Why Brexit has led to falling real wages

This might seem easy. The depreciation immediately after Brexit, plus subsequent declines in the number of Euros you can buy with a £, are pushing up import prices which feed into consumer prices (with a lag) which reduce real wages. But real wages depend on nominal wages as well as prices. So why are nominal wages staying unchanged in response to this increase in prices?

Before answering that, let me ask a second question. Why hasn’t the depreciation led to a fall in the trade deficit? Below are the contributions to UK GDP from the national accounts data. Net exports are very erratic, but averaging this out they have contributed nothing to economic growth since the Brexit depreciation.

The belief that the depreciation should benefit UK exports is based partly on the idea that exporters will cut their prices in overseas currency terms, making them more competitive. Yet at the moment UK the majority of exporters seem to be responding to the depreciation not by cutting prices but by taking extra profits. If they keep their prices constant in overseas currency terms (from currency denomination data almost as many exports are priced in overseas currency as imports), sales will stay the same but profits in sterling will rise.

While this helps account for the lack of improvement in net trade, it increases the puzzle over why nominal wages are not responding to higher import prices. If exporting firms profits are rising because of the depreciation, why not pass some of that on to their workers?

One perfectly good answer is that the labour market is weak, and what has stopped real wages falling further is that firms do not like to cut nominal wages. In these circumstances there would be no reason for exporters to share their higher profits with their workforce. So the immediate impact of the depreciation has not been a decline in the terms of trade (export prices/import prices), but instead a shift in the distribution between wages and profits. But many people believe that, with unemployment falling rapidly, the labour market is not weak.

There is another reason why exporters might be increasing profits but not sales, and not passing higher profits on to higher wages, which goes back to a point I have stressed before. We need to ask why the depreciation happened in the first place. To some extent the markets were responding to lower anticipated interest rates set by the Bank of England, but there is more to it than that. Brexit, by making trade with the EU more difficult, will reduce the extent of UK-EU trade. Furthermore there are two reasons why Brexit is likely to reduce UK exports by more than UK imports.

The first is specialisation. Because countries tend to specialise in what they produce, they may not have firms that produce alternatives to many imports, making substitution more difficult. The EU produces many more varieties of goods than the UK, so they are more likely to be able to substitute their own goods to replace UK exports. The second is the importance for UK exports of services, and the key role that the Single Market has in enabling that. On both counts, to offset exports falling by more than imports after Brexit we need a real depreciation in sterling. Exporters will have to cut their prices in overseas currency terms, and a depreciation allows them to do this.

Of course Brexit has not happened yet. We still get a depreciation because otherwise holders of sterling currency would make a loss. So firms do not need to cut their prices in overseas currency yet, allowing them to make higher profits. But these higher profits will be temporary, disappearing once Brexit happens. It would therefore be foolish to raise wages now only to have to cut them later when Brexit happens (no one likes nominal wage cuts). To restate this in more technical language, when Brexit does happen the UK’s terms of trade will deteriorate as a response to export volumes falling by more than import volumes. Firms are in a sense anticipating that decline in the terms of trade by not allowing nominal wages to rise to compensate for higher import prices.

So before Brexit happens we are seeing a distributional shift between wages and profits, but once Brexit happens profits will fall back and we will all be worse off. For Leave voters who think this is all still just ‘Project Fear’, have a look at the national accounts data release that the chart above came from. It shows clearly that UK growth in the first half of this year has been slower than that in the US, Germany, France, Italy and Japan by a wide margin. What Leave campaigners called Project Fear is real and it is happening right now, but do not expect your government or some of your newspapers to tell you that. 

Real wages are mainly a macro issue

What do I mean by this? Macroeconomists have many faults, but one clear positive is that we think about systems as a whole rather than just one particular component. One area where it is important to do this is in thinking about what determines economy wide real wages. Take, for example, this recent post by the Flip Chart Rick. (His posts are brilliant and I try and read every one, but unfortunately this one is too good an illustration of the problem I have in mind.) He starts with this chart from the FT that I reproduce below.

Why is the UK unique in having a combination of negative real wage growth but positive GDP growth? Now it just so happened that I had written a post about this, explaining I thought pretty well the key reasons. But Rick mentions none of these, but writes about a whole bunch of stuff related to labour market structure and trade union power that I think are largely irrelevant. I think he is making the same mistake that people make when they say immigration reduces real wages, or that we would all be better off if only unions were more powerful.

All these things are important in influencing nominal wages, and perhaps the distribution of wages between workers. But real wages also depend on prices, which are set by domestic or overseas firms depending on where goods are made. If nominal wages go up, prices are likely to go up.

So what do I think accounts for the fall in real wages in the UK over the last decade? We need to start with GDP per head rather than GDP: growth in the latter has been boosted by immigration. Here is what has happened to GDP per head over the last ten years.

GDP per head fell in the recession, and then steadily but slowly recovered: the slowest recovery in at least a century. To see how that is related to real wages (using ONS average earnings divided by the CPI), which I call real consumer wages, we first need to look at an intermediary measure: real product wages. These are real wages divided by the price of UK output: the GDP deflator.

This is an interesting measure because its closely related to a simple identity relating GDP to labour income and profits. We can see that real product wages have not changed very much over this period: the recession mainly hit profits, or it created unemployment. (Real wages are wages divided the number of workers, GDP per head is GDP divided by the total population, which includes the unemployed.) But if we are comparing 2007 with 2015, real product wages were as stagnant as GDP per head.

So why did real consumer wages fall? That must be because consumer prices rose more than output prices. There are two reasons why this happened in this case: indirect taxes increased (remember the 2011 VAT hike), and a large sterling depreciation during the GFC worked its way into higher prices for imported goods. It is of course another depreciation after the Brexit vote that is cutting real wages once again right now. As I always try and stress, real GDP growth per head is not a good guide to real income growth if the price of imported goods rise or the price of UK goods sold overseas falls (what economists call a decline in the UK’s terms of trade).

Real wage growth in the UK has not been lousy because of lack of union power, immigrants or higher profits, but because economic growth (properly measured) has been stagnant, austerity included raising indirect taxes and we have now had two large depreciations in sterling. [1] That is not to say that these labour market factors are not important. At a macro level they are important in keeping inflation low, which should have allowed a more rapid expansion of GDP growth than we have actually had. That is where fiscal austerity and Bank of England conservatism come in. At a micro level labour market structure helps influence the distribution of earnings between different labour groups. [2]

What I say about the unimportance of profits is factually true for the UK over this period, but it is not always the case. In the US and elsewhere we have seen a gradual shift from wages to profits over the last few decades. But even here it is not obvious that weak nominal wage growth is the main cause, because in a competitive goods market lower nominal wages should get passed on as lower prices. One explanation that is attracting a lot of interest is the rise of superstar firms. These firms make unusually high profits, or equivalently have low labour costs, and if output is shifting towards these firms labour’s share will fall. What these firms do with their profits then becomes an important issue. More generally, it may be the case that governments have become too lax at breaking up monopolies, allowing a rise in the overall degree of monopoly.

The consequence of growing concentration, superstar firms and a rising share of profits is that income derived from profit grows faster than income from labour. I say derived from profit because I would include in this CEO and financial sector pay, which in effect extracts a proportion of profits from large firms. The net result is that most of the proceeds of economic growth are going to those at the top of the income distribution. But it would be good if we could change that by making the goods market more competitive and removing the incentive for CEOs to extract surplus from firms [3], rather than by making the labour market less competitive.

Technical appendix

For those who are lucky enough to have learnt economics using the Carlin and Soskice text, this is a classic application of wage and price setting curves. If workers become weaker, this shifts the wage setting curve towards the (perfect competition) labour supply curve, reducing the equilibrium real wage (unless the price setting curve is flat) but increasing the equilibrium level of employment. An increase in the degree of monopoly (the mark-up) shifts the price setting curve further away from the perfect competition labour demand curve, which reduces equilibrium employment as well as the real wage.

[1] One possible caveat here is that low wage growth may have encouraged firms to use more labour intensive production techniques, which has depressed investment and productivity. But if we want to incentivise firms to invest in more productive technology, increasing demand is a much better method than increasing nominal wages.

[2] Another caveat. I'm not sure where the real wage data in the FT chart comes from, but the fall in UK real wages there is greater than you get by using the ONS average earnings data (which I have used), so it may be a different and more specific measure of real wages. In which cases labour market structure might be relevant in explaining that number, and I apologise to Rick in advance if that is what he had in mind. 

[3] By, for example, applying much higher tax rates on high incomes, or imposing a maximum wage.  

Is a flexible labour market a problem for central bankers?

Recessions and milder economic downturns are typically a result of insufficient aggregate demand for goods. The only way to end them is to stimulate demand in some way. That may happen naturally, but it may also happen because monetary policymakers reduce interest rates. How do we know we have deficient aggregate demand? Because unemployment increases, as a lower demand for goods leads to layoffs and less new hires.

A question that is sometimes posed in macroeconomics is whether workers in a recession could ‘price themselves into jobs’ by cutting wages. In past recessions workers have been reluctant to do this. But suppose we had a more prolonged recession, because fiscal austerity had dampened the recovery, and over this more prolonged period wages had become less rigid. Then falling real wages could price workers into jobs, and reduce unemployment. [1]

This is not because falling real wages cure the problem of deficient aggregate. If anything lower real wages might reduce aggregate demand by more. But it is still possible that workers could price themselves into jobs, because firms might switch to more labour intensive production techniques, or fail to invest in new labour saving techniques. We would see output still depressed, but unemployment fall, employment rise and stagnant labour productivity. Much as we have done in the UK over the last few years.

It is important to understand that in these circumstances the problem of deficient demand is still there. Resources are still being wasted on a huge scale. Quite simply, we could all be much better off if demand could be stimulated. How would central bankers know whether this was the case or not?

Central bankers might say that they would still know there was inadequate demand because surveys would tell them that firms had excess capacity. That would undoubtedly be true in the immediate aftermath of the recession, but as time went on capital would depreciate and investment would remain low because firms were using more labour intensive techniques. The surveys would become as poor an indicator of deficient aggregate demand as the unemployment data.

What about all those measures of the output gap? Unfortunately they are either based on unemployment, surveys, or data smoothing devices. The last of these, because they smooth actual output data, simply say it is about time output has fully recovered. Or to put it another way, trend based measures effectively rule out the possibility of a prolonged period of deficient demand. [2] So collectively these output gap measures provide no additional information about demand deficiency.

The ultimate arbiter of whether there is demand deficiency is inflation. If demand is deficient, inflation will be below target. It is below target in most countries right now, including the US, Eurozone and Japan. (In the UK inflation is above target because of the Brexit depreciation, but wage inflation shows no sign of increasing.) So in these circumstances central bankers should realise that demand was deficient, and continue to do all they can to stimulate it.

But there is a danger that central bankers would look at unemployment, and look at the surveys of excess capacity, and look at estimates of the output gap, and conclude that we no longer have inadequate aggregate demand. In the US interest rates are rising, and there are those on the MPC that think the same should happen here. If demand deficiency is still a problem, this would be a huge and very costly mistake, the kind of mistake monetary policymakers should never ever make. [3] There is a fool proof way of avoiding that mistake, which is to keep stimulating demand until inflation rises above target.

One argument against this wait and see policy is that policymakers need to be ‘ahead of the curve’, to avoid abrupt increases in interest rates if inflation did start rising. Arguments like this treat the Great Recession as just a larger version of the recessions we have seen since WWII. But in these earlier recessions we did not have interest rates hitting their lower bound, and we did not have fiscal austerity just a year or two after the recession started. What we could be seeing instead is something more like the Great Depression, but with a more flexible labour market.

[1] Real wages could also be more flexible because the Great Recession allowed employers to increase job insecurity, which might both increase wage flexibility and reduce the NAIRU. Implicit in this account is that lower nominal wages did not get automatically passed on as lower prices. If they had, real wages would not fall. Why this failed to happen is interesting, but takes us beyond the scope of this post.

[2] They also often imply that the years immediately before the Great Recession were a large boom period, despite all the evidence that they were no such thing outside the Eurozone periphery

[3] J.W. Mason has recently argued that such a mistake is being made in the US in a detailed report.

Growth will be lower if the Conservatives win

The Conservatives want Brexit to be the central issue in this election. Partly as a result, the relative macroeconomic outlook under the different parties has not been discussed as much as it should, or as much as it was in 2015. The other reason it has not been discussed very much is that the economic record of the last seven years has been dire, but prospects under either Labour or the LibDems would be distinctly better. [1]

The last seven years have seen an extraordinary decline in real wages. To quote Rui Costa and Stephen Machin:

“Since the global financial crisis of 2007/08, workers’ real wages and family living standards in the UK have suffered to an extent unprecedented in modern history. Real wages of the typical (median) worker have fallen by almost 5% since 2008, while real family incomes for families of working age have just about recovered to pre-crisis levels.”

This stagnation in real wages is greater than any other advanced economy bar Greece. [2] In addition, as Laura Gardiner from the Resolution Foundation points out, current government policies imply the “biggest increase in inequality since Thatcher”. The less you earn, the more this government plans to take income away from you.

The Conservative response is to point to record levels of employment, and to keep saying ‘strong economy’. But these two apparently diverse developments, high employment and falling real wages, may be related in a very simple way: workers may have been forced to price themselves into jobs by keeping real wages low, or workers who might otherwise have retired are continuing to work to earn enough for their old age. When high employment is a symptom of no growth in living standards, it is nothing to cheer about. They both reflect a weak rather than a strong economy.

The different party manifestos have been discussed at length, but one aspect that has been almost totally ignored by the media has been their different macroeconomic implications. A lot of the responsibility for this lies with the IFS. As I wrote in a recent tweet, the “problem with IFS analysis of manifestos is not just the absence of macro dimension, but their failure to acknowledge it even exists.” **

Both the Labour and LibDem manifestos amount to an increase in public investment, and an increase in public spending financed by higher taxes, compared to current government plans. Standard macroeconomics implies that both higher investment and spending will lead to an increase in GDP, unless the Bank of England raises interest rates to exactly offset this effect. With interest rates currently stuck at their lower bound, and with public investment helping aggregate supply, that last possibility is extremely unlikely. The conclusion therefore has to be that GDP over the next few years would be higher under a Labour or LibDem government than under the Conservatives.

This is why, according to Larry Elliott, Oxford Economics estimate that “the economy would be 1.9% bigger under the Lib Dem plans and 1% bigger under Labour’s plans than under Conservative plans.” The argument that this cannot be done because it would involve some more borrowing is rightly dismissed as pre-Keynesian nonsense. It is for this reason that the IFS approach of ignoring macro is so helpful for the Conservatives. I understand that the IFS does not do macro, but its failure to even mention this gap in their analysis not only encourages mediamacro, but in the current situation represents a clear bias towards the Conservatives.

This is not the only reason why living standards would be significantly higher under a Labour/Lib Dem government. Just as the IFS ignores macro, I fear Theresa May ignores economics. In this post I noted her obstinate refusal to take foreign students out of their net migration target (causing considerable damage to one of our leading export industries), but more generally her obsession with reducing immigration is likely to do further damage not just to the public finances, but output and living standards too. It is increasingly clear that while the the coalition government (and in particular George Osborne) had no intention of meeting their immigration target, May regards it as an unfulfilled commitment despite the economic damage this would do. This marks a big difference between the Conservatives and Labour.

Finally, in comparing the economic outlook under a Conservative or alternative government, we should not ignore Brexit. After my previous post outlining why May is in many ways unsuited to the forthcoming EU negotiations, some comments were along the lines that surely Corbyn would be worse. I think not, for two reasons. You have to put out of your mind the government’s and media’s framing of these negotiations as some kind of poker game or battle of wills. They are much more like a cooperative exercise involving give and take. I see clear reasons for thinking that May/Davis will be worse at this than Corbyn/Starmer. Last but not least, I think there is no chance of a No Deal outcome under Labour, but a significant chance that the Conservatives would walk away. As Ben Chu points out, what is best for the UK economy might well be rather different from what Theresa May sees as best for Theresa May.

If the last 10 days of the campaign seem to ignore the outlook for the economy, there will be a very simple reason why. As a result of the manifestos, attitudes to immigration and Brexit, the UK economy will be better off and subject to less risk if Theresa May is no longer the Prime Minister after 8th June.

[1] Implicit in these two sentences is that the Conservatives tend to dictate the issues discussed by the media during an election, as was clearly the case in 2015.

[2] See also this New York Times piece from Simon Tilford, which presents a rounded picture of our performance relative to other European countries, rather than the carefully chosen snippets beloved by the government's spin machine.

** In the original version of this post I said that the IFS analysis assumes GDP would be fixed. This is incorrect: what I had missed is that they do allow a short term impact from additional public investment on GDP (see slide headed 'Impact on the Economy' here). However this slide illustrates exactly the concern I have.
(1) It makes no sense to allow a short term impact from public investment, but no short term impact from a balanced budget increase in public spending.
(2) The slide says that the long term positive impact of this public investment on GDP will be exactly offset by the macro impact of a higher minimum wage and additional public holidays. Is this a result of detailed macro analysis, or just a convenient assumption?
(3) The slide also says that the Conservative commitment to reduce immigration would weaken growth and public finances, but despite this they assume no impact of lower immigration on growth. This makes no sense whatsoever, unless we are working backwards from the fixed long run GDP assumption. 

Breaking the ‘strong economy’ narrative

My last post talked about the gap between the macroeconomic narrative in the UK media (‘mediamacro’) and macroeconomic facts. The gap is created or encouraged to a considerable extent by narratives employed by the political right. So how might that change, to let reality back in?

As with other things, Labour under Miliband had the right idea but did not follow it through. They talked about a ‘cost of living’ crisis, but in doing so they implicitly suggested this was some unfortunate by-product of a strong economy. The aim should be to redefine a strong economy as one that delivers solid real wage growth.

To do so makes perfect sense in current circumstances, when we have just had a policy-induced large depreciation in sterling. GDP measures the output produced in the economy, but not how much people in that economy can buy. Welfare depends on the latter, not the former.

It also makes sense if real wages have fallen because workers have priced themselves into jobs, by in effect discouraging firms to invest in labour saving machinery. Boasts that employment is at record levels make no sense in that situation, because high employment comes from lower wages rather than from additional output. [1]

I have stressed in the past (including my last post) how weak recent UK performance has been by historical standards. But a favourite trick of the government is to make international comparisons, of GDP rather than the more appropriate GDP per head. So how does our economy look if we focus, more appropriately as I argue above, on international comparisons of real wage growth?

Luckily the ILO and Geoff Tily have already done the spade work. Here is a chart for all countries, with blue denoting OECD countries.

International comparison of average real wage growth since the crisis 

Source: Geoff Tily, ILO. 

Among OECD countries the answer is striking: only Greece has seen real wages falls greater than the UK. The UK is second best among the OECD at achieving a decline in real wages! Geoff looks at data from 2008, but a quick check suggests the result holds good if we start in 2010 instead.

The data in this comparison only goes to 2015. You could, rightly, argue that 2016 was a better year for the UK, but then you would have to address what will happen to real wages this year and next. [2] You could argue that this poor performance was a consequence of the 2008 depreciation (which had lagged effects): again you would be right, but the Brexit depreciation which is not yet in these figures is just as large.

Either way this data provides strong evidence of just how terrible UK economic performance has been over the last several years. [3] What is more, unlike GDP, it is data that directly relates to the experience of ordinary people. But as Miliband found out, to quote this data is not enough. What you need to do is start proclaiming that the UK economy under a Conservative Chancellor has performed worse than any other OECD economy besides Greece. Just that, no caveats, no qualifications, no ‘cost of living’ label. Only that way will you begin to shift the narrative that we have a strong economy.

[1] If you are worried that this might help justify calls to reduce immigration, fear not. What they show is that policymakers failed to create an adequate level of aggregate demand: another consequence of austerity.

[2] If we look at the ONS series for real average earnings, normalised to 100 for 2015, it was at 101.8 in May 2010, and in February 2015 it is 100.3, a fall of 1.5%

[3] It has even been fact checked: see here.              

Does free movement really enable a low wage economy?

Tom Kibasi writes

“Immigration is such an important issue precisely because free movement of labour is the crucial enabler of the low skill, low productivity, low wage economic model that has been imposed on much of the country.”

This line may be very attractive to the liberal left: it gets to love immigration controls and can begin again to represent the part of working class that dislikes immigration. 

The reasoning is attractive. Starve firms of cheap labour, and they are forced to innovate and invest in labour saving machinery and/or in training their workers, which drives up productivity and real wages. In a world where capital is not mobile, that mechanism could work over a very long time period. But when capital is mobile, the firm has an obvious alternative: produce somewhere else where labour is cheaper. Keynes taught us not to make the mistake of assuming output was fixed, and the same is true here. Labour shortages could equally lead to less production, more imports, and a depreciation that makes everyone poorer.

Chris Dillow talked about these issues some time ago. He wrote

“The answer to this set of problems is to increase workers’ bargaining power – which requires, among other things, policies such as stronger aggregate demand and greater redistribution.”

Chris is right. If wages are low because of immigration, that will also mean that wages are unlikely to rise if demand expands. That in turn reduces the level of unemployment at which inflation is stable, allowing stronger aggregate demand and higher output. It is this additional demand that will allow firms to invest in more productive techniques, driving up productivity and real wages.

The endogeneity of aggregate demand and therefore output is key here. We could argue about whether labour shortages would be more likely to encourage firms to invest in labour saving machinery or move production abroad. But there is a third option which can achieve higher investment without running the risk of firms going overseas, and that is to expand demand. At the end of the day the only constraint on demand expansion is inflation, and if immigration is holding back wages it will also hold back inflation. We should not base policy on the assumption that governments undertake unnecessary austerity or central banks make deflationary mistakes. [1]

The link with austerity is even clearer when Kibasi writes

“What’s more, there is nothing progressive about declining to invest in skills in this country, while plundering poor countries of nurses or doctors or carers and then approaching immigration as if people were commodities to be bought up on the open market.”

This makes exactly the mistake that right wing newspapers have encouraged voters to make, which is to confuse the symptom for the cause. It is not private sector firms that have failed to invest in training nurses or doctors, but the public sector, most recently because of continuing austerity. Once again, what would be the consequence of cutting the immigration option? More money spent on the NHS, or a smaller NHS? It seems bizarre to argue that immigration enabled austerity, and that therefore EU immigration should be controlled. [2]

There is no evidence that immigration has in practice had any significant (in term of magnitude) impact on real wages. The trend in UK GDP per head had remained remarkably constant until the global financial crisis, despite periods of low or high immigration. The initial years of A8 EU immigration showed no fall in average earnings growth, with real wages continuing to rise. What we do know is that immigration helps the public finances, which means reducing it will mean either lower spending per head on public services like the NHS or require higher taxes. 

This point about public services illustrates the real problem with how the government dealt with A8 immigrants. As Nicholas Watt and Patrick Wintour relate, it was not a problem of poor forecasts: the forecasts were not bad once you factored in that Germany would impose transitional controls. It was a problem that the migration was concentrated in particular areas or towns, and nothing was done by government in response. So these towns saw greater pressure on public services, while the taxes immigrants paid went to the Treasury in London.

The data suggests that people in the UK have always favoured lower immigration. I suspect this is similar to questions like ‘do you favour lower taxes’: faced with something that naturally raises questions and concerns, it appears most people would rather have less of it. What began to happen at the beginning of the century is voters started saying that immigration was a key issue, alongside the economy or the NHS. This rise predates A8 immigration, and is strongly correlated with concern over defence/terrorism until 2008.

In truth, immigration is too tempting for some politicians and the media. As Tim Bale reminds us, the Tory opposition quickly started talking about Britain becoming a ‘foreign land’ after Labour was elected. Stories about benefit tourism play upon existing fears, and when politicians join in they appear to validate the problem. If that happens voters can easily turn their concerns about real wages or public services into concern about immigration, erroneously believing that immigrants are the underlying cause. So when austerity began, the government exploited these associations and the media either led or played along. If spending on the NHS was being ‘protected’, what else could rising waiting times be due to other than immigration? As concern about the NHS rose, so did concern about immigration. The truth was that the NHS was not being protected, but that truth was hard to find. 

The coup de grace of this strategy was to then associate immigration with the EU, which until the beginning of 2016 had been way down the list of popular concerns. Leavers managed to convince voters that reducing immigration required leaving the EU, even though non-EU immigration remained as high as EU immigration. The Prime Minister and Chancellor, having both pretended that immigration was a major problem, could not turn around and start singing its virtues. In that sense austerity beget Brexit.

As the referendum shows, no good comes from a strategy of using immigration as a scapegoat. The obvious way of handling such a close referendum vote would have been to leave the EU but stay in the single market. But by electing a Prime Minister who had spent 6 years trying and failing to reduce immigration, that option was ruled out because it would preserve free movement. EU immigration may fall anyway as a result of the Brexit and the depreciation it has caused, but beyond that it will be difficult for the government to reduce it further without hitting businesses at a very difficult time.

You do not kill immigration as an issue by talking about British jobs for British workers, still less by pretending that low wage jobs and a decade where GDP per head has hardly increased is the fault of immigration. As I argued here, to allow policy to be dictated by popular concerns risks making exactly the same mistake of those on the left who wanted to embrace austerity, although as I also noted popular concern is more deep rooted in the case of immigration. For that reason, turning the tide on attitudes to immigration will need much more than just facts and figures.

Although that task may seem daunting now, in five years or so it is likely to seem much easier. The chances are we will have left the EU, and the benefits that so many expect in terms of their access to public services or their real wage will not materialize. Either the government will avoid bringing immigration down, or if immigration does fall no obvious benefits will follow and there will be plenty of stories of firms suffering from labour shortages and leaving to produce elsewhere. Arguing then that lower immigration will usher in a period of high wage jobs will seem even more far fetched than it does now.

[1] A point that opponents of immigration often make is that immigration puts upward pressure on house prices. If there is no constraint on building houses, that in itself is no problem, just as it is no problem that immigrants will need refrigerators or cars. Those who argue that the country is full up have obviously never been to Scotland. Of course it may be a problem that most immigrants will go to English cities rather than Scotland, but that is again an existing problem of regional or industrial strategy which can and should be solved.

[2] The language of ‘people as commodities to be bought up on the open market’ is really too much. Are people in Poland forced to go and work in the UK? Of course not. They choose to do so, and most are better off as a result. If you want to be emotive then be accurate, and talk about how immigration controls cut off the chance of potential immigrants making a better life for themselves. 

Why it’s your bloody GDP, not ours

Why does the recovery mediamacro constantly talk about seem not to apply to most people? Aditya Chakrabortty tells the story behind my title better than I did here, and picks up the important regional angle. But there is more to it than that.

First, there is the abuse of language I talked about here. I make a strong case that recovery should only be used when GDP is catching up with a past trend. Instead mediamacro use it for any non-negligible increase in GDP. They are egged on, of course, by the politicians who are partly responsible for our failure to actually recover from the Great Recession.

Second is an old favourite. Mediamacro constantly uses GDP rather than GDP per capita. This makes a big difference when an economy experiences a large increase in immigration. This chart from an article in the FT recently attracted attention, showing that the UK was the only major economy over the period 2007 to 2015 to combine growth in GDP with a fall in real wages. (I assume below the chart means growth between 2007 and 2015, rather than between 2006 and 2015.)

If we use the latest ONS data, UK GDP did indeed grow by 7% between those years (0.85% average annual growth), but GDP per head increased by only 0.8% (0.1% annual growth). It is one of the great ironies of this period, and a largely untold mediamacro secret (because mediamacro hardly ever connects dots), that the government has relied on claims about GDP growth that were in large part a consequence of the immigration which they were at the same time complaining about.

GDP per capita is of course the relevant comparison for real wages. But the claim in the FT article remains true: the UK does combine growth in GDP/capita (albeit small) with falls in real wages. The chart below uses ONS data on average earnings deflated by the consumer expenditure deflator. [1] That is the relevant deflator to use, if you want to look at the purchasing power of wages. However if instead you use as a deflator the price of GDP as a whole, the GDP deflator, then you get a very different story. As the chart below shows, that measure of real wages has increased by a similar amount to GDP per capita between 2007 and 2015.

So what has caused the price of consumer goods to increase more rapidly than the price of total output? There are a number of factors, but I emphasised two in a similar analysis I did two years ago: the depreciation in sterling in 2008, and the increase in VAT in 2011. The impact of the later is clearly evident in the chart, but so is the depreciation if you recall that there was a temporary cut in VAT in 2010, which led to a short term fall in consumer prices. The depreciation raises after a lag the price of imported goods and therefore consumer prices, relative to the price of domestic output. [2]

The disparity between GDP growth and real wages is therefore due to a combination of three factors: immigration, which boosted GDP, a rise in indirect taxes and a depreciation which both raised consumer prices. If we focus on GDP per head, as we should, then very weak GDP growth caused by the global financial crisis and austerity was translated into negative real wage growth, because of the global financial crisis (the depreciation) and austerity (the rise in indirect taxes). We are not seeing a shift from wages to profits. [3]

If there is one overall message here, it is that since the global financial crisis overall GDP growth in the UK has been terrible, and austerity plus an exchange rate depreciation has made it even worse for real earnings. That the media have not presented it that way is an important reason why it seems like your GDP, not ours. 

This disconnect in mediamacro between GDP and real wages has been very evident more recently as well. On the one hand Brexiteers have made great play about the fact that GDP in 2016 has been much stronger than some had expected. The media has also noted how inflation is increasing, and earnings growth is flat, implying a squeeze on real wages. Yet the two facts are hardly ever brought together. If they were, they might note that the 1.8% growth that the Brexiteers are so proud of in 2016 falls to 1.1% if you take out population growth (immigration). And they might also note that any growth in GDP in 2017 is likely to seem like ‘your bloody GDP’ if real earnings fall because of the Brexit depreciation. (No wonder they are in such a hurry to start negotiations.) Another message of this discussion is that the media could try a little harder to relate GDP growth to average earnings, rather than treat them as disconnected events just because the statistics are published on different dates.

[1] The fall in real wages shown in this chart is a lot less than in the FT chart, but without knowing their exact source it is difficult to know why.

[2] If you are wondering how real wages managed to ride out the recession, there are two main factors involved. The recession reduced the share of profits in national income (as recessions generally do), and in addition there was a large increase in unemployment.

[3] The labour share (of GDP at market prices) did fall by over 1% over this period, but the profit share also fell. The share that increased was taxes, reflecting the VAT increase already noted.