Rising Wages: A Sign That Brexit is Working? - Anonymous Banker

Brexit Myths Debunked Volume III

I have a friend whose economic and financial analysis is always interesting because it is apolitical. He is a former City economist with decades of experience. Unfortunately, like many people who have something genuinely valuable to add to the conversation, he prefers to protect his privacy in our turbulent political and cultural landscape. But I’ve always found his explanations and insights useful and I think you will as well. That’s why he’ll be contributing to my Substack from time to time as the Anonymous Banker.

This piece is part of a series of articles which attempt to provide an objective, data-based look at the economic impact of Brexit on the UK and debunk the myths peddled by both sides of the debate.

Read Volume I here and Volume II here.

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Having discussed GDP in our last two pieces, I’d argue the two economic variables that are of real (rather than academic) importance to people and their lives are inflation and unemployment. Economists actually have a way of measuring these together: the cheerfully named Misery Index (Unemployment Rate + Inflation Rate). In trying to assess whether the UK media is really giving us the true picture of Brexit Britain, it is worth examining how the UK compares to its European peers on these two key measures. Reading the British press one could be forgiven for believing we are in a uniquely bad economic position compared to the economic nirvana we chose to turn our backs on. But what does the data show?

Source: Bloomberg. Inflation measure is CPI. EU4 Average and Misery Index are author’s own calculation from the data.

The UK labour market is significantly healthier than that of its European peers, with unemployment half that of the major EU economies. This feeds into the debate over wage growth that the UK is having at the moment. The UK labour market is tight and this is putting upward pressure on wages, together with increased wage demands due to inflation.

Inflation in the UK is higher than the EU average. The difference is not massive but it’s certainly there. For comparison, inflation in the United States in 2022 was 8%, which is in line with the EU average. It is therefore possible that elevated UK inflation is indicative of specific Brexit factors – labour shortages/displacement and an increase in frictional trading costs between the UK and EU feeding into our prices.

When looked at in the round via the Misery Index, the UK scores well. Dramatically better labour markets, coupled with marginally higher inflation leads to the UK comparing very favourably to its key peers on this measure.

Wages

Brexit is an issue that seems to make left and right take positions that would seem counter to their traditional philosophies. Take the issue of free movement and labour. In purely economic terms, the creation of the EU brought with it access to a vast quantity of labour via free movement. From a UK perspective, with wages relatively higher than say Southern or Eastern Europe, this led to an increased supply of workers. Logically, increased supply should lead to falling prices (wages in this case). Increasing supply from lower relative wage countries was also likely to hold down wage growth domestically. In my view, this increased supply also affected the relative bargaining power between capital and labour, eroding the position of ordinary workers.

Let’s take a hypothetical widget factory with its evil capitalist owner. Prior to free movement, his ability to hire workers, and their cost, would be linked to local conditions. If there were limited labour pools locally, he’d have to pay more to attract staff. If conditions for workers were better at other local employers, he’d have to reflect that to attract and retain workers. Now imagine we join an economic union that dramatically raises the supply of labour overnight, including a vast pool who are used to working for far lower wages and in worse conditions. Suddenly, the evil capitalist owner sees his relative bargaining position enhanced – if his local workers don’t like his pay and conditions, there is a near limitless supply of those ready to replace them. Applying this analogy to the economy in aggregate – does this sound like a trend that would improve domestic workers’ wages to you?

In fact, UK disposable incomes have flatlined since the financial crisis.

Now, to evil capitalist City workers like me reducing the relative power of labour and enhancing that of capital is a wonderful thing and should lead to a higher share of the spoils for business owners. This explains why big business (e.g. The CBI) has been solidly pro EU, whilst many unions are pro Brexit. 

It’s curious therefore that Labour and the modern left are stridently pro-EU given their traditional position as the “party of workers”. Meanwhile, the “party of business” in the form of Conservatives is largely responsible for wanting to leave the EU trading bloc in the first place. The party of the workers wants to be part of a system that erodes their relative value, whilst the party of the evil capitalists who stand to benefit from perpetuating a crony capitalist system wanted out… Go figure.

Or, perhaps, Mick Lynch, Paul Embery and Tony Benn are just a little more intellectually honest and in touch with their lifelong political philosophies than our current left-wing leaders?

A feature of the UK Labour market over the last 2 years has been strong wage growth. There are various factors underlying this – higher inflation in the economy raising wage demands, sectoral labour shortages due to Covid and the post-Brexit ending of free movement.

With regard to wages, the Remain side appear to be advancing two contradictory propositions in my view. In the aftermath of the Brexit vote, they were keen to argue that EU free movement and migration had no impact on domestic workers’ wages, and therefore Leave voters should not have feared remaining in the EU with continued free movement.

I would argue that wage growth in the UK in the aftermath of Brexit is a feature, not a bug of our vote to leave. Many working-class Brexit voters cited the impact on their take home pay as a major reason to vote to Leave, particularly in sectors such as construction and hospitality. They were routinely told that their personal anecdotal experience of reduced pay and opportunity wasn’t actually borne out by the statistical evidence of various academic studies. Yet in a post-Brexit world without free movement wages are rising. If Remainers believe that this is driven by reduced EU migration given the end of free movement (which is certainly a major factor), it is difficult to claim that free movement did not suppress wages as working class Leave voters claimed they experienced when part of the EU. 

We’ve all heard the stories of people boasting about the cracking job a team of Polish builders did on their house extension, and how cheaply and quickly they did it (compared to the caricature of the lazy British builder). Can the same person who benefited from this lower priced and efficient service really then claim that local workers’ wages are unaffected by a huge supply in competing labour? These two arguments cannot be reconciled. Do the same people think that the entrance of Uber has raised the wages of London’s black cab drivers?

Let’s get back to the data and see what it really shows.

Notably, the share of GDP that went to workers was falling in the years following the Global Financial Crisis (GFC) up to the Brexit vote. Following the Brexit vote, labour has captured an increasing share of the economic spoils. In 2016, labour’s share of GDP stood at 58.1%, rising 2% to 60% in 2021. Yes, we are talking about going from 60%+ to 58% and back to 60% which doesn’t sound significant – but it’s 2% of a very large number, the GDP of the entire UK economy. Moreover, it is the direction of travel that is important.

Again, this is suggestive that increased labour costs are a feature not a bug of Brexit. It all depends on which side of the table you sit on – if you’re a shareholder, Brexit has likely raised your labour costs and cut your profits; if you’re a worker, you’re finally starting to see some leverage in pay negotiations.

Source: ONS, Labour share of income for the whole economy

This trend is also borne out in the wage data of UK workers. The charts below show the change in average weekly earnings in real terms, both pre-Brexit Vote and in the years following the vote to the present. These are volatile time series. However, what is notable is that from the 2008 financial crisis to the Brexit Vote real wages saw an average year-on-year decline of 0.4% on a monthly basis. In the period post the Brexit Vote, the comparable average is positive at 0.9%. That is to say, stripping out the impact of inflation, wages have been increasing since the Brexit Vote, whilst they declined in the years leading up to the vote.

Source: ONS

Source: ONS

As mentioned above, how people will feel about this enhanced leverage of workers in post-Brexit Britain will depend on where they sit: business owners will see it as a negative, workers will see it as a positive. The Remain argument that free movement did not suppress wages (and I acknowledge there are plenty of academic studies to support this view) is predicated on the idea that the enhanced growth of being part of the EU would offset any negative impact of increased labour supply on wages. The economy will be bigger so there will be more work to go around is the thinking. This feels like a very difficult sell to workers who can see the direct effect of the increased supply of labour on their work opportunities - an extra 0.x% of GDP is a pretty abstract concept when you're seeing your personal wages held flat by factors you feel you can directly observe. 

Given the questions we've raised over supposed reduced GDP growth in the previous articles, allied to an improved position for workers, perhaps we should consider whether the Red Wall Brexiteers had a point after all?