This is in sharp contrast to numerous decades before 2008. For example, from 1998 to 2008 wages, adjusted for inflation, grew by 25%. For most households, wages are the most important source of income, so they can only spend more if they run into debt. This creates a squeeze on living standards for workers and a skewed and unstable economy.
People cannot keep up their spending if their wages are not growing – unless they resort to borrowing. And this is what is happening in Britain. The UK household debt to income ratio is more than 150%. On average people’s debt exceeds their yearly income. Recently, the UK’s national statistics office reported, on average, each UK household spent around £900 more than they received in income in 2017. That amounts to almost £25bn in deficit for households across the country.
Longstanding debt addiction
Already before the 2007 to 2008 financial crisis, British growth was based on debt. At that time, growth was fuelled by a house price boom and ballooning mortgage debt.
Since the crisis things have changed, but not fundamentally. In fact, mortgage debt has been declining since the crisis, but now consumer credit is expanding fast. Economists speak of debt-driven growth. This is where people need to borrow to get by. It is a reflection of falling wages, and the UK remains addicted to debt.
The basic point is that households can’t spend on basic necessities (let alone luxury items) unless their wages are growing in line with economic growth. This is the essence of the idea of wage-led growth: wages should grow at least with inflation and average productivity growth. Today that would correspond to about 4%. In fact, wage growth is only half of that.
Higher wage growth is good for workers, but under current circumstances it is also healthy for the economy overall. Britain needs to be weaned off its addiction to debt. For that to happen people’s incomes have to grow, and so wages have to grow. Higher wage growth will boost spending as most of people’s wages is spent in the form of consumption.
Plus, higher wage growth creates incentives for companies to upgrade their production processes because higher wage costs motivate firms to modernise machinery. Wage growth speeds up technological progress. A 10% wage increase typically leads to 3-4% higher productivity.
Unlocking wage growth
There are many factors behind weak wage growth. Some of these are global: manufacturing firms can move production abroad where workers cost less. But much of it is homemade and a result of government policy and austerity, like weakening trade unions and allowing zero-hour contracts to spread.
Key to establishing a wage-led growth model is strengthening collective bargaining, labour unions and the rights of workers:
- Extend collective bargaining agreements to non-unionsed firms.
- Encourage collective bargaining agreements in various sectors.
- Strengthen the right to strike for trade unions.
- Strengthen worker rights in the gig economy.
- End zero-hours contracts.
- Increase the minimum wage to keep pace with inflation and productivity growth.
- Link the pay of managers to their firm’s performance and keep it in line with average wage growth.
Businesses might initially object, but employers will benefit from the stable growth that this approach offers, even if in the short term they are reluctant to raise wages. Importantly, they stand to benefit the most from a coordinated pay rise across the economy because of the boost it brings to both productivity and demand. This also strengthens the case for the state to take the lead in coordinating – and even subsidising – wage-led growth. It could also lead by example by lifting the public sector pay freeze.
Wages going up for the working population is an effective way to end austerity and boost economic growth. But, for austerity to end in the long term there must also be stricter regulation of the financial sector. Only this will stop the underlying dependence on the debt-led growth model.
Engelbert Stockhammer, professor of international political economy, King's College London