REAL wages are still falling, on average, and nobody seems to know what to do about it. Even though the economy is growing, millions are seeing their incomes depressed by low nominal pay rises and highish inflation.
Part of the problem is cyclical; but there is also a devastating structural explanation. There is a growing body of evidence – including an excellent new report from Towers Watson – that shows that rising non-wage employment costs are crowding out wages and are the primary structural cause of depressed wages.
Employers are paying more to employ people – but the staff aren’t noticing because hidden taxes and especially employer pension contributions are crowding out wage hikes.
We all know that Western societies are facing a retirement bombshell – but what few people have noticed is how badly and stealthily all of us are already being hammered already.
Wages grew at roughly the same rate as overall compensation from 1987 and 2001; during that time, employer contributions to pensions plans, other benefits and national insurance contributions lagged slightly. But all of this started to change in 2002, with wages falling behind significantly and other costs rocketing, with disastrous implication for real take-home pay, as the Tower Watson report demonstrates.
Wages and salaries accounted for 87 per cent of total compensation between 1987 and 2001; they have since collapsed to 83 per cent. Pension contributions, benefits and employers’ NICs jumped from 13 per cent of total comp to 17 per cent by 2012. This happened in the context of roughly stable compensation as a share of GDP.
If salaries had gone up at the same rate as total compensation between 2002 and 2012, the average pay packet today would how be five percentage points higher; the difference was gobbled up by surging pension payments and taxes. Had this not happened, and the previous trends had remained intact, the current row over living standards would be much reduced.
Employers’ national insurance increased from 6.25 per cent of total comp in 1987 to 7.25 per cent in 2012. Employer contributions to funded pension funds are now 7.2 per cent, up from 4.3 per cent in 1987; the cost of notionally funded schemes rose from 0.6 per cent to one per cent. Over three quarters of the rise in non-wage costs can be attributed to rising pension costs for employers.
Meanwhile, the number of private sector employees in defined benefit schemes (final salary pensions) collapsed from 26 per cent in 2002 to eight per cent; the share of private employees in defined contribution schemes crept up from 21 per cent to 23 per cent. Overall membership is down from 47 per cent to 32 per cent – though it is about to shoot up with auto-enrolment and the Nest scheme.
Thus the primary driver of higher pension costs in the national accounts – and hence the pressure on wages in recent years – has actually been the dwindling final salary pension schemes: costs to today’s workers have exploded, benefiting older workers still in the schemes and especially people who are already retired. Workers as a whole are paying a steep price – but only a minority are benefiting.
As the Towers Watson paper shows, this represents a transfer from those without pensions or with defined contribution pensions – typically low income or younger workers – to those with final salary pensions – older workers and pensioners. I don’t believe in generational warfare, but young people struggling to afford housing are also taking a pay cut to finance generous pensions of a sort that will never be accessible to them. It’s grim. Auto-enrolment will cut pay packets further in the years ahead. But there will be a big difference: workers will be saving for their own retirements, not for those of older generations. That, however, is likely to be scant consolation.
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