Wage inflation is rising at last: official figures next Tuesday could show that annual growth in pay excluding bonuses has risen to 3 per cent for the first time in three years. We should not, however, worry that this is inflationary.
There are two ways in which higher wage growth might add to inflation – via higher costs or higher demand. Neither mechanism seems strong now.
Let’s take costs first. You might think it obvious that higher wages add to costs. Not so, if they are offset by efficiency gains. Which they are. Other figures next week are likely to show that total hours worked have been flat since the start of the year; this is because although more people are in work, average hours worked per week have fallen. With output rising, this means productivity is growing. Thanks to this, figures last week showed that unit wage costs were flat in the second quarter. With productivity likely to have grown again in the third quarter, this flatlining might well have continued. It’s likely therefore that annual growth in unit wage costs in the last 12 months has been around 1.8 per cent – bang in line with the average over the last five years.
Companies therefore do not need to raise prices any faster than they have been doing in order to cover labour costs, because these aren’t rising unusually quickly.
There is in theory another channel through which higher wages might add to inflation. If workers spend their gains, stronger demand might drag up prices.
True, there are signs of demand growing. Figures next week could show that retail sales volumes rose by a hefty 1.4 per cent in the third quarter. But this isn’t causing inflation. Last month’s data showed that the retail sales deflator (the gap between sales values and volumes, a measure of the prices that retailers charge) rose by 2.2 per cent in the year to August. Although this was up on March’s 1.8 per cent, it was down from the 3.1 per cent growth in the 12 months to August 2017. This tells us that retailers aren’t yet responding to higher demand by raising prices much. Which is unsurprising. Recent profit warnings from Ted Baker, DFS and Bonmarché – the latest in a long line – remind us that there is excess capacity on the high street. That’s likely to hold prices down.
None of this is to deny that there might be a danger of inflation. One problem is that a chaotic Brexit might see sterling fall and therefore import prices rise again.
More fundamentally, the current rise in productivity might be only temporary. Most of the things that should cause long-lasting productivity gains don’t seem to be in place. Quite the opposite. Latest figures show that capital spending has actually fallen in the last 12 months; it’s hard for workers to be more productive if they are using outdated equipment. Instead, it’s possible that productivity is rising simply because Brexit uncertainty has caused companies to limit hiring and so get more from existing staff. There’s a limit, however, to how far they can do this without more investment or innovation.
So yes, inflation might become a problem. But we should not blame workers for this.
