National pay cut has only just begun

 
Allister Heath
FOR months now, it has been clear that exploding inflation, costs and taxes were the main threat to the recovery. Yesterday’s figures showing that real household disposable income dropped 0.8 per cent in 2010, the first national pay cut in two decades, merely serve as a grim confirmation that the retail boom is well and truly over. Given that the UK economy remains smaller than it was at the height of the bubble, a drop in incomes is not entirely surprising. If we don’t produce as much as before, we can’t expect to earn as much. But that is scant consolation for the pain.

Real, inflation-adjusted wages of some key groups of workers had already been stagnant in recent years. After growing by 1.8 per cent a year on average between 1977 and 2003, median male full-time pay fell by 0.2 per cent a year between 2003 and 2008, after controlling for retail price index inflation. Female wage growth was 0.3 per cent a year in 2003-08, better but still far lower than during the long period of growth from 1977, the Resolution Foundation calculates. Higher benefits, cheap credit and buoyant house prices masked the trend at the time. More work needs to be done to understand what is really happening – and to check that this is not merely a statistical artefact explained by an increase in lower paid or entry level jobs. But the data does appear to suggest that a large percentage of the population, especially unskilled men, lack the ability to compete in today’s global economy.

Another, much healthier trend, was also confirmed yesterday. Business investment was revised up in the fourth-quarter. It bounced back by 12.2 per cent over the past year. Having fallen unusually sharply in the downturn, corporate spending is now recovering more quickly than in previous upswings. If this continues, it will help drive the recovery and compensate for miserable consumer spending growth. It is vital that the government puts in place policies that increase the return on capital, as this will further encourage corporate investment. Contrary to what is usually believed, firms don’t make investment decisions only on the basis of demand – they spend when they think that the return will be higher than the cost of capital. Boosting the average return on every pound spent by UK plc by just one per cent would trigger an explosion in investment. Higher corporate spending can thus quite easily go hand-in hand with depressed consumer spending – and eventually, as the French economist Jean-Baptiste Say might have put it, supply could even create its own demand. Over time, greater amounts of capital in the economy ought to boost productivity and hence wages, thus also alleviating the problem outlined above.

One final noteworthy development. Bank of England figures show that British non-financial companies’ sterling deposits at UK banks have fallen to 36 per cent of their total deposits, from 61 per cent in 2002, with a massive surge in deposits held at non-UK banks. There has been no such decline in the extent to which UK companies borrow from UK banks. One reason could be that interest rates on foreign currency deposits are sometimes more appealing. Another could be a decline in trust towards UK banks or even sterling. It certainly shows just how globalised British firms have become, and that corporate banking is far more competitive than is usually understood. If in doubt, shop around.

allister.heath@cityam.com

Follow me on twitter: @allisterheath