UK economy: there is no puzzle – just more work on lower pay

By Jeremy Smith

Another month, another “puzzle”. How come overall employment has risen again (up 251,000 in June compared to a year ago), while the GDP figures are so poor?  The Bank of England call this “a genuine economic puzzle”, whilst many economists – such as the Sunday Times’s David Smith whom we quoted last month - argue that the GDP figures are significantly underestimated by the Office for National Statistics.

But for us in PRIME, it’s neither a puzzle nor a contradiction – simply common sense when you look at the fact that real wages have been declining faster than the level of employment is rising.  This means that overall, more people are working, but at lower real rates of remuneration, to deliver no greater output.  In consequence, there is less spending power in the economy than a year ago.

Writing before the 2nd Quarter GDP figures were released, we said:

“..it is unlikely that the 2nd Quarter GDP figures will be enhanced by the impact of increased employment over the last 6 months (up 1.62% annualised), offset by a similar rate of annual decline (also around 1.6%) in real wages across the whole workforce.”

We were if anything too optimistic, with Q2 GDP estimated to have declined by 0.7% compared to Q1, making it three negative Quarters in succession, according to ONS.

Today, several commentators have argued that what we are seeing is a decline in productivity, but another way of expressing it is as a slight decline in the totally unproductive (the unemployed) and an increase in those employed to create in effect the same volume at a reduced wage and reduced cost per caput.

What do the stats tell us? The overall workforce increased by 251,000 in the 3 months to June 2012 compared to the same period in 2011, raising the total from 29.229 million to 29.48 million. This is an annual increase of 0.86%.

Compared to the previous 3 months (to March 2012), full-timers (employed or self-employed) rose by 130,000 or 0.61%, part-timers by 71,000 or 0.89%. Employees grew by 0.51%, and the number of self-employed by 0.93%. The ONS provide another minor but still extraordinary (black swan?) statistic:

“the number of unpaid family workers (people who work in a family business who do not receive a formal wage or salary but benefit from the profits of that business) increased by 12,000 on the quarter to reach 109,000.”

That represents a Quarter on Quarter increase of no less than 12.37%!  So the picture is of a growing workforce – but a workforce growing faster in part-time jobs, and even faster in the numbers of self-employed and those working in a family business without wage but in hope of profit.

What about wages?  ONS tell us that in the three months to June, total pay rose by 1.6% on a year earlier. Average regular pay (excluding bonuses) was £442 per week in June 2012. Total pay (including bonuses) in the private sector rose by 1.8% on a year earlier, and total pay in the public sector, excluding financial services, rose by 1.5%.

Compare these wage increases with inflation. The annual CPI inflation for July 2012 is 2.6% (up from 2.4% in June), and RPI inflation is 3.2% (up from 2.8% in June).  Average CPI inflation over 2011 was around 4.5%, and for 2010 around 3.3%.  Increases in wages were well below these figures throughout the period 2010 to 2012.

We can fairly conclude that on average, real wages are rising at a significantly lesser rate than inflation, whether CPI or RPI, and this gap appears to be between 1.0% and 1.6%.  Since the overall workforce - which includes the increasing numbers of self-employed - grew by 0.86% over the last year, remuneration of the workforce has clearly declined..

Another way of looking at this issue is to take the GDP income figures for “compensation of employees” provided by the ONS.  They show that total compensation of employees grew by only 2.4% in 2010, and 2.3% in 2011, well below the respective annual inflation figures for those years.  (For comparison, the GDP deflator figures for 2010 and 2011 were 1.8% and 2.8%).  Total compensation of employees includes employers’ social charges and contributions etc., not just the wage bill.

The Bank of England, in its August 2012 Inflation Report, confirms this general position:

“Private sector regular pay growth remains substantially below its average rate prior to the 2008/09 recession and has been fairly stable over the past year at around 2%....

The only counter-indication in the ONS “compensation of employees” figures comes in relation to Q1 of 2012, which shows a Q on Q increase of 1.1%, well above inflation.  The Bank of England Report makes a relevant comment:

“Unit wage cost growth fell back slightly in Q1 [2012] as overall earnings growth slowed. But growth in unit labour costs — a wider measure, which also includes employers’ social contributions — picked up in Q1, mainly reflecting an increase in companies’ payments to occupational pension schemes.”

In other words, it seems that the higher GDP Q1 employee compensation figure represents an increase in employer costs, not overall normal pay. But we will watch the Q2 employee compensation figures with interest.

 A simple illustration

We can also illustrate our general point about what is happening – cuts in real wages outpacing the growth in employment  - with a simplistic example of an imaginary flat-lined economy, which has 100 persons in work or available for work but unemployed.

YEAR ONE

Let us assume that 90 of the 100 are in work, earning £1000 each and producing 1000 widgets.

Total annual pay = £90,000.

The other 10 are unemployed, receiving benefits of 50% of the wage, i.e. £500 each.

Total annual benefits = £5,000.

Total income for employed plus unemployed = £95,000.

YEAR TWO

Here, one more person finds work, so the unemployment rate falls from 10% to 9%.  However, the real wage declines by 1.5% for those in work, whilst unemployment benefit remains constant. But those in work deliver no more output.

So we now have 91 persons in work, each earning £985 and producing 1000 widgets

Total annual pay = £89,635

And 9 persons unemployed, receiving benefits of £500 each

Total annual benefits = £4500

Total income for employed plus unemployed = £94,135

In sum, our economy produces the same volume of output but spending power in our economy has declined over the year by £865, or 0.92%.

Our hundred persons have less money overall to spend in the economy buying goods and services – even if one has improved her lot in Year 2 by getting into paid employment. And in parallel with a decline in the economy, government borrowing declines, we assume, by £500.

There is of course a positive alternative policy, leading to increased output and activity for our imaginary but so far austere economy..... but that's another story!