All about that base?

Take a glance at labour market data in the UK recently and you’d be forgiven for thinking that you may have missed out on a bumper pay rise in the last year. Headline annual average earnings growth figures for March to May 2021 stand at 6.6% for regular pay and 7.3% for total pay (including bonuses), the highest ever seen in the data series which stretches back to 2001.

While I’m sure there will have been improved remuneration in parts of the economy, this very strong pay growth isn’t quite what it first seems and is being driven by two principal impacts, influenced by the pandemic – base effects and compositional effects.

Base effects arise because annual calculations such as this are always a comparison of current data with that of a year before. This is pretty standard for a number of headline economic statistics, with the aim of providing an idea of long-term trends rather than concentrating on what can be rather volatile changes in data each month. While that usually works fairly well there can be exceptions and that is what we are experiencing at the moment. If the previous year’s data being used as the starting point, or ‘base’, moved dramatically in the short-term then this will clearly influence the results of current calculations.

Short-term dramatic movements in data are exactly what we experienced during the onset of the coronavirus pandemic in 2020. With regards to earnings, negative pay growth rates were seen for several months from April onwards, setting a low base which is now being used in the year-on-year calculations. One driver behind the falls in pay growth last year was the furlough scheme, as millions of people started receiving 80% of their salaries. The proportion of employees furloughed is also therefore influencing the pattern of pay growth, with six million fewer people on furlough in May 2021 than a year before. 

The base effect isn’t unique to the pay growth data and can be seen across other measures such as retail sales, inflation and GDP. In addition to it, pay growth has also been affected by the changing composition of employee jobs. During the pandemic, it has been those in lower-paid roles who have been more likely to have lost their jobs and indeed the data shows a fall in the number and proportion of lower-paid employee jobs. This changing composition naturally has an upward effect on average pay.

Labour market survey data suggest that as well as a decrease in the number of jobs in lower paying sectors, the number of part-time jobs has fallen and that the changing distribution of jobs between industries has influenced average pay growth by around 0.6%. HMRC’s PAYE data also indicates a fall in new entrants to the labour market, who are lower-paid than average. These seem to be the most obvious parts of the current compositional effects, but the Office for National Statistics (ONS) is planning in-depth analysis of the issue.

While headline pay figures are clearly misleading at the moment, underlying earnings growth can be estimated in an attempt to strip out the base and compositional effects. However there’s more than one way to do this, so any answer will be uncertain - but the ONS estimates an underlying rate of regular earnings growth of between 3.2% - 4.4% at the moment. Other economic forecasters have suggested underlying growth is probably running at similar levels to its pre-pandemic norm of 2-3% and the Bank of England has noted average pay settlements of around 2% in survey data.

Eventually the current distortions will fade, or even reverse, and headline pay growth will drop from its all-time highs, but for the moment the statistics need to be interpreted with a dose of caution.