Two decades of lost earnings growth?

iangunn Jan 29th, 2018

In its response to the Autumn Budget last November, the Resolution Foundation, a ‘think tank’, painted a bleak picture of the outlook for the UK economy.

Based on the revised Office for Budget Responsibility forecasts, their analysis showed real household incomes (that is, after taking tax and inflation into account) set to fall for an unprecedented 19 successive quarters between 2015 and 2020. The rising level of employee contributions to auto-enrolment pension schemes will also squeeze disposable incomes of more than six million workers.

It also calculated that real wages will not return to their pre-financial crisis levels of 2007 until at least 2025. “We are in danger of losing not just one but getting on for two decades of earnings growth”, said Institute of Fiscal Studies Director Paul Johnson at a post-budget briefing.

A more upbeat assessment came from a speech on 17th January 2018 by Michael Saunders, External MPC Member, Bank of England, said:

To be sure, pay growth in 2018 is likely to stay well below the pre-crisis norm of 4% or so. But, I suspect it is more likely to overshoot than undershoot the external consensus (which is for AWE growth of 2.6% in 2018 and 2.8% in 2019). The Nov-2017 IR [Inflation Report] projected pay growth to pick up to around 3% in 2018 as a whole. Even with some pick up in productivity, such a trend would probably signal the likelihood that CPI inflation will stay above target over time once the direct boost to inflation from sterling’s depreciation fades. Indeed, pay growth in 2018 could rise above 3% YoY, especially if composition effects unwind and underlying pay growth picks up further.

Inflation expectations are key to estimates of real pay growth.The charts below show CPI inflation projections from the latest (November 2017) Bank of England Inflation Report.

Moving from the general to the specific, what has happened to carers’ earnings in the last decade? Measured at the 80th percentile of ASHE6115, the hourly rate was £9.79 in 2007 and £11.04 in 2017. These are gross pay rates and not to be confused with measures of disposable income, which take deductions into account. However, they are the basis for adjusting periodical payments for care costs. Adjusting the 2007 figure for CPI inflation to 2017, it becomes £12.35. By this measure, carers at the 80th percentile (only 20% earn more) have suffered a 10% cut in real earnings.

If inflation falls back to the target rate of 2% then, for carers’ earnings to have the same real value in 2025 as they did in 2007, the hourly rate would have to be £14.46. Looking at the fan charts above, 2% might be considered optimistic. However, even if inflation can be kept down to 2%, carers’ earnings will need to rise, on average, by 3.43% a year until 2025. If inflation turns out higher, pay rises will need to be correspondingly larger to hit parity by 2025.

Still, 3.43% a year pay growth does not look too far removed from the Bank of England’s 3%+ expectations quoted above. However, the opportunity for real pay growth reflects where you are in the earnings distribution. Rewards tend to migrate to the upper end, i.e. the better off tend to get better off over time in real terms, whereas those at or below the median bump along at the bottom. Only forced change – minimum wage legislation and the living wage – bucks this trend.

Carers are predominantly in the lowest paid collective occupational group (care, leisure and other service occupations) in the ASHE survey. The Government has accepted the recommendation of the Low Pay Commission’s autumn 2017 report, that the living wage should be increased so as to reach 60% of median earnings by 2020. The increase in the living wage for April 2018 is 4.40%. Policy may therefore restore the real earnings of carers a bit sooner than those of people closer to the median.