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Opinions and Analysis | |
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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.
Download the PDF - Pay Power
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.
Download the PDF - Pay Power
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