12 September 2023

Policymakers should look past the headlines on average earnings


The latest UK data on the growth of average earnings, published by the ONS today, could turn out to be the most important for some time. For a start, they will be one of the final pieces of evidence reviewed by the Bank of England’s Monetary Policy Committee (MPC) when they meet to set interest rates next week.

But these are also the figures that would normally be used in determining next year’s increase in the basic state pension, thanks to the ‘triple lock’. In both cases, those making the decisions should be willing to look beyond the headlines.

The hawks on the MPC may well swoop on the further acceleration in headline average earnings growth in the three months to July. This rose from an upwardly revised 8.4% to 8.5%, compared to 6% at the end of 2022. Normal people might think this is a good thing, especially as pay is now finally rising faster than prices. But it is bad news for those worried about a ‘wage-price spiral’.

In reality, the latest headline figures tell us little, if anything, about the future. They have been boosted by the one-off awards and bonus payments for NHS staff in England, and for civil servants, which meant that average total earnings in the public sector rose by a thumping 12.2% in the three months to July. This will clearly not be repeated.

Admittedly, the growth of average earnings in the whole economy, excluding bonuses, was also strong, at 7.8%. But this now appears to be levelling out. The more timely official data on median pay growth in August, based on PAYE records, suggest that the next set of data will be much weaker.

This is consistent with the evidence from August’s recruitment surveys, including the KPMG and REC UK Report on Jobs and the BDO summary measure, which point to a slowdown in pay growth in the private sector. And within the ONS release itself, there were falls both in employment and in the number of vacancies.

The upshot is that the leading indicators of labour market activity and price pressures are cooling. The MPC would be making a serious mistake if it chose instead to focus solely on the headline measure, especially given the known distortions from the public sector awards. That would be another example of setting policy by the rear view mirror.

There is also a strong case for a bit more imagination when it comes to determining next year’s uplift on the state pension. Like it or not, the government has committed to keeping the ‘triple lock’, at least for now, whereby the basic pension is increased by the higher of growth in average earnings, price inflation, or 2.5%. Barring a very unlikely shock in next week’s CPI data, the latest average earnings figure will be the crucial one.

However, the Secretary of State for Work and Pensions still has some discretion over the precise measure of average earnings that is used. It would not be unreasonable to apply the 7.8% figure for average earnings excluding bonuses – in other words, ‘regular pay’. This would also save about £1bn a year compared to using the headline figure of 8.5%.

Of course, this would be hugely controversial. The government would inevitably be accused of using another ‘loophole’ to ‘cut’ pensions, even though all it would be doing is raising them in line with a measure of earnings that more accurately reflects the underlying trend. That may not be good politics, but it is surely good economics. It is a pity that the two so rarely seem to go together.

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Julian Jessop is an independent economist.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.