After a decade of weak earnings growth, low productivity and years of high inflation, Ben Broadbent, an external member of the Monetary Committee of the Bank of England, said the “pretty nasty” combination is coming to an end and UK real wages are set to rise.
In a speech at the London School of Economics, Broadbent talked about two key questions concerning the current debate over the country’s economic recovery:
- Why have real wages fallen? Are they expected to recover any time soon?
- Do the components of growth today give us any idea of what growth is going to be like in the future?
Update August 24, 2014: Mr. Broadbent now says low wage growth is here to stay.
Worries today are about growth’s compositions
He points out now that the recovery has clearly arrived, worries about growth have been replaced with concerns about its composition.
“In particular, it is argued, the recovery will run out of steam without a rise in investment because of an ongoing contraction in real wages…Growth is therefore caught in a nasty scissor movement between a decline in real wages, which limits the room for further growth in household spending, and perpetually stagnant business investment.”
He adds the question as to whether this view holds up to scrutiny.
During this recovery salaries have increased relatively faster than profits, he explains, an unusual development after most recessions. But “for a variety of reasons, relative prices have moved against consumers”, so that “what UK residents pay for their consumption has risen much faster than the price UK firms get for their output.”
According to Broadbent, there are three factors that have “driven an unwelcome wedge between the prices of what the UK private sector produces and what it consumes”:
- The increase in indirect taxes over the last few years. Indirect taxation is levied on things consumers spend their money on.
- Global price movements that have raised the price of goods in relation to services.
- Poor aggregate productivity growth, which “has been much worse in sectors that produce consumer goods and services than in others.”
What is the outlook for UK real wages?
Regarding the outlook for real wages, Broadbent has a positive view:
“Encouragingly, there are signs these headwinds are beginning to abate. Tradable goods prices have stabilised, the services terms of trade have recently improved….and there has been no further rise in indirect taxes. [That would] clearly benefit the purchasing power of UK income, wages included, supporting the real growth of consumption.”
By far the most important factor – one that pushes growth in both GDP and average earnings over time – is productivity, where “the majority of forecasters, including the MPC, also expect faster growth.”
This optimism assumes that there will be a rebound in business investment. Broadbent believes business investment is about it accelerate, and for good reasons, “business investment tends to lag, not lead, the cycle in output,” he explains. According to recent survey measures, business investment is looking up.
Market Business News reported earlier this month that UK business confidence is at a 20-year high.
Broadbent warns that we should not infer too much about the future from the current recovery’s components. He shows that the composition of expenditure tells us very little about future growth.
“We like to tell ourselves that the composition of expenditure matters for future near-term growth – ‘because’ consumer spending or investment in inventories are strong one year growth in aggregate demand will “therefore” be weaker the next – but, in truth, the data provide very little support for such claims.”
What will truly determine the path of this economic recovery and whether it delivers growth in wages are such things as growth in the Eurozone and productivity, he adds.