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Ian Brinkley
Economic Advisor
Ian Brinkley

Why are wages so low?

Authors: Ian Brinkley Ian Brinkley

18 April 2013

One of the many unusual features of the UK labour market has been the fall in real wages. As yesterday’s figures show, regular average earnings (excluding bonuses) increased by just 1% comparing the  average of the three months to February with the same three months a year ago. The latest inflation figures show prices measured by the Consumer Price Index (CPI) running at just under 3% on an annual basis.

This trend started before the recession, intensified during the downturn and has persisted ever since.  The traditional linkage between wages and prices which used to underpin our understanding of how the labour market works has broken down. The question is why and will it persist? There are several reasons for thinking that it will.

Firstly, we know that private sector managers were able and willing to use wage flexibility to preserve as many jobs as possible in the downturn. According to the 2011 Workplace Employment Relations Survey (WERS), 39% of private sector managers said they had cut or frozen wages in response to the recession.  Managers seem to be persisting with wage restraint during the recovery.

Secondly, the number of people actively looking for work has increased significantly and at a faster rate than the number of new jobs created – hence the unemployment figures have remained stubbornly high despite large numbers of jobs being created. In previous periods when unemployment was high, people tended to drift out of the labour market – in some cases encouraged to do so through early retirement and movement to longer term benefits. This time round we are seeing the opposite. Employers appear to be able to hire most of the labour they need without significantly increasing average wage levels.

This may reflect successive governments’ welfare reform policies and the end of early retirement as a significant means of workforce reduction. Economists have found that the sensitivity of wages to unemployment has increased over the past decade, suggesting that it would take big cuts in the unemployment total to have much impact on wages[1].

Thirdly, we have a public pay policy and severe constraints on budgets, with the share of public sector managers from the WERS saying they had imposed a pay cut or freeze much higher than in the private sector (63%).  This restraint has been extended and is likely to intensify as austerity continues. Pay policy looks set to become a semi-permanent feature of the public sector labour market.

Fourthly, some the factors that might have pushed wages up in response to prices in the past are now absent. The most obvious is the influence of trade unions through collective bargaining. Research has shown that unions in the private sector have little impact on aggregate wage levels, a trend unlikely to be reversed anytime soon. In addition, some unions in some sectors have put their members’ jobs ahead of higher pay as a pragmatic judgement reflecting current economic realties. The latter is a more accurate description of actual union behaviour than the recent public rhetoric about general strikes.

Lastly, pay growth has been exceptionally weak in the financial and business service sector, which includes around 20% of all employees. The latest figures show that regular pay in the three months to February (excluding bonuses) fell by 0.3%. This compares with an increase of over 5% in regular pay in these sectors just two years ago. My guess is that this may be more of a temporary factor than the others listed above.

Overall, there appears to be little chance of a significant recovery in average earnings without a big fall in unemployment – and unemployment is going up, not down. Otherwise, we will have to wait for the long promised decline in inflation before we see real wages start to rise again – and therefore the chance of a stronger and more sustained recovery.

[1] Gregg and Machin (2012) What a drag: the chilling impact of unemployment on real wages, Resolution Foundation.

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