We try and solve the wage puzzle

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Confused about wage growth? Waiting for a pickup in manufacturing pay that never happened?

So am I. In this blog, I “try” to understand, step by step, the determinants of wage growth across manufacturing. I am not sure to provide an answer, but at least I tried.

Pay growth across manufacturing falls behind the rest of the economy

Growth in average weekly earnings (regular pay) came in at 1.2% in the three months to June compared with the same period a year ago, well below pay growth for the whole economy which increased by 2.1% in the second quarter of 2017.

2017-08-16-Pay-growth-awe-regular 

Manufacturers are shrugging off upward pressures on pay

The weakness in manufacturing pay growth is a puzzle in many respects:

1) Upward pressures on pay are high and increasing

The rise in inflation: Inflation picked up significantly in the past year. Consumer prices increased by 2.6% in the year to July and the Bank of England expects it to peak around 3% later this year.

The rise in the NLW: The National Living Wage increased by 4% from £7.20 to £7.50 an hour for 25-year-old workers in April.

Labour shortages in the radar: Vacancies across manufacturing increased significantly in the past 12 months. In the three months to July, there were 50,000 unfilled positions in the sector.

2) Business confidence is holding up

Confidence levels remain strong across manufacturing, as suggested in our Manufacturing Outlook and the manufacturing PMIs.

3) Firms’ profitability is on the rise

The profitability of UK manufacturing companies increased significantly in the past 12 months, and improved at a stronger pace than for companies in other sectors. It is set to improve further as the squeeze on margins is receding, a result of higher inflation and waning upward pressures on input costs.

2017-08-16-Firms-profitability 

Then why are manufacturers not offering higher pay levels?

Although important in wage formation, these factors, which have been feeding in for months now, seem to have had little – or no – impact on manufacturing pay so far. So what’s holding manufacturing pay growth?

Let’s see what factors are having downward pressures on pay.

1) A necessary adjustment taking place?

Unit labour costs have increased significantly in the UK since the recovery has been on track, and the trend has heightened in the past two years. The post-crisis catch-up effect in wage growth, coupled with a disappointing productivity performance, have led unit labour costs to pick up significantly, outpacing the trend seen in other G7 countries.

2017-08-16-ucl-whole-econ 

The divergence is even more pronounced in the manufacturing sector. Compared with their levels in 2007 - before the onset of the financial crisis, UK unit labour costs across manufacturing have accelerated at the highest pace relative to other advanced economies. Again the weak productivity is much to blame for this trend, but the rise in manufacturing pay growth in the past couple of years has also provided some pull on unit labour costs.

Although the sterling depreciation might have restored some price competitiveness for UK manufacturing exports, there is still much to be done in terms of cost competitiveness. This could offer a plausible explanation for the weakness in manufacturing pay growth, especially in the context of never-rising productivity.

2017-08-16-ucl-mfg-econ 

2) A broken Phillips curve?

The relationship between labour shortages and wage growth has changed significantly since the financial crisis, as the Bank of England seem to believe. This is true for the manufacturing sector as well.

Prior to the financial crisis, there was a positive correlation between the number of vacancies in the sector and the growth in average weekly earnings (see the green dots in the chart below). This relationship went into reverse more recently. While the number of vacancies kept going up, this has not translated into more pressure on manufacturers to offer higher wages to attract and/or retain workers. 

Why is it the case? Good question, I don’t know. Explanations could be: a more flexible labour market, a change in wage bargaining patters, an access to EU labour (if this is the case, then we should see this waning in the coming months)…

2017-08-16-phillips-curve  

3) The B-word

Yes, Brexit. Uncertainty on the UK economic outlook, as well as on the outcome of the negotiations with the EU, are likely to weigh on manufacturers’ willingness to offer higher pay levels.

 

Manufacturer? Are these trends relevant to your business? Did you witness new trends in pay growth that you want to tell us about? Please drop us a line at research@eef.org.uk

 

 

Author

This person has now left EEF. Please contact us on 0808 168 1874 or email us at enquiries@eef.org.uk if you have any questions.

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