Today brings us back to the domestic beat and in fact the heartbeat of the UK economy which is its labour market. This has in recent years seen two main developments. The first is a welcome rise in employment which has seen the unemployment rate plunge. But the second has been that wage growth has decoupled from this leaving the Ivory Towers of the establishment building what might be called castles in the sky. In that fantasy world wage growth would now be around 5% except it is not and in fact it is nowhere near it.
Oh tell me why
Do we build castles in the sky?
Oh tell me why
Are the castles way up high? ( Ian Van Dahl)
Or if we look at the Bank of England Inflation Report from earlier this month.
A tightening labour market and lower unemployment is typically associated with higher pay growth as it becomes more difficult for firms to recruit and retain staff.
This is another way of expressing the “output gap” theory which keeps needing revision as it keeps being wrong. As this from Geoff Tily shows that has been a consistent feature of Governor Carney’s term at the Bank of England.
In 2014, Bank of England Governor Mark Carney told the TUC Congress that wages should start rising in real terms “around the middle of next year” and “accelerate” afterwards” .
They did rise in the first half of 2015, but then decelerated afterwards.
Actually the Inflation Report does address the issue but only with what George Benson described as “hindsight is 20/20 vision”.
During the financial crisis, output fell and unemployment rose, as companies reduced hiring and increased redundancies. The number of additional hours people wanted to work also rose, perhaps in response to a squeeze in their real incomes. Taken together, these factors led to a substantial degree of spare capacity opening up in the labour market over this period. This, in turn, was a significant factor behind subdued wage growth during 2009–15.
It is a shame they did not figure that out at the time and looking forwards seems to be stuck on repeat.
Pay growth has risen over the past year and tightness in the labour market is expected to push up pay growth slightly further in coming years.
At least there has been a slight winding back here but something rather familiar in concept pops up albeit that the specific number keeps changing.
This was broadly in line with the MPC’s judgement of the equilibrium rate of unemployment of 4¼%, suggesting little scope for unemployment to fall further without generating excess wage pressure.
The problem here is that an unemployment rate of 7% was supposed to be significant when Forward Guidance began although it went wrong so quickly that we then had a 6.5% equilibrium rate then 5.5% then 4.5%. The February Inflation Report gave us “a statistical filtering model” which seems to have simply chased the actual unemployment rate lower. Along the way I spotted this.
The relationship between wage growth and
unemployment is assumed to be linear
You basically need to have lived the last decade under a stone to think that! Or of course be in an Ivory Tower.
Today’s data
This brought some excellent news so let’s get straight to it.
The unemployment rate (the number of unemployed people as a proportion of all employed and unemployed people) was 4.0%; it has not been lower since December 1974 to February 1975.
This of course has an implication for the Bank of England which has signaled an equilibrium rate of 4.25% as discussed above. Thus we can move on knowing that its improved models ( we know they are improved because they keep telling us so) will be predicting increased wage growth.
Returning to the quantity or employment situation we see that it looks good.
There were 32.39 million people in work, 42,000 more than for January to March 2018 and 313,000 more than for a year earlier.The employment rate (the proportion of people aged from 16 to 64 years who were in work) was 75.6%, unchanged compared with January to March 2018 but higher than for a year earlier (75.1%).
This is good news but needs to come with some caveats. The first is that the rate of improvement looks to be slowing which is maybe not a surprise at these levels. The next issue is more theoretical which is the issue of how we record employment and the concept of underemployment where people have work but less than they want. We do get some flashes of this and this morning’s release did give a hint of some better news.
There were 780,000 people (not seasonally adjusted) in employment on “zero-hours contracts” in their main job, 104,000 fewer than for a year earlier.
But if we switch back to the unemployment rate we know from looking at Japan that it can drop to 2.2% which means that we cannot rule out that ours will go lower and maybe a fair bit lower. So there could be a fair bit of underemployment out there still which is backed up by the attempts to measure it.
By this measurement, the number of underemployed people in the three months to June 2018 stood at 2.39 million, down 121,000 when compared with the previous quarter.
This compares to under 2 million pre credit crunch although I am not clear why these numbers consider the working week to be 48 hours?
Wages
This should be a case of “the only way is up” if we look at the Bank of England analysis.
regular pay increased by 2.7%, slightly lower than the growth rate between March to May 2017 and March to May 2018 (2.8%)……total pay increased by 2.4%, slightly lower than the growth rate between March to May 2017 and March to May 2018 (2.5%)
There is an initial feeling of deja vu as we were told this last month so the past has seen an upwards revision but there is little or no sign of the “output gap” pulling it higher. In fact bonuses fell by 6.6% on a year ago in June meaning that total pay growth fell to 2.1%. This means that in the first half of 2018 the rate of total pay growth has gone from 2.8% to 2.1% via 2.6% (twice) and 2.5% (twice). Unless you live in an Ivory Tower that is lower and not higher.
The Bank of England response mirrors their response when inflation was a particular problem for them which is to keep breaking the numbers down until you find one that does work. In this instance it takes two steps moving first to the private-sector to eliminate the public-sector pay caps and then to regular pay eliminating the bonus weakness. On that road you can point out a 2.9% increase although attempts to say it is rising have the issue of it being 3% in February and 3.2% in March. If they want more they could point us to regular pay in construction which is rising at an annual rate of 5.6% ( which of course begs a question about the official output statistics there).
Comment
The credit crunch era has been one where we have found ourselves ripping whole chapters out of economics 101 textbooks. By contrast both the establishment and the Ivory Towers have clung to them like a life raft in spite of the evidence to the contrary. Of course one day their persistent lottery ticker buying will likely bear fruit but there is little sign of it so far. Instead they have the Average White Band on repeat.
Let’s go ’round again
Maybe we’ll turn back the hands of time
Let’s go ’round again
One more time (One more time)
One more time (One more time)
For the rest of us we see that there is more work but that wage growth seems to get stuck in the 2% zone. Even at the extraordinary low-level of unemployment seen in Japan the wage position remains Definitely Maybe after plenty of real wage falls. I am not sure that the productivity data helps as much as it used to as we have switched towards services where it is much harder to measure and somewhere along the way capital productivity got abandoned and now it is just labour. Of course all of this simply ignores the self-employed as they are not in the earnings figures and nor are smaller businesses.