Wednesday, October 10, 2018
05:482PM / Andrew Haldane, Chief Economist, Bank Of England
Being text of speech delivered by Andy Haldane, Chief Economist, Bank Of England at The Acas “Future Of Work” Conference, Congress Centre, London.
In his speech, the Bank of England Chief Economist Andy Haldane discusses the key factors driving the ‘lost decade’ of pay growth since the financial crisis.
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It is great pleasure to be here at the Acas Annual Conference whose theme this year is the “Future of Work”. It is a particular pleasure to have Brendan Barber as Chair. As a member of the Bank of England’s Court between 2003 and 2012, Brendan’s insights on the labour market and wider economy were crucial in helping the Bank steer a policy course through a period of first macroeconomic calm and then extra-ordinary macroeconomic storm following the global financial crisis.
It is the labour market that I want to discuss today. We have seen an unusual pattern emerge here over recent years. Jobs growth has been strong, with over 2 million new jobs created since the end of 2012. But pay growth has remained weak by historic standards, averaging around 2% annually. This pattern has been replicated across a number of other advanced economies. As we reach the anniversary of what has become a “lost decade” for inflation-adjusted pay in the UK, it is a good time to take stock.
What explains this puzzling pattern of rich jobs but poor pay growth? Some of the reasons for weak pay have been cyclical. The financial crisis caused large job losses. A significant pool of unemployed workers emerged and job insecurities rose, depressing pay growth. Recently, the UK’s economic recovery has shrunk the pool of unemployed workers and reduced somewhat job insecurity. Had these cyclical factors been the only ones at work, we might have expected a stronger recovery in pay.
The reason we have not is because longer-term, structural forces have also been holding back pay growth, notably weak productivity. Over the medium-term, productivity is the single most important determinant of the national income pie. Productivity growth pays for pay rises, at individual firms and for the economy as a whole. Over the past ten years, productivity has barely grown in the UK. That second “lost decade” goes a long way towards explaining the lost decade in pay.
Productivity is not, however, the only structural factor at work in the labour market. The world of work is being reshaped in many advanced economies by the secular fall in the degree of unionisation and collective bargaining, by changes in employment contracts and working patterns and by rises in the degree of concentration and automation in the company sector. By reducing workers’ “pay power”, they too have depressed wage growth, actually and prospectively.
I will start by discussing recent pay developments and the factors responsible for driving them, cyclical and structural. I will then discuss the implications of these cyclical and structural factors for domestic cost growth, inflationary pressures and hence for monetary policy in the period ahead.
Jobs and Pay
I do not need to tell this audience that the past decade has been a strikingly weak one for pay growth. Ten years ago, the mean weekly wage in the UK was around £435 per week. A decade on, it has risen to £520 per week, an average annual rise of less than 2% in money terms. This makes it the weakest decade for growth in money wages for British workers since the 1930s.
That is not the end of the story, of course. Over the same period, consumer prices in the UK have risen by, on average, 2.2% per year. That means inflation-adjusted, or real, pay has fallen by around 3.7% cumulatively over the past decade. That weekly pay packet in 2008 has, in purchasing power terms, fallen to be worth only around £420 per week.
This makes the recent period very unusual by historical standards (Chart 1). Since as far back as 1870, there have been only two episodes when the real pay of workers has fallen over a ten-year period. The other episodes were associated with seismic shocks in the labour market, often wrenching technological change or sharp cyclical downturns, which raised levels of unemployment and job insecurity.
The past decade has bucked that historical trend, with a boom in job creation accompanying weak pay growth. The employment rate in the UK has risen to over 60%, and the unemployment rate has fallen to 4%, respectively their highest and lowest levels since the mid-1970s. The vast majority of these new jobs, around 75%, have been full-time. And this boom has persisted, with around 830,000 job vacancies currently being advertised – the highest since records began.
This picture of weak pay and strong employment has been broadly-based, spanning all regions and sectors. Real pay has fallen across every region of the UK since 2008 (Figure 1) and in all three major sectors of the economy (Chart 2). Meanwhile, unemployment has fallen steeply across every region of the UK, by at least 2.5 percentage points.
The high-level picture of the UK labour market, then, is a jobs-rich but pay-poor recovery. This pattern is broadly replicated in other countries. For example, there is a striking correlation between the pattern of unemployment and wage growth in the UK and the US (Charts 3 and 4). In the US, unemployment has fallen to its lowest levels since 1969, while pay growth has remained modest.
Given the strength of jobs growth, the weakness in pay has surprised many people, including the Bank of England. Chart 5 plots the Bank’s wage forecasts at annual intervals since 2012. Over this period, there has been a sequence of negative forecast errors, averaging around one percentage point per year. The same has been true of external wage forecasts, for the UK and elsewhere. These surprises suggest that the recent pattern in pay and unemployment has been unusual by historical standards.
In the 1950s, A W Phillips uncovered a negative empirical relationship between pay growth and unemployment: pay grows faster when unemployment is lower. The Phillips curve was born (Phillips (1958)). This relationship has since become a central pillar of macro-economic theory and policy. Part of the attraction of the Phillips curve lies in the fact that it tells a simple story: the tighter the jobs market, the greater the pressure on pay.
Exactly 60 years on, the Phillips curve is still widely used, and widely debated, by economists and policymakers. But with pay undershooting expectations, and with unemployment touching generational lows, some big questions are being posed of it. Has the Phillips curve died of old age, or is it merely sleeping? Has it changed shape or location? The juries (or coroners) have yet to reach a definitive verdict.
There have been a number of recent re-examinations of the evidence.1 Using different datasets and techniques, these have tended to conclude that the Phillips curve has a pulse and remains alive and kicking. As an illustration, Charts 6 and 7 plot the relationship between wage growth and unemployment in the UK and the US over three sample periods dating back to the 1970s. They also plot some simple regression lines of best fit.
All of the regression lines are negatively-sloped and, for the UK, statistically significant. Across the three samples, the estimated Phillips curves are similarly-sloped.2 These curves have, however, shifted downwards significantly over time. Taken together, this evidence is consistent with the Phillips curve having a pulse that is beating at a similar rate to the past, despite the patient having moved hospital.
Explaining the Pay Puzzle
To explore the behaviour of pay in greater detail, we can use a slightly more sophisticated model which takes account of factors in addition to unemployment. Table 1 provides some econometric estimates of pay relationships over the period 1992 to 2018. The factors determining pay growth can be grouped under three headings, each of which is important in explaining its evolution over the (distant and recent) past.
One key factor affecting pay growth is inflation or expectations of inflation.3 This makes intuitive sense. In the end, workers are interested in the purchasing power of their pay, not its money amount. They bargain over real wages. So inflation, or its expectation, affects pay with a coefficient close to one. Put differently, in the course of wage bargaining, employers insure workers against inflationary shocks, at least on average.
Movements in inflation have been a key driver of pay growth historically. They are the main reason why the Phillips curve shifted downwards significantly as the Great Inflation of the 1970s gave way to the Great Moderation of the late 1990s. That period saw inflation expectations ratchet down to target levels where they have remained anchored since (Chart 8). Pay growth has, in response, fallen pretty much one-for-one. This explains the first downwards shift in the Phillips curves shown in Charts 6 and 7.
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