The puzzle of rising UK wages reveals an unprecedented and tragic truth

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US president-elect Joe Biden has nominated two fantastic, highly qualified female labour economists, both of whom I have known for a quarter of a century, to senior posts. Janet Yellen, previously chair of the Federal Reserve, as the first female Treasury secretary, and Cecilia Rouse, dean of Princeton’s School of Public and International Affairs, as the first African-American to chair the president’s Council of Economic Advisers. Janet previously held the job under Bill Clinton. This is great news.

In her acceptance speech Yellen argued: “The value of work always stuck with me. So much so that I became an economist because I was concerned about the toll of unemployment on people, families and communities. And I’ve spent my career trying to make sure people can work and achieve the dignity and self-worth that comes with it.”

In hers, Rouse argued: “I found myself drawn to the study of the labour market in all of its dimensions; the reasons that jobs disappear; the impact of education on people’s job prospects, and the ways we can tear down barriers to job growth.”

Music to my ears. If only there was similar labour market expertise in the current UK government, but there isn’t. Sadly, we are going to need it.

The UK government’s introduction of a temporary furlough scheme, that was recently extended to the end of April 2021, has been widely praised. But the concern is what next after that? And then there is Brexit, which as I have made clear on numerous occasions has no economic benefits at all, only costs. The big question is what form Brexit will take and then how bad will be the negative shock to output and jobs. It does seem to me to be the worst decision in peacetime any country in the world has made in a thousand years. Lines of lorries at Dover and Folkestone do not augur well for what is to come, even before Boris Johnson cancelled Christmas.

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Recall in 2008 when the financial crisis hit, eventually the Bank of England cut interest rates and started quantitative easing, and Gordon Brown and Alistair Darling cut taxes and increased public spending. Then George “Slasher” Osborne came in and imposed austerity that slowed the economy and produced the slowest recovery in 300 years. By the start of 2020, real wages were still below what they were a dozen years earlier at the start of the financial crisis.

The former Tory chancellor Philip Hammond recently explained the need for austerity once more, while speaking on a BBC Radio 4 programme after me. They obviously have learnt nothing. Maybe the austerians will claim again we are “all in this together” as they cut public spending and prove we are not. Hopefully not.

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What is going on in the labour market right now is really complicated, and in fact we haven’t seen anything quite like this ever before. We are in unprecedented territory. Let me explain.

After the financial crisis and the ensuing great recession that started in April 2008, the unemployment rate rose from 5.5% to 7.5% over 12 months. Over the same time period, wage growth – as measured by single-month average weekly earnings in the private sector – also fell sharply. This is what usually happens in a slump. But not this time around, in 2020. Something weird is happening to wage growth. First in the US, and then it spread to the UK.

In the US, there was a big rise in the unemployment rate to just under 20% in April, before falling back steadily to 7.1% in November. But wage growth actually rose sharply, and was 5.9% in November. The picture is the same in the UK. After an initial drop into negative territory earlier this year, there was a sharp rise for -2.9% wage growth to 3.2% in October.

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So, everyone is better off right? Actually not. XpertHR, a consultancy specialising in pay, reported that pay settlements limped towards year end with median settlements at 2%.

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Labour economists have never seen anything like this before. It appears that what has happened both in the UK and the US is that the lower part of the wage distribution – the lowest-paid workers – has just dropped out. It’s a batting average effect if you like; the team average rises because batsmen 10 and 11 are not counted any more. We are not exactly sure, but it looks bad news. The issue is whether these jobs – many in pubs, clubs and restaurants – return after the furlough payments stop. But many jobs won’t return, if there are long-run changes in behaviour after the pandemic as expected.

It is unclear after Brexit and the end of the lockdown whether those jobs are coming back. Janet and Ceci where are you? Help please. This is a big puzzle.

– David Blanchflower is Professor of Economics at Dartmouth College, and was previously a member of the Bank of England’s Monetary Policy Committee