I say this for one simple reason. Unemployment has fallen, and a tighter labour market means higher real wages. There's a strong correlation between unemployment (measured in a wider sense to include the economically inactive who want to work as well as the officially unemployed) and subsequent annual changes in real wages. Since 2000, the correlation coefficient has been minus 0.59, with each percentage point lower unemployment leading to 1.1 percentage points higher growth in real wages.
With this wide unemployment rate two percentage points lower than it was in 2013, at 10.2 per cent of the working age population, this fact points to rising wage wages.
Of course, unemployment isn't everything that matters. But if we consider just three other factors, we can explain more than three-quarters of the variation in real wage growth since 2000. These factors are:
- Productivity growth. The faster this is, the faster wages grow.
- The lagged level of productivity. A high level of productivity leads to rising wages, as workers capture some past productivity gains for themselves.
- The lagged level of real wages. If real wages are unusually high, employers claw them back - and vice versa.
These three factors, however, don't overturn the fact that real wages might well rise reasonably in the next few months. If productivity is flat (as it has been in the past five years) then if past relationships continue to hold, real wages will rise by 2 per cent in the next 12 months: the standard error in that past relationship is 1.1 percentage points).
This points to real wages rising faster than productivity, which implies that profits will be squeezed.
Granted, this conclusion rests on the assumption that productivity continues to stagnate. Companies would avoid the profit squeeze if they can raise productivity - which would entail sacking workers and increasing the work intensity of their remaining staff. But as they haven't done this for a long time, one must doubt whether they'll start doing so soon.
Now, you might, reasonably, be wary of any futurological inference from an econometric relationship. But we have two other facts that caution us to expect some squeeze on profits.
One is that low-paid workers will benefit from this week's rise in minimum wages. Over-25s will see their minimum wage rise from £6.70 to £7.20 per hour, a rise of 7.5 per cent. And 21-25-year-olds will see it rise to £6.95, a gain of 3.7 per cent. Unless employers can recoup these higher costs by cutting the pay of higher-paid workers or raising productivity, profits will be squeezed.
Secondly, consumer borrowing has risen recently: national accounts data show that households net borrowing hit an eight-year high in the second quarter. Insofar as households are rational and forward-looking - and on average they might be - this might have happened because they anticipate higher future real incomes.
Now, I'm not saying here that the profit squeeze will be especially severe, nor that it will be long lasting; in the long run, weak productivity growth means weak real wage growth too. And much of the squeeze will be suffered by private unquoted companies and not just quoted ones. Nevertheless, the point is that equity investors must not ignore distribution risk, the danger of a shift in incomes from profits to wages.
