The relationship between economic growth and average pay

Readers Question: Does the level of real income grow as the economy grows? Can we say that real income grows as the economy grows? If yes, what factors surround it? 

Summary

In a period of positive economic growth, usually, you would expect a rise in real wages and higher pay. However, it is not guaranteed. GDP measures wages, but also profit, interest and rent.

Therefore, it is possible for GDP to increase but average wages to stagnate and even decline. – e.g. if profit takes a bigger share of GDP.

  • Economic growth means an increase in real GDP (Gross Domestic Product).
  • GDP is a measure of National Income / National Output / National Expenditure.

National Income measure of GDP

  • Wages and Salaries (compensation of employees)
  • Rent
  • Interest
  • Profit

Economic growth and real GDP per capita

Another issue is that we could see a rise in real GDP caused by an increase in the population. If real GDP increases 2%, but the population increases 2%, then there will be no increase in GDP per capita and average real wages will stay the same.

GDP-per-head-v-GDP

Approx 33% of UK real GDP growth in past decade has been caused by population growth.

See: economic growth per capita

Rise in non-wage rewards

Another factor is that pay could be affected by non-wage rewards. Suppose firms became responsible for providing private health care insurance (like the US). Wages would be cut to enable health care payments. GDP would not be affected but workers would see lower pay. In recent years, UK firms have become more responsbile for providing private pensions.

Economic growth but fall in average wages

It is possible economic growth could lead to a rise in company profit, but companies do not share this increase in profit with their employees.

economic-growth-quarterly

During the period 2010-2015, the UK experienced positive economic growth and rising real GDP, but average wages fell.

uk-real-wages-06-14

This was partly due to the nature of the labour market. Increased labour market flexibility and competitive pressures saw real wage growth decline. Company profit was taking bigger share of GDP.

retained-profit

Evidence suggests that between 2012 and 2014 corporations were retaining more profit. The total corporations gross operating surplus increased over 10% in the 12 months to 2014 Q2. This suggests firms are increasing profitability but are reluctant to spend the increased profit

See: Economic growth with falling wages

Evaluation

  • This experience of the UK – rising real GDP and falling wages is quite rare.In the post-war period, the UK’s economic growth led to rising real wages. Also, if you look at other economies with economic growth in this period, e.g France and Germany, wages are rising. (FT)

The UK paradox is explained by several factors:

  • Population growth causing higher GDP, but not higher GDP per capita.
  • Rising in the share of profit retained by firms.
  • Flexible labour markets putting downward pressure on wages.
  • Fall in unemployment but enabled by low wage jobs / part time job.
  • Low productivity growth. With low productivity, firms are keeping wages correspondingly low.
  • Cost push inflation reducing real wages.
  • Rise in non-wage benefits (private pensions/health care)

GDP statistics only tell part of the story

This is an important development because GDP and economic growth is the primary economic statistic. The government can point to rising GDP in recent years. Yet, for many people, this rise in GDP may feel alien or not applicable to their situation. They don’t see the effects of this economic growth – they see stagnating real wages, rising prices and poor employment prospects.

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