Britain's Faustian wage bargain

Britain's Faustian wage bargain

Let’s begin at the beginning.

Britain is poorer, much poorer, than it was five or six years ago. If you don’t believe me, take a look at gross domestic product – simply the amount of income generated in the country in a given year. Divided by the number of people in the UK this income (or, as economists call it, GDP per capita) is still about 6% lower today than in 2008.


Mull over that for a moment, because in the end that’s what almost every domestic economic story comes down to these days: that diminished national income and the question of how it is shared among households.

Today’s labour market figures are a vivid illustration of the answer. In years gone by British workers tended to insist on keeping their real pay rising. So when there were recessions and the country became poorer, the pain was delivered through job cuts rather than wage cuts.

This time around, a cocktail of factors – including globalisation, the decline of unions and, perhaps, more sensible monetary policy – has persuaded workers to allow their incomes to diminish in exchange for keeping their jobs. The upshot is that unemployment never rose as high as in previous recessions (peaking at 8.4% in late 2011, compared with peaks of 10.7% in early 1993) despite the fall in national income being even greater.

Today the unemployment rate is down at 6.5% (incidentally the level the Bank of England recently cited as the “equilibrium” rate, which would suggest that it should start raising rates, well, yesterday – but that’s another story). The employment rate has reached 73.1%, equalling the 1974/2005 record for the highest level ever. Admittedly, this includes many self-employed and part time workers who would rather be in full-time employment, but it is good news, and a massive improvement, all the same.


But since the fall in national income isn’t necessarily reflected in the total number of people in work, it is instead reflected in their wages. The annual rate of wage inflation excluding bonuses is now down to the lowest level on record, 0.7%, and is comfortably below overall CPI inflation of 1.9%. Whenever inflation outpaces wages it means families’ real earnings are falling (as the increase in their salaries isn’t enough to compensate for the erosion of that money’s spending power).


You only really get a sense of the scale of this Faustian pact on wages when you consider it in historical perspective.

According to my calculations (based on the brilliant Bank of England spreadsheet here), the five year fall in real wages was greater between 2009 and 2013 (8%) than in any comparable period going all the way back to 1864.


So how long until wages recover? The problem is that there some suspect that the real wage growth of the past few decades, which tended to average about 2.5% plus inflation, was the exception rather than the rule. According to some employment economists, the pressures of globalisation might mean that the long-term trend will be closer to 1% or even zero.

It is a worrying thought. Britons have patiently absorbed enormous cuts in their real pay over the past few years – but one presumes that that was on the basis that wages would soon bounce back. If they don’t I would expect a real backlash against those forces of globalisation (particularly immigration), which have pushed them down.

Or, to put it another way, in electoral terms the cost of living crisis might well be better news for Nigel Farage than Ed Miliband.

Incidentally, there’s much more on this in my Times column this week.