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You Can’t Have a High-Wage Economy Without Strong Unions

Boris Johnson claims that he wants to see a high-wage economy, but Britain's decade-long wage stagnation is directly linked to the decline of trade unions – and the Tory laws that helped to cause it.

As the United Kingdom is plunged deeper into chaos, Boris Johnson announces that the petrol shortages, soaring energy prices and empty shelves are all part of his master plan. He claims the economy is transitioning towards a high-productivity, high-wage model and away from the ‘old broken model with low wages, low growth, low skills and low productivity, all of it enabled and assisted by uncontrolled immigration’, promulgating the false dichotomy between wages and immigration.

It is undeniable that the UK has a long term issue with productivity, particularly since the 2008 financial crisis. Also, Brexit has played a role in the current shortage of HGV drivers, which has led to a tighter labour market. In some cases, drivers have seen an overnight wage increase of over 30 percent. However, the idea that immigration has been responsible for the low wages and low productivity to date is highly contentious.

Firstly, there is more to the current labour shortage than Brexit. The Institute for Employment Studies estimate that there are almost a million people fewer in the labour market due to younger people staying in education longer and older people dropping out of the workforce. Furthermore, changes to the ‘off-payroll working’ rules or ‘IR35‘ have fuelled the HGV driver shortage by as much as 100,000. The IR35 reforms have been designed to crack down on tax avoidance by ‘disguised employees’, i.e. contractors who work like regular employees but, because they use a limited company, gain a tax advantage by paying the lower corporate rate rather than employment rate.

This practice is illustrative of a much broader issue within the gig economy, which is partly attributable to the UK’s productivity problem. It has become common in the UK for tech-platforms and other companies operating on low margins to shift some of their operational risk onto precarious contract workers. Not only does this mean that workers go without sick-pay or holiday pay but it also obfuscates the companies’ obligation to pay employer national insurance contributions.

Figure 1. Data from ONS and The Migration Observatory, University of Oxford, adjusted for inflation calculated using Bank of England inflation calculator.

This chart looks at the relationship between immigration (foreign born population) and average weekly earnings (adjusted for inflation) between 2004 and 2017. There is not a clear relationship between the two. What is clear though is that average weekly earnings have fallen significantly since the 2008 financial crisis. This was due partly to a fall in productivity but has been exacerbated by the inane austerity policies of the Coalition and then Conservative governments.

While productivity in the UK has taken a significant hit since 2008, which has had an impact on average earnings, this doesn’t necessarily mean that an increase in productivity will be met with a commensurate increase in wages. In 2012, a study by the Commission on Living Standards found that between 1990 and 2010 there was a ‘gross decoupling’ between productivity (GDP per hour worked) and median hourly earnings. Prior to the 1990s the relationship between productivity and worker remuneration was much stronger. So what changed?

After running a successful campaign by pinning the blame for the hyperinflation of the 1970s on trade unions and Labour Party policy, Margaret Thatcher was elected in 1979. During the 80s, Thatcher’s government brought in a series of trade union reforms that included limits on closed union shops, secret ballots, and a ban on ‘secondary’ picketing, which weakened the unions and led to a substantial decline in union membership. By 1990, union membership in the UK had fallen to around 9 million, its lowest level since 1948.

Figure 2. Data from GOV.UK and Our World in Data.

Once membership had fallen below that point, average weekly earnings broke from their previous trajectory (notice the red line). Had the previous trend continued, average weekly earnings in 2008 would have been close to £600 per week, £100 higher than the actual figure of £500 per week. While this shortfall can’t be entirely attributed to the decline in union membership there is plenty of evidence across countries to support the relationship between higher union density and higher wages.

Thatcher’s reforms in the 80s were predicated on the assumption that unions had driven up wages so much that business owners and banks had lost the incentive to invest. This meant productivity, and subsequently output, had slowed leading to a stagflationary spiral. There is some truth to this narrative but it disingenuously overlooks the key global shifts that took place during that time.

The Nixon Shock of 1971 saw the end of the international fixed exchange rate system (Bretton Woods), whereby all currencies had been pegged to the US dollar (see Figure 3.). The Pound had been over-valued for years relative to the UK’s sluggish productivity and growing trade deficit. In contrast, Germany’s Deutsche Mark had been undervalued relative to its increasing productivity in order to sustain its trade surplus as part of the Marshall Plan after WW2.

Once the Bretton Woods system ended, the two currencies began to adjust to the market rate. The pound depreciated, while the Deutsche Mark began to rapidly appreciate. That meant the cost of imports for the heavily import dependent UK began to increase, leading to cost push inflation and the demand for higher wages. To add to this the OPEC oil embargo of 1973 led to a surge in energy prices, further adding to inflationary pressures and the demand for higher wages.

Thatcher’s reforms, which weakened collective bargaining rights, broke the mechanism by which workers could bid for higher wages, as well as increasing interest rates to slow credit growth in the economy. The policies succeeded in bringing down inflation, but at great cost – unemployment reached 12 percent by the mid-80s.

Figure 3. Data from The FRED Blog.

What’s more, the weakening of labour rights didn’t fix the country’s productivity issue. Businesses and the wealthy simply channelled their increased profit-share into assets like housing and financial markets, which has created to record levels of inequality and a younger generation now unable to own their own home. It was the weakening of these labour rights in the 80s, not immigration, that enabled businesses to become reliant on cheap, exploited labour.

What lessons can we learn today from the experiences of the 1970s and 1980s? First, supressing wages and raising interest rates are not an effective response to supply-side constraints. In the 70s, a weakening pound led to higher import costs and artificially created oil shortages led to surging energy prices. The position is similar today. We are still battling with the logistical and supply chain shocks brought on by global lockdowns. On top of that, a particularly cold winter for Europe last year, combined with resurgent energy demand from China, has led to dwindling oil reserves, which has been exacerbated by the UK’s woefully inadequate storage capacity.

Johnson is right to be embracing the nascent resurgence in rising wages. However, these increases will be short-lived if wages are not met with increases to productivity. Without this, increased costs will be passed onto to consumers, with a large number already facing up to a £1,000 decline in annual income from the cut to Universal Credit. Interest rate hikes at this point would be devastating.

Corporate debt for SMEs (which account for around 60 percent of employment) is at record highs. A rise in rates would lead to higher debt servicing costs, which could lead to defaults and job cuts before the economy has even begun to recover. Instead, the government should be taking advantage of low interest rates to increase borrowing for the purposes of addressing supply-side shortages, as well as longer term infrastructural investment aimed at building an economy more resilient to exogenous shocks.

However, action needs to be taken to negate the impact of low interest rates on rising asset prices. The introduction of a wealth tax, alongside rent controls on private landlords, could help to curb the excesses of rampant speculation in these markets (and both measures are popular with Tory voters). If the Prime Minister were sincere in his advocacy for higher wages and productivity, he would act to strengthen trade union rights by adopting the kinds of policies outlined by the IER’s Manifesto for Labour Law. Only then would his calls for ‘levelling up’ become more than a cheap slogan.