It’s low productivity that is holding down wages, not just robots and globalisation

 
Graeme Leach
The new Sony dog robot called AIBO 220 is launched
Why are wage growth and inflation the dogs that didn’t bark? (Source: Getty)

Much has been written in recent months on the strange disappearance of Mr Phillips – or, more precisely, the lack of inverse relationship between the rate of unemployment and inflation, as shown in the Phillips curve.

The UK unemployment rate is at a 42-year low of 4.3 per cent, but inflation – though above the two per cent target – remains relatively subdued at 2.9 per cent.

The last time unemployment was this low, in 1975, the inflation rate was 24 percent.

Read more: Invest, connect, and train: How to fill the UK’s productivity void

With unemployment this low, the conventional wisdom was that inflation would let rip, but it hasn’t. Indeed much of the source of the latest increase in inflation was rising import prices for clothing and footwear, as a result of the weaker pound.

So why are wage growth and inflation the dogs that didn’t bark?

There is no shortage of suggestions. Here are 10 I obtained from a quick Google search, in no particular order.

First, post the Great Recession, the employer mindset has been set on rigorous cost control.

Second, post the Great Recession, the employee mindset has changed also, with wage gloom feeding on itself and subdued wage expectations the result.

Third, the gig economy, with the underemployment it can bring, is offsetting some of the effect of lower unemployment.

Fourth, the impact of globalisation, technology, and competition from disruptors has reduced the pricing power of companies, and hence their ability to meet wage demands.

Fifth, trade union power is declining, with union leaders more concerned about maintaining the number of members they have than obtaining big pay awards, which might result in reductions in the number of workers, and therefore members.

Sixth, a high supply of graduates are filling non-graduate jobs, thereby dampening wage growth.

Seventh, there is the possibility that formal skills are no longer as valuable as in the past, with technology pushing people down the occupational ladder (i.e. higher skilled individuals undertaking lower skilled occupations).

Eighth, it is estimated that 40 per cent of workers in “routine” occupations could be at risk of automation.

Ninth, labour supply from the EU has provided an inexhaustible supply – up to now – of workers for the “costa-conomy”.

Tenth, there are the effects of turnover and job hopping, with the millennial generation not staying in companies long enough to create bargaining power in pay negotiations.

These explanations may be part of the answer, but there is another very simple way of looking at this.

In broad terms, wage growth would be expected to be the sum of productivity growth and inflation.

As the Office for Budget Responsibility has recently pointed out, productivity growth has been a mere 0.2 per cent per annum over the past five years. Add inflation of just under three per cent, and three per cent growth in wages would seem appropriate.

But wage growth is only two per cent, I hear you cry. Why the gap? Ultimately, employers focus on the total wage pot, not the total wage packet. In other words, they look at the total cost of labour, in addition to the wage component.

I’ve written before in this column about the impact of auto-enrolment on total wage costs, and the impact of rising employer contributions. Add this to roughly two per cent wage growth, and the mystery is no more.

Alright, I hear you say, I understand why wage growth is subdued, but why is broader inflation subdued as well, albeit above the lows of recent years? There’s probably a simple answer here also.

The total amount of money in the economy – the Bank of England’s M4X measure – is rising by around five per cent (year on year). Inflation is never going to let rip with moderate growth rates in the money supply such as this. Look out for broad money, not Mr Phillips.

The big question is not why is inflation relatively low, but why is productivity so low.

Read more: Now is finally the time to raise interest rates

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