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Chart: UK economy and employment

Between 2007 and 2015, the UK was the only big advanced economy in which wages contracted while the economy expanded. In most other countries, including France and Germany, both the economy and wages have grown.

Italy and Portugal are yet to reach their pre-crisis levels on both measures, while in Finland and Spain real wages grew in periods of economic contraction.

The UK sits on its own as a rich economy that experienced a strong economic performance while the real wages of its workers dropped.

Britain’s GDP went back to pre-crisis levels in the third quarter of 2013 and it is now nearly 10 per cent larger than in the second quarter of 2008. Yet in 2014 wages were almost 10 per cent lower than seven years before. During the same period, salaries in France and Germany grew 7 per cent.

The contraction of UK real wages was reversed in 2015, but it is not going to last. “We expect a squeeze on income growth over the next few years,” writes Jonathan Loynes, chief economist at Capital Economics in a note, “but it should be limited by past standards.”

There are various reasons for the exceptional case of the UK, not least a shift towards lower-paid jobs, low productivity levels and growth, a strong rise in employment and higher inflation.

More people in work but with lower pay

Only the US and Canada have greater flexibility in labour market regulation than the UK, according to the OECD. Thanks to a more flexible job market, people were able to find jobs quicker than in other countries. Employment expanded by 2.4 per cent in the six years to 2013, while in France there was no job expansion and the EU as a whole experienced job losses.

After the crisis, labour supply increased, but these “unusual increases in labour supply” were absorbed by the market, writes the OECD in its latest country survey. Pension reform and other policies contributed to the increase in supply with a rising number of older workers and incentives to work rather than live off benefits. Meanwhile “sustained inflows of well-educated immigrants have boosted the working-age population”, says the OECD.

Such employment expansion coincided with the loss of labour bargaining power due to the risk of unemployment and “slack” remaining higher than pre-crisis levels. Unemployment, underemployment and involuntary part-time working, for example, were far above their levels in 2008. Coupled with low and falling levels of unionisation, employment growth came at the expense of a fall in real wages.

The expansion has begun to slow, not just because of the Brexit vote, but also because the economy is close to full employment, reducing downward pressure on wages.

Wages have not kept up with inflation

Inflation is likely to squeeze real wages in the next couple of years just as it did after the crisis.

Between 2007 and 2015 the UK had one of the highest inflation rates among big advanced economies, largely because of high energy prices and the depreciation of the pound. Consumer prices expanded at an annual rate of over 5 per cent at their peak in September 2011, well above the rate of expansion of nominal earnings.

Now inflation is rising rapidly once again.

It is expected to exceed 2.5 per cent this year because of the pound falling further. But in a tight labour market, high inflation “may make it harder for firms to award small pay increases”, says Capital Economics.

When employment was expanding, it was in lower-paid jobs

Employment growth was driven largely by self-employment and part-timers, while the number of full-time jobs shrank. “The rapid rises in employment over the past few years have been made up by a larger than usual share of low-skilled jobs which tend to be lower paid,” says Capital Economics.

Chart: UK employment

The number of managers fell more than 24 per cent in the eight years to the third quarter 2015, while the number of sales and service workers expanded by a similar amount.

So as manufacturing and financial services lost workers, the workforce in accommodation and food services expanded.

The trend is now reversing, and the number of managers, professionals and technicians grew in the last year, while the number of elementary occupations contracted. Which means that the composition of jobs should stop pushing the average real wages level down.

Companies hired people rather than invested in capital

UK employment expanded at the expense of capital stock, which contributed to low (and falling) levels of productivity. In turn, lack of investment growth hampered productivity with negative effects on wages. “Whether pay drives productivity, or productivity drives pay, they go hand in hand,” as Sarah O’Connor, our labour correspondent, puts it.

Inflation and the dynamics of the labour market are pulling real wages in opposing directions. Ultimately further progress in living standards rests on boosting productivity growth, a challenge for the coming years.

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