Do high wages really mean high productivity?

Market report

1. The debt ceiling can was kicked down the road a little this week, postponing a likely still dangerous moment for the US and Global economy.
2. Bond markets continued to grapple with a more uncertain inflation outlook as soaring natural gas prices dominated the news
3. Stock markets recovered some lost ground over the week – US lead indicators remained at elevated levels, helping to dampen some stagflation fears

CIO view

It has been another busy week in the world of capital markets. China’s welcome decarbonisation drive combined with unhelpful weather have shown us some of the challenges we will face in the necessary transition to renewable energy. We will still need to use a lot of fossil fuel on this journey to sustainability. However, with investment in fossil fuel extraction and beyond understandably unpopular, related prices will surely remain well-supported at the very least.?

Demand has to do its bit of course and the pandemic has actually been unhelpful here. We continue to fly about a lot less of course. However, the mix of working from home combined with the shift in consumption patterns towards goods over services has more than offset this and other effects. All of this should normalise to some extent over the course of the next year. However, there is clearly a complicated tightrope for the world economy to walk in coming years as we wean off energy sources that have kept the lights on for centuries.

In the shorter term, this story has added extra dollops of complication to the outlook for inflation and central bank policy. How transitory is transitory is the question on the lips of all of those nervously eyeing incoming inflation data. Of course, there are explanations for why forecasters continue to be surprised here. However, at some stage we may see this higher inflation seep more durably into our collective consciousness. Measuring these collective expectations is not easy in truth, but wages and wider inflation chasing each other higher is what will keep many central bankers awake at night. In the UK, there are some hints that central bank action is coming a lot sooner than forecast only a month ago as a result.

Higher wages sound welcome of course and some are arguing that one of the solutions to the UK’s productivity slump of the last decade plus is exactly that. There is some famous historical precedent to go on here. The juxtaposition of high wages (a result of Britain’s preceding success in global textiles) with low cost, easily accessible coal is seen by some academics as a key reason for the first industrial revolution’s birth in the UK rather than China or many other competing nation states. This mixture provided the economic incentives for businesses and individuals to invest in technology to replace increasingly expensive labour. That replaced labour was soon absorbed into the freshly created industries that cropped up as a result of the revolution. Something that continued to happen for the ensuing centuries as the job market shifted from agriculture to industry to services. Perhaps the same will be true again. High wages, amidst more restrained immigration, may indeed force businesses (and other actors) to invest more in skills domestically. The substitution of labour for machines may also be given welcome impetus (retaining faith that the economy will continue to create new jobs to always absorb those displaced workers). Furthermore, the argument that some of the famously long tail of struggling businesses in the UK will be cut off by these higher wage requirements could also be accurate (and positive for productivity).

However, that so-called rump of the UK’s corporate sector is a lot larger than widely imagined. The proposed answers to the UK’s productivity conundrum are many and various. High wages may be part of it, but without the productivity to merit it, stagflation becomes the likely reality. One of the major characteristics of England (fuelled by the Scottish enlightenment) in the run up to this all-important first industrial revolution was an openness to ideas from beyond these shores. Certainly the domestic macro-economic context was aligned – the incentives for innovators to think harder on ways to improve productivity were there. However, part of the elixir of that and many other sustained productivity booms around the world, is the atmosphere of enquiry, a receptiveness to new and challenging ideas and the appetite to implement them.[i] For many reasons, this latter part seems to have gone missing for some parts of the UK’s corporate sector in the last few years. Factors beyond the corporate sector’s control surely play a large role. The years since 2007 have contained more than their fair share of confidence sapping turmoil, both domestic and international. However, facilitating the spread of corporate best practice and the frontier of technology beyond the high achieving corners of the UK’s businesses remains something to be solved urgently if the UK is to return to the productivity top table it once lorded over.

[i] Mokyr, J (2011), The Enlightened Economy – Britain and the Industrial Revolution – 1700 – 1850 – Penguin books

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