The big news in the Budget this week was one of a gloomy forecast for productivity growth. It can sometimes be hard to grasp what that really means, and why it matters.
Productivity measures how much, on average, workers in the UK produce per hour worked. Ultimately, improvements in living standards arise as a result of productivity increases – slower productivity growth means wages will grow more slowly. It is this effect on wage growth that means lower productivity is bad news for the Chancellor (as this means lower tax revenues) but it is also why the downgrade yesterday is bad news for all of us.
Wednesday’s change is just the latest setback after what has been a decade of disappointing productivity performance. Wage growth in the UK over that period has been abysmal. In 2008, the median worker in the UK (i.e. the person for whom half of workers earn more and half earn less) working full time had an annual salary of £24,500 in today’s prices. Today, a decade later, the median worker working full-time earns £23,000, still £1,500 below the pre-crisis level.
A decade without the nation’s workforce getting a pay rise is extremely disappointing, but the forecasts now imply that sluggish increases could be the new normal. Real wages are due to be flat next year, and even in 2022–23 average earnings are due to be below where they were in 2007–08. That implies a lost decade and a half of wage growth, an unprecedented period of stagnant earnings in the UK.
We should all hope that these new forecasts are unduly pessimistic, and that wages grow more strongly than expected. Nonetheless, it seems likely that private sector workers will not see strong earnings growth on average over the next few years.
“Whether you work in the private sector or your pay is set in Whitehall, the nation’s productivity performance matters to you”
One group that might be a bit more optimistic about their pay prospects after the budget are public sectors workers. The Chancellor has formally lifted the public sector pay cap, which constrained cash increases to public sector pay scales to 1% (meaning wage cuts after accounting for inflation).
This suggests that wage increases beyond 1% seem likely, though the forecasts imply public sector wages only just keeping pace with their private counterparts over the next five years. Importantly however, while the Chancellor lifted the pay cap he is yet to allocate any additional funds to cover the extra wage costs of public sector bodies. This is likely to amount to almost £3 billion in 2020.
If the money were not provided to cover the increased costs, this would put a further squeeze on the already-tight budgets of government departments over the next few years. Implementing more generous pay settlements would require reductions to non-wage costs or a smaller public workforce relative to a lower-pay scenario.
Will the Chancellor provide funds for higher pay as and when that becomes available? And how generous will those pay settlements be? That will depend at least in part on the health of the public finances in general, and the progression of private sector wage growth. And both of those depend crucially on the economy evolves.
So whether you work in the private sector or your pay is set in Whitehall, the nation’s productivity performance matters to you. It affects wages and, as a result, what the government can afford, both of which affect our living standards. We should all be hoping that the dreadful forecast for productivity in yesterday’s budget is too pessimistic. Otherwise another few years of squeezed living standards beckons.
Thomas Pope is a Research Economist at the Institute for Fiscal Studies