Thursday, 16 March 2017

Wages are falling

By Tom O’Leary

Real wages are falling once more. In addition, nominal wages have fallen in the last 2 months which is highly unusual. Both of these developments are Brexit effects and the situation is likely to get worse as Brexit unfolds.

The trends in both real (inflation-adjusted) and nominal wages are shown in Chart 1 below. Real wages peaked in April 2008. A very large gap then opened up between real and nominal wages following the crisis, as nominal wage growth slowed and inflation subtracted from real wage growth.  But as the chart shows, it is rare for nominal wages to fall, and this has contributed to a marked recent drop in real wages.

Chart 1. Trends in UK Nominal and Real Wages, January 2000 to January 2017

Source: ONS

In the two months since November 2016 real wages have fallen by 1%. In nominal terms they fell by 0.2%. Compared to a year ago, nominal wages have risen by just 1.9% and in real terms the rise is zero. All such data are subject to revision. But these changes are so marked that any revision is unlikely to alter the fundamental points.

These are Brexit effects. Just as the substantial devaluation of the pound in the 2007-2008 crisis led to a sharp rise inflation, so the renewed significant fall in the pound since the Brexit referendum is pushing up inflation once more. In both cases, flat or slow nominal wage growth meant that inflation pushed real wages lower.
The current rise in inflation has much further to run. Even if the pound had stabilised after its fall, most importers ‘hedge’ (or insure against) the risk of a currency fall. But those hedges are time-limited, usually after 6, 12 or even 24 months.  A recent article in the Financial Times argued that the hedges are only now beginning to expire. Import costs will rise sharply, and push consumer prices higher. But the pound has recently begun to fall once more, close to just 1.20 versus the US Dollar, so the extent of import price inflation will continue for some time.

The recent fall in nominal wage growth is more modest than the decline in real wages. But because it is so rare it is alarming.  There is a widespread and mistaken idea that investment leads to job losses and low wages. The opposite is the case. Investment leads to increased production and productivity. Of course, all employers would like to claim all the rewards of increased output themselves as profits. Workers try to claim those rewards as wages and benefits. The outcome is the result primarily of industrial bargaining and struggle.

But investment has been falling. It was lower at the end of 2016 than in mid-2015. Without investment it is extremely difficult to create new highly-paid jobs. The new jobs that are being created tend to be lower paid, and push down average wages, even in nominal terms.

The fall in investment is itself a Brexit effect. As SEB has argued, the biggest negative impact from Brexit is likely to be felt in investment, much worse even than trade. This is because investment is made for a return. Investment returns will necessarily be lower in the UK economy outside the EU Single Market, the world’s largest market, rather than inside it.

The link noted above between investment and jobs, and especially between investment and wages means that lower investment will place further downward pressure on wages. It is clear that significant negative Brexit effects are accumulating.

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