Friday, 14 June 2013

The jobs and productivity puzzles: not just falling real wages

Despite flat-lining output, employment in the UK has risen. This is good news in the sense that many workers have been saved from unemployment. It is bad news in the sense that labour productivity has fallen. Low labour productivity makes it even less likely that real incomes will rise in the future.
Several different theories have been offered to explain the ‘puzzles’ of rising employment with sluggish output and falling labour productivity. One simple and plausible explanation is that these puzzles can be explained by falling real wages. In the last two years, nominal wages have grown more slowly than inflation. This trend of falling real wages, it is argued, has meant that UK workers have ‘priced themselves back into work’ and in line with the now cheaper price of labour firms have switched to more labour intensive methods of production. Using this argument, it is claimed that the labour productivity slowdown is a temporary phenomenon and will be resolved once demand in the UK economy picks up.
Three problems can be raised with the above explanation. First, the idea that workers have ‘priced themselves back into work’ suggests that workers have some choice over whether they work or not. This idea is a basic premise of the standard economic model of the labour market. Yet, the reality is that employers have driven down real wages. There is no element of choice in UK workers taking work: rather they have been forced to accept lower paid work.
Second, falling real wages mean lower aggregate demand and lower sales for firms. It is a supply-side fallacy to think that firms will necessarily hire more workers when real wages fall. Firms will hire more workers if they expect to sell more output by hiring the additional workers. It is one thing to say that lower real wages have helped firms to retain workers despite stagnant output. It is quite another thing to say that lower real wages have induced firms to hire more workers when there is low confidence about future sales growth. The existence and persistence of low real wages creates a barrier to present and future growth in employment.
Third, if the explanation of falling real wages is true, it should be observed that those occupations with the most pronounced falls in real wages have been growing the fastest in recent years. Yet, there is little evidence that this is happening. Of the fastest growing occupations in the last two years, high paid occupations (e.g. managers and senior officials, and professionals) rank near the top. In these occupations, real wages have not declined by any great amount.  Some other occupations (e.g. sales and customer services) have witnessed falling real wages, yet total employment in these occupations has fallen. The fastest growing occupation is personal services encompassing an array of low paid jobs; however, real wages in this occupational group actually rose in the last two years. Overall, there is no clear evidence that falling real wages have been the main driver of the growth in employment across occupations.
The fall in real wages may have helped some firms to hang on to labour for longer. It may have also induced firms to defer investment and to hire more workers in order to meet current sales. But it cannot be the only explanation of rising employment. Some firms have employed more expensive labour – perhaps these firms are hiring more managers in order to restructure production and to cut costs. Employment growth in personal services reflects wider changes in the economy – for example, the growth of low paid care work due to an ageing population.
The shift to a services-based economy more generally may have helped to embed a low productivity environment in the UK. Historically, manufacturing has been the engine of productivity in the economy. Its secular demise may have undermined the ability of the UK economy to deliver and sustain productivity gains.
One final point can be made here. The fall in real wages reflects the broader weakness in the bargaining strength of labour. The decline in union power coupled with the financialisation of labour has made it more difficult for workers to prevent falls in real wages. Employment may be higher than if real wages had not fallen but that is cold comfort to the many millions of UK workers now struggling to make ends meet in a harsh labour market. Until its position is strengthened, it is difficult to see how labour will be able to secure the employment and pay it needs and deserves.