Inflation has remained higher for longer than expected. After initially rising because of the price of essentials like energy and food being driven up by the pandemic, war in Ukraine and possibly Brexit, inflation was expected to fall. But now there are concerns that, in a tight labour market, people are better able to drive up their wages to try and catch up with prices. Is this what’s happening?

The nightmare of real pay

It’s certainly true that the labour market is tight. Employment rates are high by international standards, unemployment low and vacancies high. This is partly a success story, but partly because rising economic inactivity among older people and disabled people have limited the labour supply. Our Missing workers report explores this more.

It’s also true that nominal wages are rising at relatively fast rates: 6.5% in the year to April 2023, though still below inflation. But of course the bigger picture is of average real wages barely growing in 15 years, leaving them £11,000 below their levels if pre-financial crisis trends had continued.

Pay growth by sector

In general, higher-paid sectors like information and communications have had higher pay rises over the last year than lower-paid sectors like retail. But this is not uniformly true and of course pay varies within sectors. This chart looks at nominal pay growth for all workers (so a higher proportion of part-time workers can drive down the average) in the year to April 2023 (x axis) and average weekly wages (y axis), with the size of each bubble reflecting how many people work in each sector.

But what about more recently? Noting that the data are volatile, 12 out of 24 sectors have seen slowdowns in annual pay growth in the last six months. The chart below shows the percentage point change in earnings growth in the year to April 2023 compared to the year to October 2022, ranked from the lowest paying sectors on the left to the highest on the right. Six of the eight lowest paying sectors saw slowing wage growth and only two saw acceleration. Four of the eight highest paying sectors saw acceleration in wage growth and four saw slowing wage growth.

This matches the Bank of England’s recent analysis that pay growth has been strongest in higher-paid sectors.

Recruitment challenges driving up earnings growth?

If wages were being bid up due to labour shortages, you might expect workers in higher-vacancy sectors to be getting higher pay rises.

The chart below shows by sector how pay growth in the last year compares to the average and how the current vacancy ratio (vacancies divided by jobs) differs from the average. The top right quadrant shows higher-than-average pay growth and vacancies, the bottom left shows lower-than-average pay growth and vacancies.

There’s a weak positive relationship with sectors with higher vacancy rates having higher pay growth. But plenty of outliers, e.g. health and social work and accommodation and food services, have higher-than-average vacancy rates but lower-than-average pay growth. Of course, it could be that pay growth six months ago has a closer relationship with vacancy rate changes – taking a number of formulations and different lags or measures does not give a more obvious or clearcut relationship.

Can we trust the data?

There are several earnings measures and each has its own flaws. The data used in most of this blog comes from the Monthly Wages and Salaries Survey which gathers data from a sample of businesses registered for VAT or PAYE, so misses business not so registered. The Annual Survey of Hours and Earnings is more definitive, but only annual. HMRC’s data is frequent and timely, but excludes people not on payroll like the self-employed and can be subject to significant revisions.

Ultimately earnings are difficult to measure, so you have to judge the overall picture and consider the strengths and weaknesses of different data sources.

The distributional dimension

To finish, let’s return to the point about higher- and lower-paying sectors. Here’s a chart showing annual pay growth each month by sector, with average wage growth and inflation for comparison. The 8 lowest paid sectors are in red, the middle paying 8 in purple, and the highest paying 8 are green.

The higher earnings growth sectors so far in 2023 are higher and medium paying. No lower-paying sector has seen real earnings growth in any month so far, and only education (January) and agriculture (March) have had higher-than-average earnings growth in any month.

Let’s make that picture starker. Aggregating these low-, medium- and high-paying sectors together in a simple numerical average (so not accounting for the relative size of each sector) shows higher-paying sectors have had the highest pay growth in both the last 3 (5.1% v 3.7%) and last 12 (7.1% v 5.7%) months than the lower-paid sectors.

What does this mean?

None of this means that nothing needs to be done about inflation. But what you do has distributional consequences.

We also need to understand this is a dynamic process. Often we focus on headline earnings growth. But the highest-growth sectors 12 months ago are not the same as today – those dynamics matter.

It’s also worth noting that the focus here is on earnings. But inflation is driven too by global factors, whether aggregate demand exceeds supply, and corporate behaviour and competition levels.

Lastly, and perhaps most depressingly, if inflation is persistently above target when GDP is only hovering around pre-pandemic levels, that suggests the growth potential of the economy is very weak.

To end on an optimistic note, we can boost our growth potential by investing in employment and skills – meaning higher pay rises and better public services for all of us.