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Wage growth and distribution: can we be hopeful about the future?

Matthew Whittaker

Date: 7. November 2012 / Category: Commission on Living Standards

Look away from events in the US for a moment and you’ll find an interesting new release from the ONS highlighting trends in UK wage growth over the past 25 years. The headline points to average post-inflation hourly wage increases of 62 per cent since 1986, which looks fairly impressive and goes to the heart of our expectation that wages in the modern economy should be growing year after year.

The authors break the overall trend into a range of periods, centred around the recessions of the early-1990s and late-2000s. This enables them to show that wages behaved very differently during the most recent downturn: falling in real terms rather than merely slowing down as they did between 1989 and 1993. It’s a phenomenon we’ve looked at before and appears to owe much to a shift in the relationship between unemployment and real wage growth that took place over the last decade.

Another change in pay patterns that the release highlights relates to the distribution of pay. The chart below sets out average annual increases in hourly pay (excluding overtime) for each point of the earnings distribution, across four periods.

Looking first at 1986 to 1998, we see that the pace of wage growth increased with earnings: that is, those who were paid more received bigger pay increases. In short, wages grew, but so did inequality.

Between 1998 and 2007 by contrast, real wages grew much more quickly at the bottom of the distribution than elsewhere, boosted by the introduction of the National Minimum Wage. There was little variation across much of the rest of the population, though the very highest earners continued to move away from the rest. It means inequality in the bottom half of the earning distribution shrank somewhat, while top-half inequality continued to grow.

Nevertheless, in absolute terms and across the period as a whole, everyone continued to get better off (although the picture looks only about half as good if we use the broader-based Retail Prices Index to adjust for inflation rather than the Consumer Prices Index, as we usually do). What the analysis doesn’t do though, is look within this time period.

As the work of the Commission for Living Standards highlighted, many of the gains set out here were realised at the start of the period, with strong wage growth at the end of the 1990s and turn of the millennia being followed by real wage stagnation for a majority of the population from around 2003. Even at the bottom of the distribution, increases in the NMW became steadily less aggressive during the 2000s, reducing the extent to which bottom-half inequality became compressed. Indeed, after taking account of inflation, the adult rate NMW is now lower than it was in 2004.

The focus on hourly wages also means that the analysis probably understates the gains made by the highest earners. Bonus payments have accounted for a growing share of total remuneration over the last decade or so (for example, in 2002 bonus payments made up 13 per cent of average pay in the finance sector; by 2008 they had jumped to 23 per cent) – with another report out this week suggesting that share options are playing an increasing role too. Such payments are typically not captured particularly well in the hourly variable of the Annual Survey of Hours and Earnings from which the ONS analysis is derived. Even on this measure though, inequality between the top and the bottom remains high, particularly in London and the South East, as the next chart shows.

Going forward, if we assume that sustainable economic growth will eventually return and with it, in time, real wage growth, what is the outlook for pay? Against a continuing backdrop of globalisation and automation the answer – without intervention on pay practices and, longer term, on skills – is likely to be anaemic and unequal. At the headline level, the last 25 years look relatively healthy and we have made some real strides in terms of improving pay at the bottom. But the evidence from the last ten years or so is much less encouraging. If, as the new President hopes, the best is yet to come, then we need to look again at how overall economic growth feeds into the pockets of ordinary workers in the UK.