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Normal people see rising wages as a source of cheer. But to Scrooge-like central bankers, bumper pay packets are a cause for concern. The OECD expects that in 2023 remuneration per employee in Britain will grow by more than 7 per cent, compared with 5.5 per cent in the eurozone (excluding Latvia, Lithuania and Croatia) and 3.7 per cent in America. How worrying is this really?
Wages can rise for lots of reasons. The obvious one is that they are part of the general upward drift in prices, which is normally about 2 per cent a year. The best one is that workers are being rewarded for higher productivity. That could support growth of perhaps another 1-1.5 percentage points.
Other sources of real wage strength might include falling import prices. (Intuitively, foreigners wanting to sell us cheaper stuff is nice and can make us better off.) Or employees might bargain for a bigger share of the economic pie, crimping companies’ profit margins. Relying on either to deliver wage gains forever is risky, though, since foreigners are fickle and eventually profits will run out.
A final set of pay drivers will attract the economic slur “unsustainable”. Central bankers frown on the dynamic of employers bidding up pay simply to secure scarce workers. They also frown on workers demanding higher wages to cover the rising cost of imports, which their bosses don’t want to absorb either. (Intuitively, if foreigners whack up their prices, someone has to suffer.) Above all, they fear “second-round effects”, where higher wages feed back to higher prices, pushing inflation above 2 per cent. In an extreme case that could cause a wage-price spiral.
It’s tricky to decipher what all that means for inflation today. In America, the eurozone and Britain, real remuneration per employee has fallen over the past couple of years. But it is unclear exactly how much of that is the inescapable effect of real shocks such as higher import prices or lower productivity, and how much is only temporary as wages catch up with prices at the expense of profits.
Over the medium term, central bankers do seem sure that nominal wage growth will have to be lower if they are to meet their inflation targets. Reassuringly, nominal pay growth seems to have peaked, and in America it may not have to drop very much further. Still, rate-setters are struggling to relax.
The basic fear is that although tight labour markets were not the source of the original inflation, they could interfere with the job of getting wages and prices back on a sustainable path. This year the economists Ben Bernanke and Olivier Blanchard estimated that in America the “catch-up” effect of workers trying to maintain their real income in the face of a shock to prices was pretty weak. But after the initial inflation shock faded, a high ratio of vacancies to the unemployed had a lingering effect on workers’ ability to bid up pay.
A related warning comes from economists at Goldman Sachs, who warned of a historical interaction between high inflation and tight labour markets in pushing up wage growth. That suggests that as inflation first falls, wage growth should plunge too without much of a deterioration in the health of the labour market. But once inflation is at less extreme levels, getting wages down as well will require something more draconian.
In the eurozone the good news is that import prices have fallen recently. The ECB has also spotted signs of firms absorbing higher wages into their profit margins. Both should support some real wage growth after its recent decline. But productivity has disappointed. In a speech on November 2, the ECB’s Isabel Schnabel warned about “labour hoarding”, whereby companies might hang on to workers, pushing up labour costs and inflation.
Policymakers at the Bank of England are probably feeling most tense. A recent study by Jonathan Haskel and others replicated the analysis of Messrs Bernanke and Blanchard, and found that Britain’s wage growth seemed to be stickier than in America. Recent annual wage growth of almost 8 per cent has been even stronger than most expected — and than the bank’s standard models predicted.
The good news is that there is a path to something more sustainable. The OECD forecasts that while nominal wage growth will fall in each of Britain, the eurozone and America, inflation will fall faster. That means some recovery in real pay per employee over the next couple of years, in line with other episodes that have started with high wage growth and inflation. Fret, by all means. But there is still a chance of a happy ending.