Who’s in the driver’s seat?
Global growth is robust, employment is strong, and almost everywhere you look asset prices have been rising. Edward Smith, our head of asset allocation research, examines why despite this strong backdrop wage growth remains so weak, and where it's headed.
Workers in advanced economies seem to be losing their bargaining power. Despite UK and US unemployment being very low, wage growth is muted –will this trend continue, and could demand for the services of financial advisers shrink along with disposable incomes?
In economics, the relationship between a country’s employment conditions and inflation is known as the ‘Phillips curve’. In theory, as unemployment declines, the rate of inflation increases, highlighting the trade-off that policymakers face. But empirical evidence in recent decades has cast doubt on this link.
For one thing, globalisation has increased the importance of the global cycle. Indeed, there is evidence that global competition has reduced the ability of firms to pass on wage increases.
Financial globalisation has also led to more synchronised economic cycles between countries; when one region sneezes another is now much more likely to catch a cold. Still, our analysis suggests that the influence of the global business cycle over inflation is not particularly strong.
Another possible explanation is that central banks, with their explicit inflation targets, have managed to establish more credible monetary policy and this has resulted in inflation becoming better ‘anchored’. If inflation expectations act as an anchor around which the ebb and flow of the economy may cause actual inflation to deviate, a strong anchor means less deviation.
Numerous studies confirm a steady increase in the importance of long-term inflation expectations, which have been stabilised by central bank targets. This may be why there was no deflation spiral after the financial crisis despite large increases in unemployment. There is also evidence that when inflation is low and everyone expects it to stay anchored, it becomes irrelevant for wage negotiations and other price setting decisions. But this state of affairs does have its benefits when it comes to financial planning.
A third potential explanation relates to changing work patterns, a trend that advisers will be well aware of. Growth in the number of self-employed, part-time and workers on ‘zero hours’ contracts has clearly changed the face of the UK workforce. Such flexible arrangements can bring benefits and there is some evidence that this has enticed previously inactive people back into work. And more people entering the workforce may dampen wage growth even as demand for workers increases.
Furthermore, employment is arguably more precarious when you are paid by the task or hour. The rise of flexible employment is therefore likely to have reduced workers’ ability to bargain for higher wages, and has certainly reduced their ability to bargain in groups. Data from job listings websites appears to confirm this, with far greater dispersion of wages around similar self-employed jobs than around full-time pay. In essence, there is no ‘going rate’ for the ‘flexibly’ employed.
According to Andy Haldane, the Bank of England’s Chief Economist, while changes in working patterns may not be the main culprit in supressing wage growth, they have probably contributed and look likely to continue doing so in the future.
A fourth credible explanation is that the Phillips curve itself is simply difficult to specify. Some historically stable statistical relationships seem to have shifted recently. In some countries, the inactivity rate (the proportion of the population neither in work nor looking for it) has increased, while in others the proportion of long-term unemployed has risen.
In others still, a pronounced increase in the number of jobs available for every unemployed person may indicate that the unemployed don’t have the right skills. Each of these changes could materially shift the slope of the Phillips curve; as such, it is extremely difficult to know what measure of domestic conditions is best.
In our next and final article in this series on inflation, we’ll explain why we don’t see either a profoundly inflationary or deflationary scenario developing in the coming years. That should be good news for advisers tasked with helping clients to achieve their financial goals.
Please visit Rathbone’s inflation hub where you can try our personal inflation calculator and read about the economic themes driving inflation in greater detail in our investment report Under pressure?