Thu 28 Jul 2022

Close the productivity gap to survive the bursting wage bubble

In the year from June 2020 to 2021, real wage growth in the UK recovered from a low of -1.3% to a peak of 9%. To simplify the statistics, this means someone on a £30,000 salary had £2,665 more to spend over the course of a year.

This was primarily driven by a chronic shortage of labour due to the huge shift in employment trends during the Covid-19 pandemic.

What began as a labour shortage crisis has now become a wider inflation problem hitting the real economy. These combined issues have sustained wage growth for many months now. Wage inflation hasn’t dropped below 4% since November 2020 and recently hit 7%.

Official inflation statistics have taken some time to catch up with this. Inflation didn’t start to creep above 2% until the summer of 2021, long after wage growth was being seen.

Now, the tide has changed. The 12-month rate of inflation is sitting at 7.8% and it is rising. Higher costs are putting even more pressure on employers to increase wages, despite a consistent effort to do so for the past two years.

It is important to note that these figures are averages. In many industries, the reality of their marketplace makes these numbers seem restrained.

In January this year, a professional recruitment firm said it was placing newly-qualified lawyers at top City firms on starting salaries as high as £150,000.

And the long-standing labour shortage in road haulage has seen many drivers secure huge pay rises. Indeed, the average wage of a lorry driver is now more than that of a secondary school teacher.

Late last year, we also heard of warehouses across the nation paying up to 30% more to recruit staff. Indeed, warehousing is one of the sectors paying inflation-busting pay rises consistently for the past year. Others include health and social care, hospitality and retail, and office work.

Yet these inflationary pressures simply aren’t sustainable. The old rules of economics must be set aside as new dynamics force employers to rethink their strategies.

It is time to talk about productivity.

UK productivity has been highly erratic since the Covid pandemic began and dramatically nosedived between Q2 and Q3 2021 before flatlining at the end of last year. Over the past decade, output has grown fairly consistently between 1 and 2 per cent. It is hardly seismic.

Yet boosting productivity could put downward pressure on prices, raising supply and cutting costs. In Scotland, we face a particular set of productivity challenges. The most recent Scottish Productivity Index showed how Scotland lags behind other parts of the UK and the rest of the world, including in areas like business investment, exporting and innovation.

That’s not to be downbeat – improvements are being made, but not nearly fast enough. Improving productivity is no longer just important; it is urgent.

The lack of debate about this issue is palpable. The word ‘productivity’ appears only twice in the Scottish Government’s 47-page Covid Recovery Strategy. Yet improved productivity is at the heart of fair work – it means more people share in the benefits of employment and outputs.

We must also be cognisant of the fine balancing act employers are trying to strike. Paying higher wages is something we all want to do in order to retain and reward staff.

There may also be softer levers we can use to improve productivity and keep employees engaged. This month, world’s biggest ever trial of a four-day working week is taking place across the UK amongst 70 companies and over 3,000 workers. In Iceland, where a four-year study ended in 2019, productivity improved or remained the same in the majority of cases.

And while we seek ways to protect people’s income and improve productivity, the risk of over-stretching our economy is stark. In a macro sense we must be mindful that the negative consequences of a burst bubble far outweigh the positives felt by wage growth.

As more and more employers pay higher and higher wages to cope with ever-increasing costs, the bubble edges closer to bursting point. Inflated wages may temporarily encourage consumer spending but in many cases, such is the exceptional impact of cost inflation, this is unlikely to last long. The economy is going to slow down, and that brings real-world problems like unemployment and pay freezes.

We need real-economy solutions to a real-economy problem. This requires long-term thinking while dealing with short-term issues.

Investment is a prime example. A sure-fire way to improve the nation’s productivity is to invest in technology and better connectivity. Advanced technologies improve productivity in many ways, from ensuring people can work on the move to reducing the time processes take or the effectiveness of sales journeys. We simply cannot get superfast broadband and 5G installed in Scotland quickly enough. If we are to catch up with other nations, we have to invest further and faster.

Yet investing in the future feels counter-intuitive at a time of rising costs, rising wages, high demand and low supply. We are still coming out of a massive labour shortage, too.

More businesses must see that investment is possible, even now.

Private markets, for example, are booming – globally assets in private markets have increased five-fold since the credit crunch. Wealthy investors are also increasingly backing private equity houses to seek higher returns. Foreign direct investment (FDI) in Scotland also strongly outperforms the UK as a whole and increased 14 per cent last year – our attractiveness to investors now sits at a record high, driven primarily by digital and utility projects.

As unsustainable as rising wage growth is, how we invest in our future to improve our productivity may determine how resilient to a burst bubble our nation may be.

A shortened version of this article first appeared in The Times. 

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