“Productivity isn’t everything, but in the long run it’s almost everything.”
These wise words of the Nobel Prize-winning economist Paul Krugman have special relevance for the current state of the British economy. The recent squeeze on real wages has been due to the appalling performance of productivity, aided and abetted by the deterioration in our terms of trade, brought about by the surge in international energy prices.
Of course, it is possible for individual groups of workers to escape these constraints by forcing up their pay. But this usually ends badly. We seem to be on course for having to relearn some old lessons.
It has been a depressing few weeks for those of us who are worried about the exercise of union power. The Labour Government has awarded pay rises of 5pc to 6pc to about 3.5m public sector workers without securing any productivity improvements. That award adds 0.4pc to the overall level of average earnings in the country as a whole.
The Government also offered doctors a rise of 22pc over two years but GPs have voted for industrial action. The Government caved in to striking train drivers. Admittedly, since there are 21,000 train drivers, this award will have a negligible effect on overall average earnings. Yet no sooner had this happened than the train drivers’ union, Aslef, announced more strikes by its members who worked for LNER.
Meanwhile, Border Force workers at Heathrow have said that they intend to take industrial action for most of September.
There will be calls at next month’s annual meeting of the Trades Union Congress for widespread awards of above-inflation pay rises to make up for the squeeze on real incomes that has happened over recent years. The Public and Commercial Services Union – which represents almost 200,000 public sector workers – said that since 2011 real pay had fallen at an average rate of 1.5pc per annum.
It says that pay restoration in the public sector should be a key feature of unions’ campaigning with the Government. More aggressively, it said: “We think the Government should invest in pay to put living standards where they should be.”
Yet the squeeze on real pay has not been restricted to the public sector. It has been experienced across the economy with hardly any group of workers escaping a squeeze and millions of savers suffering negative real incomes from their savings as inflation soared above interest rates.
The use of the word “invest” made me smile. It conjured up memories of Gordon Brown’s heyday when all sorts of public spending would be justified by calling them investments. It also filled me with dread that we are about to experience a return to the dark days of the 1970s.
Twice that decade, huge increases in international oil prices drove up price inflation significantly. Prices and wages chased each other upwards in what was referred to as a wage-price spiral.
Admittedly, Labour apologists say that we should not worry because at the moment – settling current disputes is all about tidying up after the mess left by the last government. They say that, later in the year, the Government will stand firm against rapacious public-sector pay deals and seek to wring productivity concessions out of the workforce, including in the NHS.
Let’s hope this is right. But the trouble is: if you pay Danegeld, then the Danes will come back for more.
With regard to pay negotiations, the state of expectations is critical. Having conceded so much in the weeks since the election, this Government is now on the backfoot. It has created the expectation across the economy that it would not stand firm and the mere threat of strike action would be likely to bring a reward in the form of higher pay.
The same applies in the opposite direction. This is why Mrs Thatcher’s defeat of the miners’ strike in 1985 was so important. Once a government has established the expectation that it will stand firm and resist pay demands even in the face of damaging strike action, that shifts the economics of going on strike and makes it much more likely that unions will be compliant. If you like, standing firm against union militancy is an investment that pays dividends later.
Admittedly, things now are very different from how they were in the 1970s. Union membership is now much lower and a smaller proportion of the economy is in public ownership.
This being the case, it is possible to imagine a wide swathe of public sector workers successfully pushing up their pay without engendering much of a knock-on effect in the private sector. In that case, the pay of public sector workers would rise relative to the private sector.
But this would hardly be a good thing. Although there are parts of the private sector where low productivity is a distinct problem, there is little doubt that low productivity is an especially acute problem in the public sector. The way forward is surely to concede higher real pay in the public sector only in return for major productivity improvements.
Meanwhile, the increases in public sector pay will worsen the already poor public finances and present the Chancellor with an awkward choice between increasing taxes, cutting departmental spending and letting borrowing increase. Recent mood music has suggested that the bulk of the finance will come from higher taxes. This is hardly the way to stimulate the economic growth which the Government avidly wants.
Lord Mandelson has apparently advised the Government that it should make difficult decisions early. However difficult they are now, they will only become more difficult later. I do not suppose that he had Labour’s relationship with the trade unions in mind. But his advice applies here also.
The situation is not irretrievable and we are not going back to the 1970s. Yet the Government has made a bad start with the unions. There will be a heavy price to pay later.
Roger Bootle is senior independent adviser to Capital Economics – roger.bootle@capitaleconomics.com
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