Shifting the balance of power

Workers, employers and wages over the next parliament

An essay by Alan Manning, Professor of Economics in the Department of Economics and Director of the Community Programme at the Centre for Economic Performance at the London School of Economics

Forty years ago an improving labour market and prices rising faster than wages would have led trade unions to march into the boardroom demanding higher wages and threatening strike action if those demands were not met. Pretty soon, union leaders would have been invited round to Number 10 for beer and sandwiches to be cajoled into wage moderation to prevent an inflationary spiral taking hold. A lot has changed in the past 40 years.    

These days the Prosecco remains in the fridge and David Cameron used a speech to the British Chambers of Commerce in February to urge pay rises for workers, a somewhat surprising sight. But, there is a simple explanation. Since the crisis began, the average British worker has suffered a fall in living standards deeper and longer than anything experienced for more than a generation. The recent drop in oil prices and the resulting lower inflation will offer some respite but not much.

It will be the votes of average people that decide the outcome of the upcoming general election. As such, the leaders of all political parties would love to offer up policies designed to raise the living standards of the average worker. But there are not many ideas around on how to do this, hence David Cameron's plea to business.

Comparing the situation now and 40 years ago, it is hard to escape the conclusion that there has been a fundamental shift in the balance of power from workers to employers and that perhaps this shift has gone too far and it is time to redress the balance somewhat.

Figure 1 presents the time series for nominal wage growth from 1975 to the present day.

Figure 1: The new normal? Trends over 50 years of wage growth

The 1970s were a turbulent period but since the 1980s there seems to have been three distinct periods, each illustrated in Figure 1 with the three horizontal lines. From the early 1980s to the early 1990s through to 2008, nominal wage growth averaged about 8 per cent. Then from the early 1990s nominal wage growth averaged a bit over 4 per cent per annum. But following the crisis, this fell to 2 per cent and there it seems stuck. The three take-aways from this are that there are quite long periods in which norms in wage growth seem strong; change occurs only rarely; but when it does change it can be quite rapid. The recent low level of wage growth has probably had an up-side: the rise in unemployment has been less than would have been predicted given the severity of the recession and unemployment has been falling fast. Instead of the recession leading to unemployment for a minority but protected living standards for the majority, we have seen a general fall in real wages that may mean the pain of recession has been shared more equally but this has arguably been more difficult politically.

Once workers would have been looking for the first opportunity to press for higher wages, now employers are looking at pay rises as a last resort

In the past, the change in norms seems associated with changes in inflation expectations. But the low current norm for wage growth has been associated, until recently, with quite high inflation and inflation expectations. It seems like something quite fundamental has changed. 

When it comes to thinking about how wages are determined, these days one must think about things from the perspectives of employers as that is with whom the decision now lies. Once workers would have been looking for the first opportunity to press for higher wages, now employers are looking at pay rises as a last resort. What makes employers pay higher wages is when they are struggling to recruit and retain workers, as a result of competing for labour directly with other employers. One of the features of the labour market in recent years (and not just the UK, the US as well) is that the level of direct job-to-job moves has been falling – these days a higher proportion of new hires are from non-employment rather than from other jobs.  And when your latest hire is from non-employment there is no other employer to compete directly with.

Figure 2 shows the relationship between the fraction of recruits who were previously employed and the unemployment rate.

Figure 2: Increased competition for work: the changing relationship between unemployment and recruitment, 1992-2014

There is a clear inverse relationship between the two – in a recession a lower fraction of hires were immediately previously employed. But, more interestingly, this relationship seems to have changed since about 2000. For a given level of unemployment the fraction of new hires who were previously employed is lower than it used to be. This would suggest that for a given unemployment rate there is now less pressure on employers to raise wages because there is not so much direct competition for workers with other employers.

Even if falling unemployment does shift bargaining power towards workers, ensuring an appropriate balance of power is still something we should be concerned about

We currently seem stuck in a situation where wage growth is very weak and employers seem very reluctant to move from this. This is a result of the shift in the balance of power. But this does not mean that we will necessarily be stuck in this situation for ever. If the labour market continues to recover and, more importantly, if productivity growth re-starts, then the pressures for wage growth will build and ultimately this will translate into higher wages. And once there is a tick up in the going rate, norms may change very fast as Figure 1 has shown can happen.

But even if falling unemployment does shift bargaining power towards workers, ensuring an appropriate balance of power between worker and employer is still something we should be concerned about. In the belief that labour had become too powerful in the 1970s, the view became common that an unregulated labour market would automatically deliver a suitable balance of power.

But there is an old view that this is not the case and that came to be forgotten. In the Wealth of Nations, Adam Smith wrote that "in the long-run the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate". A similar view that the relationship between employer and worker was fundamentally one of unequals and some state intervention was necessary to redress the balance was behind the original introduction of most labour market regulation, from UK interventions in the early 1900s to the New Deal era legislation in the US. There are areas where it has been rediscovered in recent years; equal pay for women and the minimum wage were once extremely controversial policies but are now widely accepted as part of the furnishings of a fair and efficient labour market.

It is not just in wage determination that one observes the shift in the balance of power. We see employers trying to pay as little as possible for workers: the growth in zero-hours contracts; not paying for social care workers’ travel between client; perhaps forcing workers to become self-employed so they will not be covered by the minimum wage.

But without a solution, it is quite possible that the general air of discontent within our economy and institutions will continue to grow

Those things happen at the bottom end of the labour market but there also seem to be similar changes at the top where employers are increasingly trying to appropriate knowledge that one might think is the property of the worker themselves. A law professor at UCSD, Orly Lobel has written a book titled Talent wants to be Free on the numerous ways in which American employers have tried to gain an advantage over their workers. Some household names in the tech sector (Adobe, Apple, Google, Intel, Intuit, Lucasfilm, Pixar) had mutual arrangements not to pro-actively recruit each other’s workers, something the US Department of Justice ruled anti-competitive. The resulting civil case seems to be coming to a conclusion with a sizeable pay-out for workers who were harmed by this.  What we do not know is if this was an isolated instance (at least one similar case is currently working its way through the courts) among a few companies in a particular period of time or whether these cases are the tip of an iceberg.

If it is time to redress the balance of power between workers and employers, what can be done? There are several strands to a strategy. 

First, and returning to a theme others in this collection have touched upon, make sure the unemployment rate is low to maximize the competition between employers for workers.

Second, use government regulation where necessary, for example as Philpott has argued to limit zero-hours contracts, to force employers to pay carers for the time spent travelling between clients.

Third, try to rejuvenate unions to provide some countervailing power. Unions have rarely raised the pay of the lowest-paid in society because they have little representation amongst these workers. But there is work to be done to convince workers that the solution to what they see as an individual problem (struggling to maintain their standard of living) lies in collective action. Amongst workers under the age of 25, under 5 per cent have ever been a member of a trade union compared to 20 per cent 20 years ago. An important part of people’s identity was once their job and their union, and this sense of pride and solidarity needs to be re-created in the middling jobs in today’s labour market – they are just as vital to the economy as the coal miners ever were.

Fourth, mobilise grassroots campaigns on specific pay issues. These have had some success not just in those employers who sign up to the Living Wage but have probably also played a role in, for example, Walmart’s recent decision to raise its lowest hourly rate to $9.00 per hour (though commercial considerations also loomed large). As Dube discusses, in the US there are now cities setting minimum wages at a level we have not seen for a generation (and possibly too high) as a result of such campaigns.

Solving the problem will not be easy – trust in government and faith in collective action to solve problems is not high at the moment. But without a solution, it is quite possible that the general air of discontent within our economy and institutions will continue to grow.