Why has pay not risen at the same rate as company profits?

A trader walks past a display screen
Image caption The gap between medium and low income earners and those at the top of the UK's pay scale began to widen years before the global economic crisis began

Pay for ordinary workers has not kept up with economic growth and rising company profits - and there are several reasons why writes Duncan Weldon, senior economist at the Trades Union Congress.

Have you noticed how your boss seems to be doing quite well, but your own pay is stagnating? The cost of living is going up, but your wages are not keeping pace?

It is easy to blame the recession, but you may be surprised to hear that the trend for weak wage growth predates it.

Pay for ordinary workers had flatlined before the the current global financial crisis began.

Research by the think tank The Resolution Foundation, which focuses on people on modest-to-low incomes, reveals that between 2003 and 2008 there was a pay freeze for people earning the median wage or less.

"We saw almost no wage growth for those in the middle income bracket and below despite the fact that the UK economy grew by 11% in that period," says The Resolution Foundation's James Plunkett.

Basically, little of the economic growth of recent years found its way into the pay packets of ordinary people. A large part of it went into company profits and to the very top earners.

"Essentially the workforce has been separated from the proceeds of growth... and at an accelerating rate," says Stewart Lansley, author of The Cost of Inequality.

The growing pay divide

Since the 1970s there have been major structural changes in the British economy.

The impact of the globalisation of production and technological advances since that time have combined to radically change the nature of the labour market.

Image caption The financial sector accounts for much of the UK's wages growth of the past two decades

Some jobs have simply vanished, either replaced by machines or outsourced to lower cost countries.

Other jobs have been made much more productive - a financial trader armed with a quick internet connection is able to make a lot more money than one reliant on a telephone and fax machine.

In fact, it is estimated that around 80% of the UK's wage growth in the last 20 years has been in the finance sector.

Some analysts refer to this as the 'hollowing out' of the labour market. The idea is that the old middle-income jobs have gone and what is left are either very highly skilled, highly paid jobs at the top or low skilled, low paid ones at the bottom, like in retail and the care sector.

Throughout the 1980s a larger share of national income started to flow to those at the top of the earnings ladder as they disproportionately benefited from the increases in productivity brought by globalisation and technology.

Earnings for those at the top rose at a much faster pace than for those in the middle and at the bottom.

From the late 1990s that trend became even more pronounced, with the top 1 to 3% of earners starting to detach themselves from everyone else.

Some argue that these trends alone do not tell the whole story. Technology and globalisation are obviously important factors but other forces are at work, too.

They point to the fact that these wage discrepancies are less marked in other advanced western economies, suggesting that governments can do something to influence them, either through the tax system or through a better minimum wage - or indeed that stronger unions can negotiate better deals for the workforce.

False sense of wealth

The notion that median wages - those in the middle - were not growing in the five years running up to the fall of Lehman Brothers may seem odd.

People did seem to feel better off at the time and, indeed, now look back on it with something approaching nostalgia.

Whilst wages were not going up for many, other factors were mitigating this - house prices were rising making home owners feel wealthier, credit was easily available and the system of tax credits topped up the income of lower earners.

Yet policy analysts on the centre-right think the generosity of the welfare state encouraged companies to pay less.

Matt Oakley, head of economics at the think tank Policy Exchange points to the rise of in-work benefits introduced under the last Labour government:

"The tax credit system spanned households with incomes of up to around £55,000 ($87,000), so a large chunk of households were taking tax credits home.

"There's been some evidence it can have an adverse effect... by giving tax credits, this allows firms to actually pay less wages than it would do otherwise. It acts as a kind of firm subsidy, reducing wages."

It is important to remember that wages, although very important, are only one part of household incomes. A two-earner couple with children will have an income made up of two sets of wages, child benefit and possible tax credits and interest from savings.

Through the 1980s and 90s, the entry of more women into the labour market was a major driver of household incomes as second wages topped-up family budgets. In the 2000s, the introduction of tax credits did the same.

So the question is, is there anything else that is going to drive up household income in the next ten years?

With the tax credit system being scaled back and with childcare costs preventing many women increasing their working hours to boost household income, it may well be that wages will become a more important factor in increasing incomes.

The problem is that they show little sign of growth at the moment.

Gavin Kelly, the head of the Resolution Foundation, says it will take a long time simply to regain lost ground, let alone move forward.

"It will take a long time for many households to recover the position that they had previously attained prior to the recession. We're looking towards 2020... and that's assuming that the economy does recover."

So if the economy does return to growth, one key question will be who benefits from it? Will it resemble the growth of the 2000s and flow to those at the top and into company profits or will ordinary people get their fair share?

Without the alleviations of a generous tax credit system, a high increase in the number of two-earner couples or cheap credit then wage growth will be crucial in driving living standards higher.

Listen to Duncan Weldon's full report on Analysis on BBC Radio 4 Monday, 20 February at 20:30 GMT and on Sunday, 26 February at 21:30 GMT. You can also listen again via the Radio 4 website or by downloading the podcast.

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