Reasons for falling wages

Since the financial crisis, we have seen an unprecedented stagnation / decline in real wages. This decline has been most noticeable for low income workers, with growing levels of inequality.

The decline / stagnation in real wages is a global phenomena – though some countries have been more affected than others.
Reasons suggested for falling wages since 2008 include:
  • Recession – causing unemployment and downward pressure on wages
  • Decline in trade union membership.
  • Increased labour market flexibility, such as more zero hour contracts, new gig economy and limited bargaining power of workers.
  • Increased inequality with relatively higher share of GDP growth going to pensions and company profit rather than wages.
  • Decline in productivity growth, leading to lower economic growth and lower scope for wage growth.
  • Net migration has been suggested as a reason for low wage growth, especially for unskilled workers.

International real wage growth

Real wage growth US

real-wage-growth-us-uk

Source: LSE

Median real wage growth has stagnated in the US before global financial crisis.

real-wage-growth

Source: LSE blog on real wage growth

UK experienced strong real wage growth in the 1980s and 90s, but has experienced sharp falls since 2008.

wages-inflation

UK wage growth and CPI inflation since 2004.

More detail on factors causing falling wages

1. Recession

unemployment-total-uk

The recession of 2009 and subsequent rise in unemployment is a partial reason to explain falling wages. With less demand for workers, there is downward pressure on wages. It is quite usual for wages to fall during recessions, however compared to previous recessions of 1981 and 1991, the fall in wages is much sharper and prolonged. Also, the fall in unemployment since 2012, did not see a corresponding recovery in real wages.

One reasons suggested is that falling real wages are actually a reason why unemployment has fallen quicker than previous recessions. With greater wage flexibility firms have been able to increase employment by offering lower wages.

Structural changes to labour market

Since the early 1980s, labour markets have seen many changes.

  • Decline in trades unions. In 1979 UK trade union density was 58.3%. By 2013, that had fallen to 25.6%
  • Growth in part-time / self-employment / flexible working patterns. See: Gig economy and effects on wages
  • Growth in zero hour contracts. See: Zero hour contracts

All these changes increase flexibility in wage setting and diminish the influence of workers to bargain for higher wages. Many of these labour market changes occurred in the US before the UK, which might explain low median US wage growth in the 1980s.

Structural changes to the economy

Mirroring changes to the labour market are changes to the structure of the economy. The UK and US have seen a decline in the percentage of manual work in manufacturing, and a relative rise in service sector jobs. The decline in manufacturing jobs are due to two main factors:

  • Rise in manufacturing productivity – more produced with less workers.
  • Shift in comparative advantage has seen many manufacturing processes move to China and Asia.

The decline in well paid, unionised manual work has harmed the prospects for unskilled workers – often male. There are new jobs in the service sector – transport, retail, but these are often poorly paid in comparison.

Labour productivity

labour-productivity-index-since1987

Since 2008, there has been an unprecedented fall in labour productivity with productivity in the UK barely reaching its pre-crisis peak. Also, UK productivity is 30% lower than our major competitors – Germany, France and US. (link)

The US has fared little better – between 2010 and 2016, labour productivity rising only 2% (US Productivity)

With stagnant labour productivity, it is no surprise firms have been unwilling to raise wages. It is rising labour productivity that can cause firms to pay higher wages.

Divorce between productivity and pay

productivity-vs-wages

Despite low productivity growth, wages have fared even worse – with a bigger gap between pay and productivity. In essence – from the revenue a firm receives, a smaller share is going on wages. The gap is caused by rising provision for pensions, a higher share of company profit and higher executive pay. (See: Rise in retained company profit)

The gap between productivity and wages has not led to a higher investment with the UK still experiencing relatively low levels of investment.

Growing inequality

median-mean-wages

US average wages (mean) have performed better than median wages (workers in 50th decile). This is because the top 1% paid workers have seen good wage growth – this pushes up average (mean) wages, but doesn’t increase the pay for median workers.

The role of net migration in wages

In a period of falling real wages, scrutiny is often placed on levels of net migration. In the last decade, the UK has seen record levels of net migration, with approximately 50% coming from the EU. It has been suggested net migration from lower income countries, puts downward pressure on UK wages, especially for unskilled workers.

net-migration-uk

A Bank of England study Dec 2015, found that for the overall economy, immigration has little noticeable effect on average wages. However, they did find a small effect for semi/unskilled service sector occupations, where a 10% rise in migration leading to a 2% fall in wages. Report: Bank of England

According to NIESR, the impact of immigration on wages is marginal.

Allowing for this, we can calculate that the new paper implies that the impact of migration on the wages of the UK-born in this sector since 2004 has been about 1 percent, over a period of 8 years. NIESR

The impact of immigration on wages is laden with political significance. Especially since immigration is often a more visible factor than poor productivity and labour market changes.

However, although the years 2008 onwards have seen falling wage growth, there have also been many other times when high levels of immigration have been consistent with rising wages – e.g. early 2000s until the credit crisis.

Conclusion

Several factors are responsible for falling wages – not just in the UK, but across the developed world. Most convincing are poor productivity and changes to labour markets leading to greater wage flexibility. Also, growing inequality is a major issue, making low wage growth more problematic as the low paid see others in society gaining an increasing share.

Unfortunately, many of the structural factors behind low wage growth show no sign of immediate change – meaning low wage growth could continue for a significant time. This low wage growth is also more problematic when combined with rising living costs – especially housing for young people.

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