In what has been a rather lacklustre economic recovery one standout success for the UK has been job creation. In the last eight years the number of people in employment has risen by 10% to record levels. Self-employment is up by a quarter. Britain’s unemployment rate today is one of the lowest in Europe and at the lowest level since 1975. There are three quarter of a million job vacancies in the UK today.
Common sense suggests that as unemployment falls, and employers struggle to fill vacancies, wages will rise. This relationship is embodied in a simple economic model, the so-called Phillips Curve. Yet today this model, and this way of thinking about wage pressures, no longer seems to work for the UK.
Two years ago real wages, after inflation, were growing at an annual rate of almost 3.0%. Today, with unemployment down sharply, real wages are contracting, and have fallen by about 1.0% in the last year. A golden age for jobs has also seen what the Resolution Foundation, a think tank, describes as the slowest period of wage growth since the Napoleonic wars.
How can we explain the apparent breakdown in the relationship between unemployment and wages?
Four forces seem to be at work.
First, there may be more slack, or spare capacity, in the jobs market than meets the eye. Free movement of people within the EU has expanded the potential supply of labour for UK companies from 32 million UK-based workers to tens of millions of people across Europe. At the same time higher levels of part-time employment, which now accounts for a quarter of UK jobs, means that more people with existing jobs can work longer hours if needed.
Second, a series of changes have eroded the bargaining power of labour. Globalisation and technological innovation have led to the loss of many mid-level jobs. Union membership has declined from around 13 million people in the late 1970s to about six million today, in the process eroding the wage premium associated with union membership. The Bank of England estimate that this premium typically adds between 10 to 15% to pay.
The composition of the workforce has also shifted away from full time jobs. Part-time and temporary work, self-employment and zero hours contracts have flourished and today account for 43% of the UK workforce. Pay in these growth areas tends to lag behind equivalent full time occupations. The pay ‘discount’ for self-employment is around 15%, for zero hours contracts 7%, temporary contracts 5-6% and for agency workers about 2.5%.
Third, business and government have reacted to a volatile, slower growth environment by squeezing costs, particularly wages. Deloitte’s Chief Financial Officers’ survey shows that cost control has remained a consistent business priority in the recent years, even at times of accelerating growth and buoyant confidence. In the public sector pay rises for key workers are capped at 1.0% a year until 2019-20, a level which is well below current and forecast inflation rates.
Economic uncertainty has encouraged workers to stick with their current job rather than moving in search of higher paid work. This immobility, which contradicts the popular notion of a footloose workforce, has weighed heavily on the pay of younger people. At the same time the wage premium for older workers which comes with long service has fallen by a third in the last 20 years.
Fourth, the boost to wages from having a degree has weakened. Bank of England research shows that the wage premium commanded by those with a university degree has diminished substantially since the mid-nineties. One obvious explanation is that a much expanded supply of new graduates has outstripped demand.
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Andy Haldane, the Bank of England’s Chief Economist, has argued that growth in alternative forms of working, from self-employment, to part time work and zero hours contracts, has made work and workers more “diffuse, more granular and more divisible than in the past”. Changing forms of work link individual tasks and with individual workers. People are more likely to be paid by the task or the hour and less likely to be represented by unions.
Mr Haldane points out that, in some respects, we may be seeing a return to older ways of working. Before the Industrial Revolution most workers were self-employed or worked in small businesses, there were no unions, hours were flexible and work was artisanal, task-based and divisible.
The good news is that the number of jobs in the UK has risen substantially in recent years. Yet for many the returns to work have stagnated or fallen. The nature of work itself has changed, in the process altering the relationship between employers and workers. These are profound shifts, which, like the changes in the workforce that occurred in the Industrial Revolution, are likely to have social and political effects.
Ian Stewart is Deloitte’s Chief Economist in the UK. The full version of his Monday Briefing can be subscribed to here.