluctantly be prepared to accept a lower price and prices will thus fall more. Once people come to expect price falls, supply may increase further as vendors seek to sell before the price falls even more. So we could well see further falls over the coming months.
Lower house prices and falling sales is a picture repeated in many parts of the UK. It is particularly marked in central London. There, estate agents have begun to offer free gifts to purchasers. As The Guardian puts it:
London estate agents have begun to offer free cars worth £18,000, stamp duty subsidies of £150,000, plus free iPads and Sonos sound systems to kickstart sales in the capital’s increasingly moribund property market. The once super-hot central London market has turned into a ‘burnt-out core’ according to buying agents Garrington Property Finders, prompting developers to offer ever greater incentives to lure buyers.
… Land Registry figures show that in the heart of the city’s financial district, average property prices plummeted from £861,000 at the time of the EU referendum to £773,000 in February, a decline of 15%, although in London’s outer boroughs prices are still up over the year.
But lower property prices are good news for first-time buyers, although some of the biggest falls have been in the top end of the market.
The fall in property prices may continue for a few months. But population is rising, and with it the number of people who would like to buy their own home. Once real incomes begin to rise again, therefore, demand is likely to resume rising faster than supply. When it does, house prices will continue their upward trend.
Articles
UK house prices in first quarterly fall since 2012 BBC News (8/5/17)
UK house prices fall again in April as buyers feel the pinch The Guardian, Angela Monaghan (28/4/17)
Buy a home, get a car free: offers galore as London estate agents struggle to sell The Guardian, Patrick Collinson (3/5/17)
London is now one of the five cities with the lowest house price growth in the UK City A.M., Helen Cahill (28/4/17)
London Housing Market Property Bubble Vulnerable To Crash The Market Oracle, Jan Skoyles (3/5/17)
A key indicator of a healthy housing market is flashing red in London Business Insider, Thomas Colson (29/5/17)
House Price Data
UK House Prices – links to various sites Economic Data freely available online – Economics Network
Questions
- Why are UK house prices falling?
- What determines the rate at which they are falling? How is the price elasticity of demand and/or supply relevant here?
- How does speculation help to explain changes in house prices? How may speculation help to (a) stabilise and (b) destabilise house prices?
- Draw a demand and supply diagram to show how house transactions will be lower if the market is not in equailibrium.
- Why are house prices falling faster in central London than elsewhere in the UK?
- Why are rents falling in central London? How does this relate to the fall in central London property prices?
- How has the Help to Buy scheme affected house prices? Has it affected both demand and supply and, if so, why and how?
- How do changes in residential property transaction volumes relate to changes in property prices?
- What market imperfections exist in the housing market?
The French have elected Emmanuel Macron as their new President. He claims to be from the economic centre. But just what does this imply for his vision of how the French economy should be run? What policies is he likely to put in place? Can these policies rightly be described as ‘centrist’? In practice, some of his policies are advocated by the centre right and some by the centre left.
He wants to institute policies that are pro business and will have the effect of stimulating private investment, increasing productivity and resulting in faster economic growth.
His pro-business policies include: reducing corporation tax from its current 33.3% to 25%, the hope being that firms will invest the money that this will free up; reducing labour taxes on companies for employing low-wage workers; making the current 35-hour working week less rigid by giving firms greater ability to negotiate special arrangements with trade unions.
Other policies drawn from the centre right include reducing the size of the state. Currently, general government spending in France, at 56.5% of GDP, is the highest of the G7 countries. Italy’s is the next highest at 49.6%, followed by Germany at 44.3%, Canada at 40.8%, the UK at 39.4%, Japan at 36.8% and the USA at 35.2%. President Macron wants to reduce the figure for France to 52% over his five-year term. 
This will be achieved by cutting 120,000 public-sector jobs and reducing state spending by €60bn. He plans, thereby, to reduce the general government deficit from its 2016 level of 3.4% of GDP to 1% by 2022 and reduce the general government debt from 96.0% of GDP to 93.2% over the same period.
Drawing from centre-left policies he plans to increase public investment by €50bn, including €15bn on training, €15bn on green energy and €5bn each on transport, health, agriculture and the modernisation of public administration. But as this additional expenditure is less than the planned savings through greater efficiency and as GDP is projected to grow, this is still consistent with achieving a reduction in the general government deficit as a percentage of GDP. He has also pledged to extend welfare spending. This will include making the self-employed eligibile for unemployment benefits.
M Macron isalso strongly supportive of France’s membership of the EU and the euro. Nevertheless he wants the EU to be reformed to make it more efficient and achieve significant cost savings.
Articles
Macronomy: What are Emmanuel Macron’s economic plans? BBC News, Simon Atkinson (8/5/17)
Factbox: Emmanuel Macron’s presidential election policies Reuters, Brian Love (14/4/17)
What Analysts Are Saying About Macron’s Victory Bloomberg, Chris Anstey (8/5/14)
The Main Points of Emmanuel Macron’s Economic Programme NDTV, India (9/5/14)
Can Emmanuel Macron solve France’s economic riddle? The Guardian, Larry Elliott (30/4/17)
Why Emmanuel Macron’s bid to haul France out of its economic malaise will be harder than he thinks The Telegraph, Szu Ping Chan and Tim Wallace (30/4/17)
Macron’s policies on Europe, trade, immigration and defence Financial Times, Hannah Murphy (7/5/17)
French presidential election: Investors, economists and strategists react to Macron’s victory Independent, Josie Cox (8/5/17)
Questions
- Compare the performance of the French, German and UK economies over the past 10 years.
- Why does France have much lower levels of inequality and much higher productivity than the UK?
- How would (a) a neoliberal and (b) Keynesian economist explain the slow growth performance of France?
- Give some other examples of centre-right economic policies that could be pursued by a centrist government.
- Give some other examples of centre-left economic policies that could be pursued by a centrist government.
- How do M Macron’s policies differ from those of the (a) Conservative, (b) Labour and (c) Liberal Democrat parties in the manifestos for the 2017 General Election in the UK?
- What economic difficulties is M Macron likely to find in carrying out his policies?
- Would you describe M Macron’s macroeconomic policies as demand-side or supply -side policies? Explain.
- What specific economic policies does France want Germany to pursue?
