What killed the UK’s economic recovery? Low wages


2:39 pm - August 15th 2011

by Duncan Weldon    


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It is now fairly widely acknowledged that the British recovery has stalled in 2011. Whilst Britain may yet avoid a double dip recession growth looks set to be sluggish.

Given the more pessimistic outlook it is important that policy makers are clear about the reasons for this slow down, otherwise we risk a misguided policy response.

George Osborne is relatively clear that the slower growth profile of the UK economy, and the reasons that 2011 growth may well miss the OBR (Office for Budget Responsibility) forecasts, is because of a more troubled global outlook – the debt standoff in the United Statesand the ongoing Eurocrisis in particular.

The left meanwhile are mainly focussed on the impact of austerity.

Both answers risk missing the point – what is killing the UK recovery is actually falling real wages.

Each month he Treasury publishes a compilation of independent forecasters views on the UK economy. The table below shows the median forecast from back in January (when optimistic observers expected growth of 2.0%) and the most recent forecasts from July, when the estimate had fallen to just 1.3%.

For completeness sake I have also included the OBR’s own numbers.

Whilst there has been a lot of attention (rightly) paid to the falling headline number, I have seen less comment on the make up of that falling growth forecast.

The first thing to notice is that since January independent forecasters have revised up their export growth forecast and revised down their import forecast (as a result of domestic weakness meaning less imports). The end result is that the contribution of net trade to GDP growth was expected to be 0.5% in January but is now expected to be 1.3%. In other words – for all George Osborne’s talk of global headwinds hitting growth independent forecasters now expect Britain’s export performance to be better than they did in January. A questionable assumption maybe – but weaker external is not a fact explaining the downgrades to the growth forecast.

What has caused growth to be revised down is dramatic collapse in domestic demand forecasts from an expected 1.5% contribution to growth in January to just 0.1% now.

The chart below demonstrates this:

What has caused this collapse in domestic demand? A huge fall in private consumption forecasts from expected growth of 1.2% in January to an expected contraction of 0.3% in July.

Whilst the government has talked up exports and investment for the past year and the opposition has focused on spending cuts, the consumer outlook has become dire.

Why has consumer spending been revised down so heavily?

A substantial part of the answer can be found in falling real wages. Back in January independent forecasters expected RPI inflation to be 4.0% in 2011 and average earnings to grow 2.6%, implying real wages would fall by 1.4%. They now forecast RPI of 5.3% and average earnings growth of 2.5%. Real wages are now expected to fall by 2.8% – double the estimate of January.

Because of this consumption estimates have been radically revised down and GDP with it.

If one wants an answer to why the recovery is faltering, one would do well to start looking at real wages – an area policy makers haven’t spent anywhere near enough time talking about.

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About the author
Duncan is a regular contributor. He has worked as an economist at the Bank of England, in fund management and at the Labour Party. He is a Senior Policy Officer at the TUC’s Economic and Social Affairs Department.
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Reader comments


Let’s put this in context: it’s low wages relative to insane house prices and rents which were inflated by the greedy banks and lazy politicians.

2. Duncan Weldon

Slight problem with the graph – the July column shows net trade adding 0.7% when it should be 1.3% (accidently used the OBR trade figure) – now correcting. Doesn’t change overall picture of falling growth driven by a huge collapse in domestic demand, offset by an increase in net trade.

(All numbers correct in the table).

Let’s put this in context: it’s low wages relative to insane house prices and rents which were inflated by the greedy banks and lazy politicians.

And I thought house prices were inflated by consumers being desperate to profit from rising house prices.

How foolish of me to not realise the whole blame lay at the doors of politicians and bankers.

Is it possible that we are now taking what money we have and using it to pay off debt, rather than buying things for ourselves?

Because we’ve been racking up personal debt for a long time, so if we’ve moved to paying that down then presumably that would contribute to any contraction in growth.

5. Duncan Weldon

Andrew @4,

That is certainly part of it. ‘Consumer deleveraging’.

@4 & @5

And the estimates underpinning the OBR’s forecasts rely on the opposite of this, that is for the savings rate to fall and consumers to ‘leverage’ all the more.

Nice to see this issue finally being dealt with by someone, while unemployment, I would argue, has been a major factor in the continued failure to improve consumer confidence there is obviously a massive area that is causing continued stagnation which is of course a good old reversed wage spending spiral.

Economics 101 is that higher wages often lead to inflation, the exact same situation is put into reverse in a recession, this inevitably means that we have less money to spend, which means business’s have less money and downsize, which means either wage cuts or laying off staff.

Problem i would ask though is how do we deal with this matter? Unemployment is more clear, you engage in fiscal expansionary policies and move the unemployed into labour. But its surely much harder to demand business’s simply give their employees more money. (Unless they’re a banker – Bah-Zing!)

Presumably, the faster wages increase, the quicker and more certain the recovery.

For the aged among us, that sounds remarkably like an attempt at a replay of the mid 1970s when average earnings in cash terms at one point were rising at an annual rate of c. 25%.

What ensued was the winter of discontent of 1978/9 when rubbish piled up in Leicester Sq in London and the dead went unburied in Liverpoool:
http://www.independent.co.uk/news/uk/politics/david-camerons-cuts-will-disfigure-uk-says-tuc-2077189.html?action=Gallery&ino=3

@4 – There’ll be an element of that for certain. However, the fact is that even before the credit boom, and in fact for the last 30 years, low-to-median wages have either remained stagnant or fallen compared to the cost of living, within which we should include the insane increase in property and rent costs, but also food and fuel – especially the latter.

Executive pay on the other hand has increased to a level and at a rate that is as insane as the property boom.

10. Planeshift

“But its surely much harder to demand business’s simply give their employees more money”

Whilst it’s tempting to send Tim Worstall to his A+E tonight by writing “raise the minimum wage”, I think its the wrong way to look at things.

What is actually needed over the long term is rents and house prices to come way way down, and in the short term some interventions that directly put money into people’s pockets – which is a tax break for the rich if you are a right wing tosser, a suspension of council tax if you are a right winger who doesn’t want to gas the poor, or a subsidy/keynesian investment in a social good if you are on the left.

Before my wife and I were able to buy a house (1972) our Building Society insisted that we had saved with them for at least a year. We were offered a motgage of £6000 on a property priced at £7750, They were prepared to lend on the basis of 3 x my salary and 1/2 of my wifes’ The outstanding sum we had to find ourselves.
If you believe that banks and politicians had nothing to do with house price inflation contrast our experience with that of a mid 2000 year couple wishing to get a mortgage based on five and a half times their joint salary on 120% of a property’s price. And when after six months they believed their property was now worth £10k more, their bank was happy to remortgage their house to release the exra equity so that our new couple could go out and ‘spend, spend, spend’ on the high street. Serving.the banks, the economy and Gordon Brown.
Those properties are still overpriced but if interest rates were increased to control inflation, there would be a massive rise in house repossessions.
So the savers have to be punished to serve the profligate.
Gordon Brown and the FSA were criminally negligent and The Bank of England was hopelessly irresponsible.
Who controls a child’s access to the biscuit tin, the parent or the child?

Higher wages without an increase in productivity would hardly improve the economic situation.

@12

But that’s just the thing – productivity has been consistently improving as a long-term trend for the last 30 years. It’s one thing to blame the wage levels of the ’70s for the Winter Of Discontent, but they weren’t pegged to productivity.

Our social “betters” have had the vast and sweeping majority of us doing more work for the same money or less in real terms since the end of the ’80s. Access to easy credit in the late ’90s onwards turned out to be a handy way of distracting us from that fact.

Duncan

Why do you use RPI when the BoE MPC targets CPI ?

The trend of private-sector wage growth is running at around 2.6%. Normally, 4% wage growth with 2% trend productivity per annum.would be consistent with 2% CPI. However, if the trend rate of UK RGDP has fallen and our productivity trend rate is now between 1-1.5%. Why then would wage growth above the current rate contribute to anything but inflation?

If wage growth was running at a higher rate do you not think that the MPC would be forced to tighten policy to be consistent with the 2% CPI target?

Do you not think that our low RGDP growth rate indicates supply side problems in the UK economy?

The problems in the UK economy and why people feel poorer and their real wage eroded is not through real wages falling, but because RGDP is lower. Government supporting demand would be offset by the BoE MPC tightening policy if they were being consistent with their CPI target.

15. DisgustedOfTunbridgeWells

Lolz, if real wages tracked productivity, we’d all be very well off.

http://online.wsj.com/article/SB118005313993514160.html?mod=home_whats_news_us

16. Peter Hansford

Duncan, are you really saying nominal wages “should” be higher in response to what is obviously a “cost-push” inflation shock, despite high unemployment?


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