Tuesday, October 19, 2021
HomeBrexit WatchHigher wages? What’s not to like?

Higher wages? What’s not to like?

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‘I’ve got the guts to make this a high wage economy‘ – Prime Minister Boris Johnson

WELL, that’s marvellous. Put up the minimum wage, berate the bosses to increase pay, give the teachers more and we’ll all be happy. But is it that easy? If it was, what would stop the Zimbabwean government doing the same? They could offer a couple of million Zim dollars for an hour’s work and they would all be rich, surely?

Johnson’s intervention and emollient motherhood and apple pie words are yet another example of the utterly delusional economic and political debate this country is facing. Wages cannot be set at the whim of a Prime Minister to add red meat to the slogan of a levelling up agenda. Pay levels are the result of a number of complex and unique factors generally dictated by supply and demand, complexity, training, productivity and competitive position domestically and internationally. 

Of course we want a high wage economy but that does not come from Government decree or desire to level up.  Indeed in this article I will show his noble intentions may have the very opposite effect with highly undesirable consequences.

Before we examine the consequences of Johnson’s comments it would be useful to understand the starting point. As usual that point is a bit different from what the Westminster bubble and the BBC think.

Thankfully Britain is not the low wage economy of Dickensian sweat shops and zero hours gig work that is so often portrayed. It is a highly diverse, high wage and successful economy, or certainly was before lockdown.

The chart below shows the UK minimum wage to be already the most generous in Europe of any significant nation and almost twice the US level. Further, it is 3-5 times more than most Eastern European countries. The rhetoric and deliberate political and media framing are thus somewhat different from  the reality. 

Ewen Stewart 06.10.21 #1.jpg

Second, as outlined by the chart below, in a European context Britain’s pre-pandemic employment record was outstanding, with jobs created across the board and generally in high value-added sectors. The UK is well placed with globally strong positions in the structural growth sectors of finance, elite education, science, IT and the arts amongst others.  

These are (were pre-lockdown) growth and generally high value-added industries and with the right environment can be again. It is thus a total fallacy to claim, as some do, that the growth was just amongst the Uber drivers or Deliveroo riders, valuable to many as that service may be. The UK’s strategic employment strengths are pretty unique in an EU context – hence the desire of so many Europeans to work here.

Third, as described by the chart below, wages are growing very rapidly in absolute and real terms. If anything, wage growth is accelerating at a red hot 8.3 per cent, far ahead of inflation. Thus the political framing of a cost of living crisis may be true at one level, as inflation is rising, but again it is a complete fallacy as for the substantial majority earnings are growing even more strongly.

This wage explosion contrasts with the collapse in productivity, as indicated from the chart below, with the public sector in particular performing lamentably.  

Ewen Stewart 06.10.21 #4.jpg

Public sector productivity as measured by the ONS is now 13 per cent lower than in 1998. This is truly remarkable, given the benefits that should have been wrung from technology. As a benchmark, public sector productivity growth since 1998 lags private service growth by some 17 per cent and the manufacturing sector by a staggering 44 per cent.

Unless this can be addressed (and the Johnson government shows no sign of even understanding the scale of the problem let alone acting on it), given the untargeted open-ended funding offered, the unprecedented rise of public spending, which now accounts for 56 per cent of GDP, will weigh very heavily on the UK’s long-term growth potential. Simply put, while the private sector is bouncing back from enforced lockdown it risks being ‘crowded out’ by excessive and grossly inefficient public spending. 

This takes us back to the beginning. Pay them more, Johnson says. That is at best a one-dimensional approach. Sure, you can increase the minimum wage to almost whatever level the bureaucrat decrees, but there will be a number of impacts.

First, those further up the wage curve will demand more to preserve their differentials. Thus the cost increase will ripple right up the curve. Yes, you might have more money but you won’t necessarily be better off as inflation bites. You can’t be. Wages are where they are for a reason – simply paying people 30 per cent more cannot make them 30 per cent richer. That should be obvious.

Second, wages cannot be set in isolation of what the competition does. An obvious example is the devastating impact the growth of low-wage China has had on numerous industries in the UK and Europe. Raise wages materially further and more jobs will be up for review with ways to be found to reduce the payroll bill. Sure, you might be able to pay a nurse more, as that job must be done locally, but that does not necessarily apply to the manufacturing or internationally traded service sectors which are the real economic drivers.

Third, if the minimum wage moves to, say, £12 over the next few years, that is the equivalent of £24,960 a year for a 40-hour week. Then there are pension contributions, holiday and sick pay and employers’ National Insurance, taking the cost to an employer of employing one full-time employee on the minimum wage to a staggering £28,000 pa. How will employers react to that? At the margin might they substitute labour with machines? Might they seek efficiency savings and might it reduce total employment? Could it result in off-shoring, particularly at a time when the UK’s competitive position is also being undermined by increasing regulation and tax rises?

Fourth, metaphorically constantly clapping public sector workers emboldens their unions to push harder. Regardless of the sector’s wanton productivity during lockdown and beyond, how, if you have told the world ‘they are brilliant’, can you resist their union’s demands? The reality is this government seems to have little ability to say No, whether it is to home working, unreasonable Covid-19 working requirements or indeed pay. The public sector unions appear to be pushing at an open door.

Fifth, and perhaps most dangerously of all, agitating for pay rises, as this government seems to be doing, when monetary policy remains hot with substantive quantitative easing and 0.1 per cent interest rates is a toxic mix. I have constantly warned of the dangers of such a stance. While Chancellor Sunak may claim that the fiscal budget needs balancing, the truth is that the Government is a million miles from such an outcome, with a further £200billion deficit this year on top of the £330billion last year and significant budget deficits probable in the medium term. 

In my view, the Bank of England won’t change tack, other than perhaps with a tokenistic interest rate rise arguing that ‘inflation is temporary’. But increasingly it does not look temporary but structural. Once inflationary expectations become embedded they are hard to erase. How will markets react if inflation becomes embedded and interest rates remain close to zero?

So Johnson may have his good headline today. Wages are rising but it is likely an illusion. His preferred cohort may do a bit better but the price will be to create arbitrary winners and losers. His actions will not create wealth or true productivity-driven levelling up. 

Inflation makes us all paper-rich. He risks creating an illusion but one that will not end well. A puffed-up boom for now as the pent-up demand from lockdown asserts itself coupled with unbridled and inefficient public spending and higher taxes. But stagflation lies ahead. Low growth, poor productivity, a bloated public sector and inflation.

The winners are those in sectors with pricing power and those in debt, where inflation erodes the balance outstanding, and those with assets, particularly property. The losers will often be the self-employed, the small businessman and woman, the young, who generally don’t have many assets or property, and pensioners often seeing their savings eroded. 

A ‘high wage economy’ is a vacuous slogan that sounds jolly good, but without the productivity growth to match it will prove to be illusionary.

This first appeared on Brexit Watch on October 6, 2021, and is republished by kind permission. 

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Ewen Stewart
Ewen Stewart is a City economist who runs the consultancy Walbrook Economics. He is director of the think tank Global Britain and his work is widely published in economics and political journals.

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