A wage recovery

Posted on February 27, 2015 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

In the last year the Central Bank has urged trade unions to raise their wage demands. What? Yes it did happen. But not here. The German Central Bank, the Bundesbank, urged German trade unions to up their wage demands – at least above the rate of inflation (the message was relayed through Jens Ulbrich the Bundesbank chief economist at the Bank). Somehow, it is unlikely that Dame Street (or Merrion Street) will be issuing similar advice in the Republic of Ireland. As matters stand, real wages have been in free fall since 2009 – compounding a fall in levels of consumer demand. Last week’s news of a modest recovery in average weekly earnings is welcome (Chart 1).

The latest trends show a downward overall trend in average weekly earnings from the beginning of 2009 to the third quarter of last year. There was a sudden and sharp increase in estimated average weekly earnings in the last quarter of 2014. This pushed the average weekly rate back up to where it was at the beginning of the recession. While there can be some flux in quarterly estimates and the final quarter estimate is ‘provisional’ it does appear that the pattern of falling wages has come to an end – provided that the economy continues to recover. When inflation is taken into account (using the consumer price index which includes the effect of falling mortgage interest costs in recent years) ‘real wages’ have moved more or less in tandem with nominal wages since the beginning of 2011 (reflecting low inflation). The thin blue line in Chart 1 shows the movement in the consumer price index. There was a re-emergence of very mild price deflation in the second half of last year – reflecting among other factors the impact falling oil prices.

The pattern of recovery in wages is very uneven across sectors and occupations (for further details see the latest CSO statistical release ) with some sectors and occupations faring worse than others. From peak real earnings (end of 2009) to the end of 2014 real average weekly earnings fell by just over 6% on average.  Coupled with the impact of cuts in social welfare and increases in taxation the actual cut in livings standards for households mainly dependent on wage income was greater than 6% over that period.

Chart 1

 However, a weak recovery in wages and in demand is not the equivalent of a nuclear wage explosion. The share of wages in total national income has been trending downwards over a long period even before the recession. An interruption to this long-term trend in 2009 as a result of a recession-driven collapse in company profitability (some of which was linked to the banks going bust) did not buck the longterm pattern (Chart 2)

Chart 2

Share of wages in total national income (Republic of Ireland)

The reasons for a decline in labour share of income both in Ireland and in some other countries are many and complex and reflect shifts in the composition of the workforce, demographics, technological change, globalisation as well as, in some cases, diminished power of labour.

Looking to the coming months and years what are the prospects for a recovery in wages? With a modest continuing fall in unemployment and increased demand for labour in growing sectors of the economy we are likely to see some modest growth in earnings in the order of 2 to 3% in most sectors. With GDP likely to grow at a faster rate it is likely, in the absence of any other major shocks, that wages as a share of ‘value added’ (Gross Value Added which is close to GDP) will decline. In other words, it is likely – in the absence of other factors – that corporate and other ‘non-labour’ income is growing faster than wages as some sectors recover.  The latest available published data from Eurostat/CSO indicate a slow recovery in profits from 2010 onwards. The closest proxy measure for ‘profits’ is ‘Net Operating Surplus and Mixed Income’ of all corporations (financial and non-financial). After a plunge of 22% in 2009, the total rose at an annual rate of just over 10% in 2010 and 2011 before levelling off at €47 billion in 2012. Chart 3 compares Ireland (Republic) with the average for the Eurozone (18 countries). While the structure of GDP and company profitability differs with Ireland attracting large number of ‘profit-shifting’ and ‘profit-booking’ companies compared to other countries it is clear that company profitability has recovered well since the crash of 2008 with a steady increase in profits as a percentage of GDP. The share is back up to 28.9% in 2012 compared to 27.5% in 2007 before the recession hit.

It should be remembered that GDP – even though it contains a large amount of ‘booked profits’ some of which are ‘repatriated’ abroad by multinational companies operating here, represents the total amount of income or production in Ireland which is liable or taxation BEFORE repatriation.

Chart 3

In any period of bust and boom profits – a residual in the income flows to producers tend to be more erratic. While the share of profits held up well during the Celtic Tiger period up to 2007 many companies took a huge hit in 2008 as did employees who lost their jobs, many (though not all) of the self-employed and most workers in the public and private sectors.  Clerical, manual and retail works took a bigger wage hit than professional and managerial workers (see CSO data).

What we have seen in the 3 years since the worst point of the recession has been relative stagnation in real wages (notwithstanding the turnaround in the last quarter of 2014). It is highly likely that company profitability has recovered well in 2014 (reflecting rising GDP, investment and retail sales).  Provided that GDP continues to grow at a rate of between 3 and 4 % there are grounds for a recovery in average nominal wages ahead of the rate of inflation and broadly in line with GDP. However, any recovery in wages will reflect conditions in different sectors and occupations including the public sector where some unwinding of previous cuts and re-alignment in salary and wage scales can be expected.

Would Irish policy makers, negotiators and analysts consider the case of the German Trade Union IG Metall!  Last week the Union won a 3.4% pay increase and a one-off payment of €150 to workers in the state of Baden-Württemberg. The issue at macroeconomic level is no longer whether there should a pay rise from here on. Rather, it is how much and where.

A wage rise in Ireland would stimulate consumer demand in Ireland, would increase revenue flow to the exchequer and, if implemented wisely, could contribute to a reduction in household income inequality.  The Republic of Ireland has a lower hourly labour cost in the case of manufacturing industry than: Germany, Sweden, Belgium, Finland, Denmark, France, Netherlands and Austria. [ See NERI Quarterly Economic Facts. Indicator 3.1 ]. Yes, the Republic of Ireland has higher hourly labour costs than the UK (by a difference of very roughly €3 per hour depending on sector). However, the UK comes second lowest in the EU15 group of advanced European economies.

In considering what is likely to happen in Ireland and what is desirable from a wider social and economic perspective analysts, negotiators and policy makers should pay attention to:

-          The relationship between low pay and poverty (which is significant among the low paid).

-          The role of the statutory hourly National Minimum Wage and low pay broadly.

-          The gradual uplift of quarter of million workers on low pay towards a ‘living wage’ (as proxied by €11.45 per hour for single person household. This rate which is an estimate for single persons, only, will increase somewhat in line with inflation in the future).

-          The degree of inequality in wages among employees as well as the returns to different sources of income – employees, self-employed, farming and businesses.

-          The relationship between a sustained and evenly spread wage recovery and domestic demand.

-          The relationship between costs (including labour costs) and price competitiveness especially in those sectors of the economy susceptible to international competition in trade.

-          The interaction between public expenditure, public services and the public sector pay bill including the cost of pensions.

And last but not least of all ….

-          The Social Wage – defined as those collective goods and services such as care, education, health and income protection in sickness, old age and unemployment – which together with individual wages ‘in your pocket’ make for a healthy, prosperous and happy society.

And to fund a European standard of social wage Ireland needs to develop a European standard of taxation and social insurance – very different from what we know today.

Posted in: IncomeLabour costsWages

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