Pay Are earnings going to rise by more than 3 per cent next year? 12 November 2014 by Laura Gardiner Laura Gardiner Another BoE inflation report, another set of rosy forecasts for earnings next year. Just as 2014 was supposed to be the year of the pay rise, now it seems 2015 will be the year when things turn positive. And, according to the Bank, wages won’t just creep into positive territory next year, they are going to take something of a jump upwards. In the last quarter of 2015 the Bank expects nominal wage growth of 3.25% at a time of inflation of 1.4% – so a gear shift from the current position of at best flat-lining real pay to healthy growth of roughly 1.8% in a year’s time. How sceptical should we be? The Bank’s Chief Economist has been admirably forthright in highlighting his organisation’s own habit of promising sunshine tomorrow, with spring always just around the corner but never coming to pass, as the chart below from his recent speech illustrates. At some point though, things have to brighten. And every passing month in which unemployment continues its fall and GDP continues to rise makes a degree of optimism about the following year that bit more plausible. Of course, no-one knows whether wage growth of over 3% in 2015 is likely to come good. But we can identify some of the things you’d need to believe about the jobs market to make this forecast feel achievable. Our reading is that you’d need to put reasonable faith in the following: That the current downward shift in the make-up of the workforce towards lower-paid groups and roles is a blip not a trend. We have recently arrived at some clarity on the much-speculated question of how the employee mix affects average pay. In contrast to most of the decade prior, the first half of 2014 was one in which the changing composition of the workforce caused a significant wage drag rather than a boost, as recent Resolution Foundation analysis has uncovered. A return to strong wage growth next year rests on this drag dissipating swiftly. One of the main drivers has been the entry and re-entry of younger and less experienced workers, reflecting rapid employment growth and falling youth unemployment. We might reasonably expect this to fall out. But the biggest drag has come from shifts away from managerial occupations and towards lower-paid caring, labouring and cleaning jobs. Whether this trend will dissipate remains much less clear. That spare capacity is bottoming out. An often-cited explanation for real wage falls having persisted is that there is more slack in the labour market than was expected, boosting supply and therefore giving employers little impetus to raise pay. With the headline unemployment rate proving an imperfect indicator, factors such as underemployment and cumulative welfare reforms pushing the unemployed to intensify their search for work have prompted the Bank to revise upwards estimates of spare capacity in previous Inflation Reports. Today’s report suggests that slack has started to narrow (though it highlights considerable uncertainty over this). An imminent up-tick in pay growth rests partly on this tentative judgement proving accurate. That job turnover continues to pick up. Many, including the Bank and the ONS, view employees moving from job to job as a leading indicator of wage pressure, reflecting peoples’ confidence about their labour market prospects. Although still far from the pre-crisis peak, this indicator has started to pick up. To be optimistic about wages you need also to be optimistic that this trend will continue, and that the expected relationship between churn and pay bears out. Again, we just don’t know. That the low-earning self-employed stay put. A group of workers not accounted for in any of the above is the self-employed. They are not measured in the official earnings data but have accounted for two thirds of the employment growth since 2008. The data we do have suggest self-employed earnings are low and have been squeezed even harder than those of employees. If – and it is an if – some of the post-crisis growth in self-employment is a response to higher unemployment and lower vacancies then we may expect their number to fall as some move into employee roles (over recent months their number have tailed off slightly). Recall that a significant minority of the self-employed appear to make less than the minimum wage, so for this group an employee job would represent a pay rise. While this would mean an improvement in their personal prospects, it would also drag down the official employee pay figures. If the self-employment surge starts to unwind it could also be a drag on pay. That pay settlements continue to improve. Data from other surveys that more closely reflect settlements within firms or sectors has been much stronger than official earnings measures of late. Prospects for average pay rest on this trend continuing and feeding though to the average. One factor that might prompt optimism in this regard is the first real-terms increase in the National Minimum Wage in six years. If this becomes a widely referred to benchmark for pay settlements in 2015, this would raise the average wage growth even further.