Business Irish

Saturday 20 July 2019

Wages and prices in balance but interest rates a threat

The temptation to perform an act of financial conjuring to get voters on side might prove to be too much for politicians to resist, even if the situation calls for a subdued budgetary policy
The temptation to perform an act of financial conjuring to get voters on side might prove to be too much for politicians to resist, even if the situation calls for a subdued budgetary policy
Brendan Keenan

Brendan Keenan

Winter came, with a vengeance, but the winter of discontent never did. In another prediction which went awry, the industrial relations unrest which might have been expected to follow such a period of austerity failed to materialise.

The Great Recession produced a prolonged period of wage stagnation, with little or no growth in overall wages for almost a decade. These were years when living standards were falling as a result of tax increases, charges for public services and reductions in the services themselves.

The economy began to pick up some five years ago. One might have expected something of a stampede to restore those lost living standards as soon as recovery became obvious.

Not as long as five years ago perhaps, but from 2015 or thereabouts. In fact, it was only last year that a clear upward trend emerged, with signs that it was accelerating in the final quarter.

Average weekly earnings were 2.5pc higher than a year before - the fastest 12-month growth since the recession and twice the growth rate of 2016 .

There was no general fall in wages in the years from 2012 - just no increase - so average annual earnings are now at a record high of around €38,000.

It is true that that stagnation hid considerable variations. Sectors such as finance, professional activities and IT were much less affected by the recession and wages picked up earlier in the recovery.

This was especially true in the information and communications sector. Looking at hourly earnings, which may be a better guide in turbulent times, there was a 13.3pc increase for that sector over the five years from 2012, whereas, at the other end, the overall public sector saw a 1.5pc fall.

That has since been eliminated by a 3pc rise last year, but 'public administration & defence' is still bottom of the list for increases. Who would ever have thought it?

Economists at the Central Bank, among others, have pointed to the apples and pears problem of comparing wages over such a long period of enormous change.

They are not the same mix of jobs as before, especially where construction is concerned. In many cases the increases in employment in the recovery were first-time jobs or people coming out of unemployment, who would be enjoying an increase in income even if the rate for the job had not improved.

Employment statistics need careful examination. As recently as a year ago, 10pc of workers surveyed said they were willing to work up to 16 hours more per week if the work was on offer - suggesting there was still scope for employers to get more hours from staff, rather than having to pay more per hour to attract new workers or retain the ones they had.

The bank research found that the rule of thumb which says wages respond to unemployment tends to apply only when unemployment is particularly high or low. Changes of a few percentage points in moderate rates of unemployment do not have a significant effect on wages. The problem is defining the low point at which things change.

Other influences are quite different from pre-crash days, with an unusual - perhaps unprecedented - pattern. The public sector is well-paid, at €26 an hour but has had limited gains so far.

Workers in accommodation in food earn just half as much, but saw a 5.5pc rise in pay over those five years. Also odd, but welcome, is that the other lowest-paid sector, wholesale & retail, did even better, with a rise of almost 9pc. Only the professional and communications sectors had bigger increases in earnings.

A lot of statistical regressions will be needed to provide analytical evidence as to the causes of these unexpected patterns. In the meantime, we will have to make do with everyday observation.

The most obvious difference from pre-crash times is the virtual absence of inflation and the shifts in trade union power. One also has to add the development of the gig economy and the free movement of workers from the newer EU members.

Recent data showed employment growth among Irish nationals up by 1.7pc, while the number of non-Irish nationals at work increased 5.3pc.

There is also the very free movement of Irish workers to the airports when jobs are scarce. Three of these factors would tend to reduce workers' bargaining power but the fourth - zero inflation - may mean that they do not mind as much.

That might help explain developments in the public sector. Yes, there were strikes and threats of strikes, but settlements were mostly reasonable, given what happened for so long before.

There was not the wave of unrest that those of us with long memories might have expected. Union power is not the issue here, but member militancy and public tolerance may be.

It raises the thorny question which has bedevilled economists and central bankers: what exactly is the role of inflationary expectations on wage behaviour?

Monetary policy, which is supposed to look ahead, lays great stress on expectations but, as with nearly everything in monetary policy, the actual evidence is hazy. The Irish experience may be support for the theory that expectations do make a difference.

Some statistical explanation is needed here too. The 6pc increase in rents (5pc for local authority rents) is a long way from the 0.3pc inflation rate in the year to January. That figure itself incorporates a 1.7pc increase in the cost of services and a similar fall in the prices of goods.

Everyone has their own personal inflation rate but it seems fair to say that not many are worrying much about rising prices eroding the value of their earnings.

The CSO's measurement of the vacancy rate has fallen to 1pc and many workers will instead be expecting further rises as labour supply gets tighter.

This is how it should be, with wages balancing supply and demand for labour without the complication of rising prices, but another complication is on the way.

As central banks begin to raise interest rates, prices will rise, and expectations of more along with them. This effect will be more pronounced in Ireland because of the high level of borrowing, especially on tracker mortgages.

They will have to follow the ECB all the way, while there might - indeed ought to be - some reduction in bank margins for those on variable rates.

Irish rates will still be too low for Irish conditions but the shock of any significant change should not be underestimated. That will help restrain consumption but it will also increase pressure for wage increases.

In these unusual circumstances, the old nostrums about inflation and loss of competitiveness should not be wheeled out too readily. This may be a time to let market forces do their work.

If so, it creates dilemmas for government policy as well. There has rarely been a better moment to achieve the elusive ideal of the private sector leading the way on wages, while keeping the increase close to the nominal rate of economic growth.

Masterly inactivity on budgetary policy might be the best approach but, with the political cycle looking the way it does, that may be too much to hope for.

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