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Ian Brinkley
Economic Advisor
Ian Brinkley

Is pay coming out of the deep freeze?

Authors: Ian Brinkley

04 March 2015

The labour market statistics published earlier this month were heavily scrutinised for any signs that  growth in pay was strengthening before the General Election. Regular pay measured by the monthly ONS estimate of average weekly earnings suggests that while bankers seem to be doing better than shop and hotel workers, there isn’t much sign yet of a general pay revival. And as a new IFS report  shows, household incomes have only just recovered to their pre-recession levels – a far weaker recovery than in the 1980s and 1990s.

The CIPD has also  recently published a report  on pay which provides some insights on what has been happening.  In 2014 about 40 per cent of private sector employees reported that they had a pay freeze or a pay cut (though the latter is mercifully rare).  This is almost exactly the same figure as in 2012 and 2013. The share of private sector employees reporting a pay freeze or cut has fallen from the recession peak of nearly 60 per cent in 2009, but it is still much higher than the 30 per cent reported at the start of the recession in 2008. We seem a long way from the era when annual pay awards were the norm for the vast majority of employees.

It is clear that a very large share of the private sector workforce has had no pay rise in each year since the recovery began in 2010. We do not know how persistent this experience has been for individuals, as it is not the same 40 per cent who miss out in any one year.  Freezing pay for the same groups for lengthy periods would normally be asking for trouble in a competitive labour market, though if pay is increasing very slowly elsewhere it may not be quite the trigger for disgruntled employees to leave as it has been in the past.

The public sector has been on a roller-coaster. In 2008 about 20 per cent of public sector employees said they had a pay freeze or a pay cut, but this rocketed to between 75 and 80 per cent in 2011-2012 as the Coalition introduced a public sector pay policy, before falling back to around 50 per cent in 2013-2014.  This might suggest greater flexibility in implementation in some parts of the public sector so that more people get at least something, albeit public service pay overall is increasing even more slowly than in the private sector.

The CIPD report also asks employees whether they think they will get a bigger pay rise, the same pay rise or a pay freeze in 2015. Employees seem a bit more optimistic, with the share expecting a pay freeze or cut dropping to 25 per cent in the private sector and to just under 40 per cent in the public sector. Those expecting a bigger pay rise than last year however remain a minority – just 24 per cent in the private sector and only 14 per cent in the public sector.  The vast majority of employees either expect more of the same or a pay freeze.

Some employer organisations certainly think average earnings growth will be a bit faster in 2015 – the CBI is forecasting 2.4 per cent growth, the British Chambers of Commerce a more cautious 2 per cent.  The average forecast from City institutions is 2.5 per cent. However, in recent years such forecasts have proved optimistic – at this time last year organisations were predicting average earnings growth of 2.2 per cent in 2014, while the expected outturn is 1.2 per cent .

So what might make the forecasts more accurate this year? We can discount calls from the Prime Minister and others for firms to pay more - they will have no impact whatsoever on pay settlements. More influential will be further falls in the unemployment rate making labour scarcer, increasing incidences of skill shortages, and faster productivity growth on the back of a recovery in business investment. So far neither lower unemployment or the threat of skill shortages have induced most employers to be more generous, and we may need to see much more movement in both these indicators before it feeds through to pay. This leaves us with a productivity led pay recovery – and that has proved elusive and hard to predict.

My guess is average earnings growth will be stronger in 2015 than in 2014, but we are looking at slow improvement rather than a dramatic jump. This is consistent with the modest employee expectations shown in the CIPD survey, and the more cautious macro-economic forecasts. It is proving a slow road back to the sort of earnings growth we would normally associate with an unemployment rate of 5.7 per cent and an economy in its fifth year of recovery.