We tend to assume that rising productivity will lead to rising wages but it ain’t necessarily so, says the Resolution Foundation’s Gavin Kelly:
The productivity crisis of the last few years is far from over but economic recovery is now well-established and there are at least a few flickers of life in the official data on output per hour. The widely shared assumption, often unspoken, is that when productivity picks up then typical wages will grow at the same rate. But that’s not necessarily a safe bet.
Look closely at the relationship, as a new RF report does (building on an important earlier study for RF by the LSE’s John Van Reenen and João Paulo Pessoa), and we see that since the early 1980s productivity has risen by over 60 per cent while median pay increased by just under 40 per cent: a 23 percentage point gap.
Over the past ten to fifteen years, the relationship between productivity and median pay has come adrift.
The Resolution Foundation report gives four reasons for this:
- The ‘labour share effect’ – which looks at what share of national output flows to workers and what share flows to non-workers. All else equal, a falling labour share increases the ‘wedge’ between productivity and pay;
- The ‘compensation effect’ – which considers what share of overall employee compensation (the labour share) gets paid as wages and what share comprises non-wage compensation such as employer National Insurance and pension contributions. All else equal, a rise in non-wage compensation will mean wages don’t grow as quickly as productivity;
- The ‘wage distribution effect’ – which focuses on differences between mean and median pay growth. Even if average wages are growing in line with productivity, rising wage inequality will serve to reduce the pace of typical pay growth; and
- The ‘deflator effect’ – which accounts for the fact that the value of output is adjusted using a producer price deflator while wages are adjusted using consumer price deflators. If the consumer deflator rises more quickly than the producer deflator then the relative price gap that opens up lowers the real value of wages and increases the ‘wedge’ between productivity growth and median pay.
A combination of these factors has led to a decoupling of median wage growth and productivity. Of these, says the Resolution Foundation, the labour share effect has had the least impact and the deflator effect is probably temporary. The wage distribution effect and the compensation effect are the main reasons for the gap between productivity growth and median wage growth.
The wage distribution effect is shown on this next graph. Mean pay has, until recently, more or less kept pace with productivity while median pay has fallen behind. To put it another way, the median wage earners’ share of the overall wage pot has fallen so, while pay as a whole has kept up with productivity, the highly paid have taken more of the rewards.
The other major factor is the compensation effect, which means that, although the overall compensation paid by employers is rising, less of it is finding its way into pay packets and more is going into pension payments. The reason for this is that many employers now find themselves with pension deficits.
[R]ecent work from Brian Bell suggests that a significant share of this increase in pension contributions relates to unfunded pension liabilities in defined benefit schemes that are no longer open to new members. So, even as firms have reduced their pension promises to employees, they’ve increased the amount of money being set aside. The implication is that a sizeable part of the non-wage compensation recorded in the National Accounts is actually flowing towards pensioners, rather than serving as a deferred payment for today’s workers.
Older workers and the recently retired worked through a time when those on middling earnings had a greater share of overall pay and when employers paid into generous pension schemes. Their accumulated assets have enabled them to preserve that advantage into later life. Middle-earners from later generations not only have a lower share of the pay bill, they have also been shut out of final salary pension schemes.
It is tempting to blame the baby boomers for all this. Here’s Phillip Inman in the Guardian:
Maybe this should not come as a surprise after more than a decade watching those who own assets – mostly the over 55s – ringfence their booty from anyone planning to tax it or allow the market to diminish its value.
Baby boomers had successfully lobbied in the early noughties to protect their final salary pension payouts, even when it was obvious they were becoming unaffordable. It was never fair that one generation could secure its own pensions knowing everyone else would be left with a pittance in old age – as companies rushed to ditch their final salary-linked schemes – but we did not know it would also mean people sacrificing wage rises.
But is lobbying to protect pensions really so unreasonable when pension pots were part of the deal under which people were employed? Many people stayed in unrewarding jobs with the same company for years simply because they were due a good pension. They’d be bound to feel a bit aggrieved if they were told, towards the end of their working lives, that they weren’t going to get it after all.
Perhaps this is more to the point (my emphasis):
The blame lies with the retired baby boomer and their employers who failed to ensure enough funds went into their final salary schemes during their working lives. The deficit-ridden schemes must now be filled from company cashflows, denying today’s workers a proportion of the forecast wage rises.
Blame corporate Britain for the pensions mess. The TUC does. It says greedy directors, keen to cut costs, have seen employee pensions as an easy target.
In the 1990s many companies took the seemingly painless decision of stopping contributions to occupational schemes. The stock market was riding high and companies thought they could take “pension holidays” and still meet their obligations to pensioners.
Collectively, according to Inland Revenue figures, employers saved almost £18bn during the 1990s pension holidays – although staff were forced to carry on making payments. It was a time of booming corporate profits, although in hindsight much of that profit came directly from the savings in pension contributions.
£18 billion worth of missed contributions eh? And how much is the deficit now? Here’s the Resolution Foundation again:
Clearly this area is worthy of more investigation but, as a working – and highly indicative – calculation, Bell puts the potential size of pension deficit funding accounted for by the retired population rather than today’s workers at somewhere in the region of £6 billion to £16 billion.
So £18 billion invested during the 1990s would have more than covered it.
There’s more though. As Ros Altman says, some pension funds were used to fund the corporate restructuring of the 1980s and 1990s. Offering generous early retirement schemes meant firms could get rid of people without having the redundancy payments hitting their profits. Instead, the pension schemes paid, the headcount went down, the City was happy, the profits were untouched and those at the top were handsomely rewarded. I saw some of this first hand, though I don’t know if anyone has studied the overall impact it had on pension schemes. In her 2011 book Retirement Heist, the Wall Street Journal’s Ellen E. Schultz accused US firms of siphoning off billions from pension funds to pay for corporate restructuring. If anyone has any similar data for the UK I would be fascinated to see it.
The result of all this is that employers will need to shore up their pension funds for some time if they are to meet their obligations. This is likely to act as a drag on wages, preventing those on the median wage from feeling the benefit of any productivity improvement. As Gavin says, “the pay pot might get leakier at the same time as a reduced share of its contents flows to workers in the middle of the distribution.”
Today’s middle earners are understandably resentful but is this really just a question of intergenerational fairness? The boomers are comfortably off only because they lived through a time when those on middling incomes secured a relatively large slice of the pie. Most of the rewards from the pension scheme raids went to the very few. The relative decline in the median wage is due to pay hikes for those at the top and the reduced bargaining power of everyone else. As the pay prospects for many younger workers look ever more bleak, and the prospect of them owning their own homes recedes into the distance, boomer blaming is becoming fashionable. But rather than blaming their parents for stealing their pay rises, they might ask why the pension schemes ended up so short of funds in the first place.