Is the wages puzzle getting less puzzling?

By Andy Verity
Economics correspondent

Image source, Getty Images

For months now, economists have been struggling with what they call the "wages puzzle".

Conventional economic theory says if unemployment gets low enough, wages will take off - with inflation following close behind.

The general idea is that when labour markets are tight, workers' bargaining power is increased.

Therefore employees can demand wages that beat their expectations for inflation.

Until recently it was painfully obvious that that wasn't happening. The rate of unemployment kept hitting 40-year lows but wages kept sagging.

On Wednesday the wage optimists were given something to cling on to. Unemployment hit 4.4% in the second quarter of the year, the lowest - once again - since the mid-1970s.

But, against expectations, pay rises improved, up by 2.1% (excluding bonuses) compared with a consensus prediction of 2%. Maybe the economic theory was right after all - and pay is now ticking up because labour markets are tight.

It remains, however, a long way short of what would be required to trigger the sort of wage-price spiral about which central bankers have been hyper-vigilant since the 1970s.

That employees are prepared to accept wages that shrink by a tiny bit less than they did the last time these figures came out does not exactly bespeak a dramatic new assertion of workers' bargaining power.

Bank of England hawks

With inflation on the official CPI measure at 2.6%, wages are still shrinking in real terms - by 0.5%. And pay rises averaging 2.1% compares to 2.8% as recently as November last year. Not much ammunition there for the hawks on the Bank of England's monetary policy committee who would like to raise interest rates sooner rather than later.

But it does look like deeper changes in the labour market are afoot. With the weaker pound, it is in theory less worthwhile than it used to be for workers to come to the UK from elsewhere in the EU to earn pounds, sending them home to convert into Polish zlotys or Bulgarian levs.

Is that theoretical prediction coming true? The number of non-UK nationals added to the UK workforce was just 109,000 on the year. In the first quarter it was a much sharper increase - of 207,000. Here too, the economic theory may, eventually, be proved right after all.

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