Making Britain work for everyone

Making Britain work for everyone Facing up to challenges in our labour market

Contents Growth must make a difference to everyone

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The challenges in our labour market

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Flexibility – essential, but not enough on its own

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Finding solutions that tackle weaknesses but preserve our strengths is a challenge for us all 20 Annex – Research methodology

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References 27

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Making Britain work for everyone: Facing up to challenges in our labour market

Growth must make a difference to everyone

Almost seven years on from the collapse of Northern Rock, the effects of the financial crisis are still affecting the daily lives of people throughout the UK. There has been a squeeze on living standards across the board and that is going to take years to reverse. But some have been hit harder than others. And many of those same people find life tough in the jobs market even in better times. We need to change that.

People deserve the chance to get into work and get on at work. That’s good for them, good for business and good for our nation.

So the CBI is looking at how to tackle these challenges in our labour market. This paper is the start of that work. A beginning to the conversation. And over the coming months the CBI will be drawing together ideas designed to improve prospects for people to progress, achieve better pay and improve their living standards.

The recession has hit living standards…

The banking crisis and the deep recession triggered by it have had long-lasting effects on the daily lives of people across the UK. Unemployment rose markedly – though not as high as some predicted. And even for those in work, there has been a long squeeze on incomes.

So-called “real” pay – the value of earnings after taking account of price rises – has fallen. Using this measure, average pay is 7% lower than before the recession and it’s 20% behind where it would have been if the economy had continued to grow on prerecession trends.1 While virtually everyone has been affected, it is the lowest paid who have been hit hardest by inflation.

…and recovering that ground will take time After a long period in the doldrums, the UK economy is finally on the path back to more robust growth. Employment is growing strongly and 2014 should see pay starting to rise faster than prices.

But there is a long way to go to make up all the ground we’ve lost.

Most workers are still worse off than they were before the recession and they’re looking to business to restore their standard of living. For many, this will come in time as the economy grows. As we highlight in this paper, the UK has a good record on job creation and raising real pay for the average employee. In the same way that the UK’s flexible approach to working saved jobs in the recession, it will create new jobs and pay growth in the recovery. It will take time for this to happen, so we must adopt policies to accelerate it where we can.

Making Britain work for everyone: Facing up to challenges in our labour market

But we also need to make the jobs market work better for everyone We must also be honest. For some people the issue of making ends meet is not simply to do with the ups and downs of the economy. Who you are – the background you come from – still has too great an influence on whether you find a job, are able to hold onto it or see your wages rise. This is something we must address. Above all, people must have the chance to progress to better-paid work.

This is an issue that concerns businesses as much as workers. Businesses are at their strongest when they make the most of all the talent available. If there are obstacles that lead to wasted talent and a less diverse workforce, then people are not fulfilling their potential and business can’t fulfil its potential either. They also need a pool of consumers to buy their products with the income those consumers have generated as employees.

The analysis we present here shows that the UK’s flexible labour market has been a strength rather than a weakness. It has benefited employees as well as business. It has brought investment and jobs to the UK, ensured workers benefit when firms grow and raised living standards for employees in the good times. But it is not enough on its own – we must do more. There are two areas where we believe further action is needed: higher productivity and improved opportunity. The CBI will be undertaking further work over the summer with a wide group of stakeholders to develop ideas on how to give people the chances they need to break into more productive work that will pay better.

Who you are – the background you come from – still has too great an influence on whether you find a job, are able to hold onto it or see your wages rise.

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Making Britain work for everyone: Facing up to challenges in our labour market

The challenges in our labour market

An individual’s standard of living depends on their income. For the vast majority of people, that means what they can earn in their jobs.

So gaining a job, staying in work and progressing up the jobs ladder are crucial for people’s quality of life. We need to know what helps in that process and what holds some people back. In this section, we look at the findings of research specially commissioned by the CBI on the factors that boost the ability of an individual to find a job, stay in work, and increase their earnings (Methodology in annex).

Some people face greater challenges in getting into work…

Getting into work is the first crucial step in improving living standards. It is transitions into and out of work that have the greatest impact on family budgets. Yet your chance of having a job and avoiding spells of unemployment is too closely linked to your background.

Unemployment is higher than average among those with lower skills, among the young and in most minority ethnic groups.

Having recognised skills, for example, reduces a person’s chance of being unemployed. Among graduates more than eight in ten have a job, but having no formal qualifications halves a person’s chances of having a job.2 Most young people don’t have much work experience. That is understandable, but it does make getting into work more difficult, so the unemployment rate for this group is almost three times as high as the average.

This is a serious problem as research shows that unemployment in youth can scar prospects throughout working life, not just at the time.3 While the employment rate for women is higher than ever before, it is still below the rate for men. There may well be an element of choice in this by families who choose to have mum stay at home with the children, but even in these cases it is likely that many women who want to work may feel unable to do so due to the limited employment choices that match their need for flexibility.

…and find it harder to stay in work But getting a job is just the start. It’s then important to stay in work. Moving up from the entry-level floor of the labour market is the best way for individuals to protect their employment in tougher economic times and boost their incomes.

The same groups who struggle to get into work also struggle to stay in work. This makes them proportionately more likely to lose their jobs in any downturn. It puts them at risk of getting into a cycle of low-paid, short-run work and unemployment.

Our research shows that before the recession it was progressively easier each year for people to stay in employment from one year to the next. But it hasn’t been equally easy for every group. The positive finding is that the proportion of workers in the lowest income group (the bottom fifth or quintile) remaining employed a year later increased between 1997 and 2013, but their rate of retention remains lower than in any other group. They remain the most at risk of unemployment (Exhibit 1). Our research also shows that workers who had a job at the start and end of the year, but were unemployed for a period in between, were less likely to see their earnings keep pace with the rise in the cost of living (Exhibit 2).

Making Britain work for everyone: Facing up to challenges in our labour market

Exhibit 1: Those with the lowest earnings are the least likely to remain employed a year later Workers remaining in employment the following year (%)

Highest wage group

4th wage group

3rd wage group

2nd wage group

Lowest wage group 80

85 1997/98-2001/02

2002/03-2006/07

90

95

100

2007/08-2012/13

Source: Analysis by Dr Abigail McKnight (LSE) of Labour Force Survey data, 1997-2013

The formula for staying in work raises issues we need to address…

Exhibit 2: Periods of unemployment mean lower pay growth Workers receiving higher wages the following year (%)

Sustained employment At least one period of unemployment within year 30

35 Nominal growth

40

45

50

55

60

65

Real growth

Source: Analysis by Dr Abigail McKnight (LSE) of Labour Force Survey data, 1997-2013

70

Given the importance of finding and preserving employment as a tool for people to build their careers, and therefore their standard of living, it is important to understand what separates those who manage to stay employed – whether in the same job or moving to another one – from those that don’t. Exhibit 3 summarises some of the key factors.

The type of job someone holds has a big impact on the chances of being employed in a year’s time.

Having a permanent rather than a temporary job is the biggest single factor.

In reality, most temporary workers are still employed a year later – either in the same or another temporary job or have moved into a permanent job.

But the fact that employment retention is higher among permanent workers makes it important that temporary work is either an arrangement that suits the individual or acts as a springboard into the jobs market. That means ensuring that temporary workers can progress and grow their skills. There also needs to be a strong flow between temping and permanent work to avoid a two-tier labour force. This is equally true for those working part-time rather than full-time – another key factor affecting work continuity.

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Making Britain work for everyone: Facing up to challenges in our labour market

Exhibit 3: The greatest difference in the chance of staying in work is between full-time permanent workers and part-time, temporary workers.

Positive factors

Negative factors

Permanent job

Temporary job

Full-time job

Part-time job

Age 40-45

Age under 25

Degree or higher education

Median earnings group

Recently received training

Public sector

Male

Source: Analysis by Dr Abigail McKnight (LSE) of Labour Force Survey data, 1997-2013

No qualifications

Lowest earnings group

No recent training

Private sector

Female

Making Britain work for everyone: Facing up to challenges in our labour market

… and shows the value of education and skills Beyond the form of employment contract, there are a range of other factors shaping how successful someone is in holding down steady work. Those most likely to remain employed over the course of a year have higher-level skills, are in their early forties, and have full-time jobs paying median hourly earnings.

The people most vulnerable to unemployment are those aged under 25, with no qualifications and relatively low hourly wages.

The benefit of higher skills is broad-based. Looking at differences in an individual’s chance of remaining in work based on the type of qualification they hold shows the value of vocational qualifications, in particular. We find no difference between workers with degrees and workers with other higher level qualifications. Both groups do better than those with lower level qualifications or none. These findings have important implications for policy makers. They lend weight to the idea that investment in apprenticeships deserves the same attention as other education and training routes.

Exhibit 4: More low paid workers saw their pay increase faster than inflation than workers in higher wage groups Workers receiving higher wages the following year (%)

Highest wage group 4th wage group 3rd wage group 2nd wage group Lowest wage group 0

10 Real growth

20

30

40

50

60

70

80

90

Nominal growth

Source: Analysis by Dr Abigail McKnight (LSE) of Labour Force Survey data, 1997-2013

100

Once in work, some people still find it hard to progress up the earnings ladder After getting a job and holding onto it, the next step is moving on up. There will always be lower paying jobs.

That isn’t itself a problem – and the pay level reflects the productivity of those roles. What is important is that people who start their careers in lower paying jobs have opportunities to progress and increase their earnings over time. They must not be cut adrift from the rest of the workforce.

To understand the extent to which people can progress, our research tracked the hourly wages of workers in five groups (quintiles). It looked at how their pay changed from one year to the next and whether they managed to increase their pay sufficiently over that 12 months to move from one wage group (quintile) to another.

Between 1997 and 2013, the group of workers with the lowest wages were more likely than others to receive annual pay rises that matched or exceeded the rate of inflation (Exhibit 4). The introduction of the National Minimum Wage (NMW) has probably played some part in this. But with NMW jobs making up only a little over a quarter of the jobs in this group, it cannot be the only factor. It also cannot explain why workers in the second lowest wage group also more often saw their earnings outstrip inflation than those in higher-paid groups.

These different rates of pay growth mean there has been a lot of movement between wage groups. In each year since 1997, between three and four in ten workers from the lowest wage group have moved up the pay distribution. The majority of these workers moved up one quintile and a smaller group moved further up the distribution into the median quintile or higher. This ‘longer-range’ mobility dropped in the years after the recession – perhaps unsurprisingly – although 2012-13 data suggests it may now be recovering again (Exhibit 5).

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Making Britain work for everyone: Facing up to challenges in our labour market

Exhibit 5: Most workers moving up within a year moved one income group

These findings show the UK labour market works for many people. Each year a large group of workers who start in the lowest wage quintile are able to increase their pay enough to move up the earnings distribution.

Workers from the lowest wage group moving up the pay distribution (%)

But the picture is not quite that simple. While mobility upwards is highest amongst those in the bottom quintile, many workers do get stuck at this level.

These findings are broadly in line with previous research published by the Resolution Foundation which analysed a different data source, the Annual Survey of Hours and Earnings.4

2012/13

2011/12

2010/11

2009/10

The formula for moving up the pay ladder also raises issues

2008/09

So why do some workers progress upwards from the lowest pay group while many others don’t?

To understand the factors lying behind this our research looked at the impact that different individual characteristics have on a worker’s likelihood of improving their pay position. Like our analysis of the factors associated with staying in work, our analysis of pay growth highlights challenges that need to be addressed (Exhibit 6).

2007/08

2006/07

2005/06

2004/05

Some of the findings confirm what we expected to see. For example, the greatest difference is between people with a degree and those with no qualifications, confirming that skills are essential to raising pay.

Workers with degrees had larger pay rises than those with other higher level qualifications. Those people in turn had higher pay rises than those with A-Levels, GCSEs or no qualifications. So skills and qualifications matter now and their importance is set to increase in the years ahead (Box 1).

2003/04

2002/03

2001/02

2000/01

1999/00

1998/99

1997/98 0

5

10

Moved up two or more wage groups

15

20

25

Moved up one wage group

Source: Analysis by Dr Abigail McKnight (LSE) of Labour Force Survey data, 1997-2013

30

Making Britain work for everyone: Facing up to challenges in our labour market

Exhibit 6: Factors ranging from having a degree to living in London are associated with faster wage growth.

The widest gap is between those with the lowest pay and the highest pay.

Faster wage growth

Slower wage growth

Lowest earnings quintile

Highest earnings quintile

Degree

No qualifications

Sustained employment

Period of unemployment

Full-time worker

Part-time worker

Lives in inner London

Lives in Tyne & Wear

Received training within the year

Aged 40-45

Male

Temporary contract

Training before start of year

Public sector

Source: Analysis by Dr Abigail McKnight (LSE) of Labour Force Survey data, 1997-2013

Did not receive training within the year

Under 25 years old

Female

Permanent contract

No training

Private sector

11

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Making Britain work for everyone: Facing up to challenges in our labour market

The issue is less clear cut when it comes to gender. Our analysis finds that even if we allow for differences in qualifications, the type of job, where you live and a number of other characteristics, women are likely to experience lower pay growth than men.

The issues around the gender pay gap are numerous and complex. They often include cultural and occupational elements as well as personal decisions around caring responsibilities and work-life balance.

Because these issues often reflect attitudes absorbed in childhood, we recently called for measures to tackle occupational segregation in school to help avoid these patterns developing at an early age.5 But our analysis suggests more needs to be done to ensure that all of the skills of female employees are put to good use and reflected in their pay. It also highlights the importance of putting in place support systems that mean women don’t have to trade pay for flexibility on hours for example, and that flexible working can open the way to more senior positions.

Perhaps the most surprising result is that temporary workers fare better on pay growth than permanent workers. Part of the explanation may be that many of those starting the year as temporary workers moved into permanent work and received a pay rise when they did so.6 It may also reflect that highly-skilled temps fill skills shortages and are paid a premium for this and that many other temps are new entrants to work and their value increases rapidly as they gain experience.

A second surprise is that being a higher earner has a negative impact on pay growth. This suggests that it is the other factors that our analysis ‘controlled for’ – skills level, age and location for example – that are more important. Policy should therefore focus on these factors rather than positions within the pay distribution alone.

This analysis suggests that there are significant issues to address in our labour market related to how people progress and build both sustainability in employment and better pay growth. This is a view that has led some commentators to question the UK’s commitment to a flexible jobs market and seek more law to “protect” employees. We turn to that question now, and ask whether flexibility works for employees, as well as companies.

The greatest difference is between people with a degree and those with no qualifications – skills are essential to raising pay.

Box 1

Making Britain work for everyone: Facing up to challenges in our labour market

Skills matter now – this will only increase We have already seen that skills define someone’s ability to hold onto a job and progress in our labour market. That is no surprise, and this effect is likely to grow in coming years as the UK seeks to compete in highly skilled globally tradable sectors.

If the vulnerable groups we have identified are left behind, the attainment gap and the obstacles to their progression at work may grow.

Our labour market is already creating highly-skilled, and better paid jobs. Between 1992 and 2012, the proportion of UK jobs that required highly-skilled workers increased from 33.6% to 43%.

The latest forecast by the UK Commission for Employment and Skills predicts that this will continue over the next decade so that by 2022 almost half (47.6%) of all jobs in the UK will require highly skilled workers. If we have a group of workers who are falling behind in the current labour market, then this trend will tend to worsen over time, as the skills needs of business grow.

These jobs have mostly replaced the traditional ‘middle’ jobs – skilled trades and secretarial roles – rather than reducing the proportion of jobs that require lower levels of skills. Exhibit 7 shows this change – the reason low-skill jobs have reduced so slowly is the growing demand for care, leisure and other service workers. There are many factors at play here, not least that the UK’s ageing population is increasing the demand for care workers.

Changes in workforce jobs data also shows this growth of highly-skilled, better-paid jobs. The UK has been creating a significant number of jobs in sectors with above average hourly earnings.

• D uring the recession itself the only jobs we created were jobs in sectors with above average (median) wages.

• I n the aftermath of recession, more jobs were created in sectors with below median wages than jobs in sectors with above median wages. This was a sign that lower-paying sectors – hit harder during the recession – were recovering.

This is confirmed when we look across the period between 2008 (Q3) and 2013 (Q4) as a whole. By the end of 2013 there were a million new jobs in sectors where the median wage was higher than the median wage in the economy as a whole and 86,000 fewer jobs in sectors where it was lower (Exhibit 8).

Exhibit 8: Job creation has been concentrated in higher paying sectors Change in workforce jobs ('000)

Q3 2008-Q4 2013

Q1 2010-Q4 2013

Q3 2008-Q4 2009

Exhibit 7: Almost half of UK jobs will need highly-skilled workers by 2022

-900

-600

-300

Above average hourly earnings*

0

300

600

900

Below average hourly earnings*

* Based on median hourly pay in 2008, full-time employees

UK jobs by skill level (%)

Source: ONS, Labour Market Statistics, ASHE

2022 2017 2012 2002 1992 0

20 Other low-skilled jobs

40

60

Care, leisure & other services

Skilled trades & administration

High-skilled jobs

Source: Analysis of Wilson, R. Et al. (2014) Working Futures, 2012-2022, UKCES

80

100

The recession has not derailed the UK’s progress in creating higher-skilled jobs – neither has it increased the demand for lower-skilled work, therefore. But what this data does emphasise is that the skills challenge that those at risk of exclusion in our labour market face is getting tougher all the time.

1200

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Making Britain work for everyone: Facing up to challenges in our labour market

Flexibility – essential, but not enough on its own

For several decades now, the UK has been praised for its so-called “flexible labour market”. This is an approach that involves maintaining a strong basic floor of employment rights, but limiting interference by policy-makers beyond this, with the aim of making job creation attractive. It works best when firms create jobs, the economy grows and employees’ pay increases.

On balance, the gains of this approach are thought to outweigh its costs. On the other hand, trade unions and others have argued that flexibility is not good because it discourages investment in skills, makes laying people off easier and leaves employees vulnerable to arbitrary treatment.

When politicians debate these issues and what needs to be done to tackle the challenges we have already identified, views can quickly become polarised. On one side are those who take the view that more government action is needed. On the other is a view that the UK’s flexible labour market will continue to deliver if left alone.

Our analysis has shown that flexibility alone is unlikely to be enough given that there are clearly issues with some workers being left behind. But does this imply ditching our flexible approach, or building on it?

In this chapter we look at whether flexibility helps or hinders people as they aspire to improved living standards. We find that flexibility brings important strengths to the UK that should not be lightly thrown away.

After all, in the last chapter we showed that many workers in the lowest income group can move up the earnings distribution effectively because of the opportunities our jobs market creates. Flexibility has brought us strong job creation, advanced economy leading pay growth and stable employment relationships. But it is not enough on its own.

The UK has a record of keeping people in work – even in the tough times…

Jobs are the foundation of living standards.

And the UK has a strong overall record on job creation. Over the 15 years before the recession hit, a rising proportion of people of working age in the UK found jobs, catching and then overtaking the US where the employment rate was falling.

Flexibility not only helped create jobs during the good times – it also helped protect them during the recession. Losing a job in the family is the worst thing that can happen to a household’s income. So when employment fell by 1.9 percentage points in the recession this caused a lot of pain in many homes around the country.

But it might have been a lot worse. That fall in employment was set against a fall of 7.2 percentage points in GDP. If the ratio of jobs lost to the fall in GDP had been the same during the most recent recession as it was in the 1980s, then twice as many people would have lost their jobs.7 The wage squeeze, and shorter working hours for less pay in some firms, have been tough – but they kept people in work. And that meant fewer families facing a catastrophic loss of income.

Making Britain work for everyone: Facing up to challenges in our labour market

Exhibit 9: Pay has risen faster than the cost of living through most of the last 50 years Real average weekly earnings (% change on a year ago) 15

10

5

0

-5

2013 Q1

2012 Q1

2011 Q1

2010 Q1

2009 Q1

2008 Q1

2007 Q1

2006 Q1

2005 Q1

2004 Q1

2003 Q1

2002 Q1

2001 Q1

2000 Q1

1999 Q1

1998 Q1

1997 Q1

1996 Q1

1995 Q1

1994 Q1

1993 Q1

1992 Q1

1991 Q1

1990 Q1

1989 Q1

1988 Q1

1987 Q1

1986 Q1

1984 Q1

1985 Q1

1983 Q1

1981 Q1

1982 Q1

1979 Q1

1980 Q1

1978 Q1

1977 Q1

1975 Q1

1976 Q1

1973 Q1

1974 Q1

1972 Q1

1970 Q1

1971 Q1

1968 Q1

1969 Q1

1967 Q1

1965 Q1

1966 Q1

1964 Q1

-10

Source: ONS, An examination of falling real wages, 2010-2013, January 2014

And the jobs market has bounced back since. By February 2014 the UK’s flexible labour market had seen the creation of 800,000 more jobs than were lost during the recession. This is despite economic growth being weak and the outlook uncertain throughout most of this period. The issue now is ensuring many of the people at risk of being left behind are in a position to take up these new jobs.

…and a history of raising living standards through pay growth The recent squeeze on real pay and living standards has certainly been tough for households across the country. And there is a lot of ground to make up, as we have already noted.

If we look back over a longer period, however, workers have seen their pay rise faster than the cost of living through most of the last 50 years (Exhibit 9). In fact, between 1990 and 2008 the UK achieved faster real wage growth than most other major economies – including both the US and much more regulated countries like Germany and France (Exhibit 10). This is an important point – it shows the policies we need to boost pay are not ones that undermine the UK’s long-standing flexibility, but rather ones that ensure more people benefit from it. Average performance in

the UK has been good over time – the focus must be on ensuring the at-risk groups we have already identified are able to take advantage of the same progress.

During the late 1980s and the 1990s, real wages rose by at least 20% for all income groups, albeit they rose fastest for those in the higher earning groups and slowest for those in the lowest pay group.

But between 1998 and 2011 the picture was different.

Again, real wages rose for all groups, but in this period wage growth was more even across most groups of employees. Those at the very bottom and the very top saw their pay rise faster than the average – the wages of the lowest earners rising quickly in part because of the introduction of the NMW in 1999 (Exhibit 11).

The NMW was a success because it was set by the independent Low Pay Commission with affordability for businesses in mind – that is its strength – and because of this it has raised wages without major effects on employment. By building on rather than damaging flexibility – something many businesses feared when higher introductory rates were being discussed before the 1997 General Election – the minimum wage shows us how to help at risk groups without damaging the UK’s strong average performance.

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Making Britain work for everyone: Facing up to challenges in our labour market

Exhibit 10: Real wages have risen faster in the UK than in other advanced economies Average annual growth of real wages (%)

UK

Canada

US

France

Germany

Italy

Japan -0.5

0.0 1990-08 *

0.5

1.0

2000-08

1.5

2.0

* Data for Germany is from 1991

Source: CBI analysis of OECD

Exhibit 11: Real wages have risen for all groups over the last 25 years Increase in real hourly wage, by pay percentile (%)

5 10 20

As well as average pay increases and job creation, a flexible labour market works if it ensures that workers benefit from company performance over time. Largely, that has been the case in the UK – though the forms of this compensation has changed over time.

The squeeze on pay in recent years reflects the tough trading conditions businesses have faced. But there is little reason to think there has been a fundamental realignment in the balance between what workers and shareholders will gain from future economic growth. As Exhibit 12 shows, the total compensation of employees as a share of company income has not fallen over the last 50 years. Within that total it is true that wages taken as cash have decreased as a proportion of business income – but this is because other elements have diverted spending away from pay.8 Since the data series started in 1955, the share of business income being spent on employees through wages, pension payments and National Insurance contributions, has fluctuated between 67% and 82%.

Looking at past recessions shows the worker share tends to rise during recessions as profits are hit and then tends to fall back during recovery periods as companies rebuild profitability. This is what happened in the most recent recession too. Having declined for much of the last decade, the share of business income spent on workers increased during and since the recession to 72.9% by the end of 2013. It now stands at broadly the long-term average of 72.7%.

UK employees also fare remarkably well by international standards. Compared to other OECD countries, employees in the UK receive the third highest share of value of output, behind only Slovenia and Korea. So the UK’s flexible labour market certainly doesn’t act as a drag on employees’ stake in business success.

30 40 50 60 70 80 90 95 0

When businesses grow, employees benefit too

10 1998-2011

20

30

1986-1998

Source: Analysis by Oxford Economics of ASHE/NES data

40

50

60

Making Britain work for everyone: Facing up to challenges in our labour market

Exhibit 12: Measuring wages alone has become a less accurate measure of worker compensation % of non-self employment business income 85

80

75

70

65

60

55 1955

1959

Wage Share

1963

1967

Compensation Share

1971

1975

1979

1983

1987

1991

1995

1999

2003

2007

2011

Recession

Source: Analysis by Oxford Economics of System of National Accounts data

In short, workers are receiving roughly the same proportion of business income as they have, on average, over the past half-century. Pay as a proportion of this has reduced as the value of pensions and other benefits has increased.

Exhibit 13: Pensions and taxes have risen as a proportion of the cost of employing workers Non-wage compensation as a percentage of total compensation 18 16 14 12 10 8 6 4 2 0 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

The reason why wages have reduced as a proportion of business income is that the value of other benefits and the tax wedge on employment has increased.

For example, the rising cost of pensions has driven up the pension share in the proceeds of growth going to workers (Exhibit 13). Deferring income to provide more support in retirement is important for longerterm living standards, so the rising value of pensions relative to the value of wages is a somewhat positive trend. Successive governments have also raised employer National Insurance contributions to fund welfare benefits, adding to the non-wage employment costs of businesses.

Imputed Social Contributions Non-NI

Notionally Funded Pensions

NI Contributions

Source: Analysis by Oxford Economics of System of National Accounts data

Funded Pensions

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Making Britain work for everyone: Facing up to challenges in our labour market

Working full-time on a permanent contract of employment remains the norm Our analysis earlier in this report showed how important permanent contracts and full-time work are in avoiding periods of unemployment – so it is essential that our economy is able to create these kinds of jobs. Despite frequent claims of “mass casualisation” from some unions, the evidence does not support the idea that this is happening.

In the UK, working full-time on a permanent contract remains the preference of most – but not all ¬– employees. And these are exactly the arrangements most businesses are able to offer most of the time.

Firms favour this form of open-ended commitment because it helps them retain key staff. Fewer than one in 20 workers in the UK is working part-time because they cannot find full-time work and fewer than one in 40 employees works on a temporary contract because they cannot find a permanent job.9 While the flexible component of the workforce remains relatively small, it is vitally important to the success of businesses. In a recent CBI survey the most commonly cited reasons why flexible employment is important were to cope with fluctuating demand (87%) and to respond rapidly to growth opportunities (81%).10 Flexible work patterns were also valuable during the recession because they enabled employers, in conjunction with employees, to keep people in work. When the downturn hit in 2008, the number of workers working part-time when they were available to work full-time and the number working on temporary contracts because they could not find permanent work both rose.

But the UK’s short-term response to recession does not mean there has been a structural shift away from full-time, permanent work. Recent data on job creation shows that as the recovery has gained momentum, employers have been creating the fulltime, permanent jobs that most employees want. In the year to February 2014 there were 376,000 more permanent employee jobs compared to 20,000 more temporary ones. At the same time there were 329,000 more full-time employee jobs compared to 66,000 more part-time ones.11 The pattern of full-time jobs on open-ended contracts is reasserting itself as the core model of employment in the UK. In this chapter, we have seen that – on average – a flexible labour market brings UK companies and workers substantial strengths on job creation, pay growth and permanent stable work. This is a strong basis that it would be foolish to undermine.

The question for the future is what we can do to share the advantages of our labour market more inclusively with the groups most at risk of falling behind. This is the subject of the next chapter.

Flexibility has brought us strong job creation, advanced economy leading pay growth and stable employment relationships.

But it is not enough on its own.

Making Britain work for everyone: Facing up to challenges in our labour market

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Making Britain work for everyone: Facing up to challenges in our labour market

Finding solutions that tackle weaknesses but preserve our strengths is a challenge for us all

As we have seen in the past two chapters, things need to change if we are to make the best of all our talent. Too many workers are left behind, and if businesses aren’t making the best of their staff then they aren’t making the best of their company. Untapped potential and wasted talent is lost business performance – there is a clear business case for realising the potential of all workers and making the most of their talents, alongside a strong moral one.

Given what we have seen in the previous chapter, the benefits on average of flexibility are significant. So maintaining them is important – but that doesn’t help much if you are being left behind. To address this we must move on from debating whether to regulate our labour market more tightly. That would be a fundamentally damaging move to the average worker and not address the barriers the groups we are most concerned about face. Instead, it’s time to focus on what we can do to support all workers to have opportunities to fulfil their ambitions and achieve their potential through successful working lives in higher-productivity jobs, in addition to supporting flexibility.

This is an important debate. And the CBI is planning to make a significant contribution to it during 2014. In this chapter, we offer more questions than answers - providing early insight into some of the issues our team are looking at in the search for solutions. We focus on two areas in particular to start this debate: productivity and opportunity.

Policy makers need to work with businesses on solutions that will be effective in the long-run There is little reason to think that workers in the UK will not benefit from business success in a growing economy.

The challenge is how we boost the UK’s performance further, on a more inclusive basis, to support higher wages and higher living standards for the vast majority – not just the average.

But employing somebody must always make economic sense to a business. For instance, a wage floor which is politically-determined and not based on sound economic evidence risks jobs by elevating wages above the contribution workers make to the company.

That would be a real shame. It should not be forgotten that since the introduction of the NMW – a policy which benefitted from the sound economic evidence provided by the Low Pay Commission – in 1999, inequality between the incomes of the lowest earners and the highest earners in the UK has decreased slightly, going against the trend of rising income inequality in Germany, Japan and the US.12

Making Britain work for everyone: Facing up to challenges in our labour market

At the same time, both the lowest earners and the highest earners have increased the proportion of wages that they receive, squeezing the proportion going to groups in the middle of the income distribution. The ratio between the lowest incomes and the median income has reduced and the ratio between the median and the highest earners has increased (Exhibit 14). This suggests that while we should focus on re-engaging those groups we identified in Chapter 1 as being at risk of falling behind, there is an ongoing challenge of continuing to boost the skills base – and therefore the productivity – of the whole workforce. New rules on controlling executive pay, introduced recently, will also ensure pay setting for the very highest earners is subject to greater transparency and scrutiny.

Exhibit 14: The lowest paid have been closing the gap to other workers 1999=100 110

105

100

95

90

85

80 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 90:10 earnings ratio

90:50 earnings ratio

50:10 earnings ratio

Source: Analysis by Oxford Economics of ASHE, real annual pay

8% The drop in the difference between the lowest and middle income earners.

Productivity holds the first key to improving living standards It is a fact of life that pay reflects the economic value of the work done by someone – their productivity in their job. If pay and employment costs outstrip productivity, that job will rapidly become unsustainable. In the UK, our overall productivity performance is remarkably poor by comparison to both pre-recession and international standards.

In part, this is linked to the level of employment retention that our jobs market delivered in the wake of recession. It is as yet unclear how much of this weakness reflects structural rather than cyclical issues. But boosting productivity – generally and in key sectors where it would help disadvantaged groups – is the first key to making progress in raising living standards.

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Making Britain work for everyone: Facing up to challenges in our labour market

110

100

90

80

70 1998 99 2000 01

02

03

Pre-crisis trend

04

05

06

07

08

09

10

11

12

13

Output per hour

Source: CBI analysis of ONS

Exhibit 16: Productivity has recovered faster in other countries Real output per hour worked (Q1 2008=100) 115

110

105

100

95

90

Norway Italy

Sweden France

Source: CBI, Haver Analytics

Denmark Germany

UK

US

Spain

2013 - Q4

2013 - Q3

2013 - Q2

2013 - Q1

2012 - Q4

2012 - Q3

2012 - Q2

2012 - Q1

2011 - Q4

2011 - Q3

2011 - Q2

2011 - Q1

2010 - Q4

2010 - Q3

2010 - Q2

2010 - Q1

2009 - Q4

2009 - Q3

2009 - Q2

85 2009 - Q1

Output per hour worked remains lower than its pre-recession peak and around 17% below trend (Exhibit 15). Internationally the UK stands out too, as one of very few countries where productivity has not yet recovered to where it was before the recession (Exhibit 16). Indeed, the UK is unique as the only country where output fell but employment rose. The only other countries where employment rose between 2008 and 2013 were countries where output rose too.

Making up lost ground is therefore critical in ending the pay squeeze in the UK. As productivity grows, so can wages.

120

2008 - Q4

As we explained earlier, flexibility allowed workers and their employers to work together to protect jobs during the recession. But this meant that economic output fell by significantly more than employment and hours worked. That in turn meant productivity plummeted and pay was held back. While recessioninduced pay freezes thawed from 2010 onwards, the fact that firms have taken on more staff in the aftermath of the crisis despite weak output growth means pay for most employees has continued to increase more slowly than prices.

2010=100 130

2008 - Q3

There are two targets for improving living standards through productivity – recovering the ground lost over the recession and catching up with the higher productivity of other countries.

Exhibit 15: UK productivity is 17% below trend

2008 - Q2

We need to make up ground lost in the recession‌

2008 - Q1

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Making Britain work for everyone: Facing up to challenges in our labour market

…and catching up with other advanced economies We must be more ambitious than just getting productivity back to where it was before the crisis.

We also need to close the gap with other nations.

Before the recession, we were making progress.

Real output per hour worked grew by 1.8% per year between 2000 and 2008 in the UK, marginally faster than in Japan (1.76%), Germany and the US (1.7%), and comfortably above the rates in France (1.2%), Spain (0.5%) and Italy (0.4%).13 But this catch-up started from a very low base.

UK productivity remained a long way behind most other G7 countries throughout the period – and has slipped further behind in the wake of recession. By 2012 the UK was ahead of only Japan and more than 30 percentage points behind Germany, France and the US. Improving UK productivity levels to the G7 average offers a sustainable longer-term route to real wage growth and higher living standards for a wider group of our citizens. The CBI team will be looking at how we might go about achieving this in the next phase of our work. We will look in particular at key sectors where progress would help the at-risk groups we have identified – and how we can improve productivity in them both over the short term and longer term.

Exhibit 17 shows that the contributions of sectors to productivity and added value growth vary from sector to sector and over different periods. Productivity gains are not equal in all jobs and the make-up of the economy and job mix also shift over time. The onus is on businesses in every sector to invest in improving labour productivity to support higher wages.

Exhibit 17: Productivity growth varies by sector Sector contributions to market economy labour productivity growth

Electrical machinery, post and communication

Manufacturing excluding electrical

Other goods producing industries

Distribution services

Financial intermediation

Business services and renting of machinery and equipment

Personal and social services 0.0

0.1 1979-1996

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1997-2007

Source: Corry, D. Valero, A. and Van Reenen, J. UK economic performance since 1997 growth, productivity and jobs, November 2011

Productivity improvements will help wage growth Progress on productivity will only help, of course, if productivity is linked to wage growth. In the US, the link has been called into doubt because wage growth has lagged behind productivity growth in recent years.

Some have made the same argument for the UK by comparing aggregate productivity to real terms median wages, but there is more to the story than this.

This is a complex and technical area, but the appearance of ‘decoupling’ between pay and productivity is misleading. The price of imported items such as food and energy has been rising faster than the value of items produced at home here in the UK in recent years.

As a result workers’ real wages, which are affected by rising prices at home and abroad, have declined. But UK businesses employing them aren’t seeing the prices they charge rise enough to be able to compensate their workers for this increased cost of living. Similarly, the rise in VAT in 2010 increased the cost of living but did not lead to firms having any more revenue to pass on to workers. This means that in recent years there is a notable difference between wages net of CPI inflation, which includes inflation at home and abroad, and wages net of GDP inflation, which accounts for changes in domestically produced items only (see Exhibit 18).

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Making Britain work for everyone: Facing up to challenges in our labour market

Exhibit 18: Prices rising faster than business income limits the ability of firms to increase ‘real’ pay

Exhibit 19: There is a strong link between the cost of employing workers and productivity 1994=100

2005=100 190

110

180 105

170 160

100

150 140

95

130 120

90

110

2013 Q3

2013 Q1

2012 Q3

2012 Q1

2011 Q3

2011 Q1

2010 Q3

2009 Q3

2010 Q1

2009 Q1

2008 Q3

2008 Q1

2007 Q3

2007 Q1

2006 Q3

2006 Q1

2005 Q3

2005 Q1

2004 Q3

2004 Q1

2003 Q3

Median earnings (CPI deflated)

Real output per hour worked (GDP deflated)

Cost of employment per hour (GDP deflated)

Product wage (Average Weekly Earnings deflated by GDP deflator) Consumption wage (Average Weekly Earnings deflated by CPI)

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

100

85 2003 Q1

24

Mean earnings (GDP deflated)

Output per hour

Source: CBI analysis of ONS, ASHE & NES Source: CBI analysis of ONS

Another factor that has led to the appearance of ‘decoupling’ is the fact that comparing wages with productivity does not take account of the non-wage labour costs. Employing a worker has become more expensive as non-wage costs – such as pensions – have risen, something we discussed in the previous chapter. These additional costs have to be met, but they don’t all end up in a worker’s take home earnings.

Between them, the rising cost of imports in recent years and the rising cost of employment account for much of the appearance of wages lagging behind aggregate productivity in the UK in recent years (Exhibit 19). This suggest that economic growth and productivity growth – especially in key sectors – is a sustainable long-term answer to boosting people’s incomes, and it is something that the CBI team will look at later this year.

Boosting opportunity for all is the other key imperative for better lives If boosting productivity is an answer in general to raising living standards in the UK, it will only work if access to it is widely shared, especially amongst those who currently struggle. It cannot be right that the factors we discussed earlier hold people back – we need a more widely-held and inclusive approach to delivering opportunity in the UK, so that young and old, male and female, temporary workers and permanent workers, can find ways to stay engaged, progress in their careers and achieve escape velocity from entrylevel wages and the risk of unemployment.

Next steps This report has been clear that our jobs market – while working well on average – leaves some people behind. This damages our potential as a nation – people must have the opportunity to make it in working life, based on a combination of hard work and the right investment in skills.

Making Britain work for everyone: Facing up to challenges in our labour market

Some of this concerns areas we’ve long been passionate about, such as our campaign on schools reform. But schools reform represents only the starting point. There is much more to be done to ensure everyone has the opportunity to achieve their potential. We need action on progression, skills, diversity and inclusion and the wider reward package as well as on improving productivity. The areas that will form the starting point for our analysis are: • The productivity challenge, as outlined above • S kills: We know a worker’s skills matter a great deal for his or her prospect of being employed and seeing their pay increase over time. So we will be looking into how businesses can support workers in improving their skills at all stages of their careers • C areer progression: Choices and circumstances can make it easier or more difficult to access the best career opportunities. Much of this happens before a young person enters the workforce.

But whatever level a young person enters the workforce at, there need to be opportunities for them to make progress towards higher-skilled and higher-paid work. Clear career pathways and individualised support from line managers are key to this and we will be looking at examples of best practice which more firms could adopt • D iversity and inclusion: our data shows there is a long way for business and government to go on the inclusion agenda. Our work will address what more we can do. Too many groups of people are not able to make the contribution that they might.

For instance, fewer women are in work than could be and many of those that are in work are in jobs that do not fully utilise their skills. Barriers like the availability of flexible working and quality affordable childcare are things that governments and businesses can do more to address • T he reach different opportunities have across different places, sectors and networks: How do we ensure that where someone lives does not restrict the opportunities they have? What can we do to enhance inclusion and progression in different sectors? How can we ensure that good ideas spread across the country?

Later this year we will publish a fuller analysis of the challenges this paper has raised, accompanied by policy priorities for creating a labour market full of opportunity. We will make recommendations on the role of business and government in supporting this.

In the spirit of this work, the CBI wants to engage in an inclusive analysis of what we can do together as a nation. We would welcome reactions to this paper and the issues it raises from businesses, public bodies, academics, trade unions and third sector organisations. We encourage interested parties to submit their views by email by Friday 25th July to livingstandards@cbi.org.uk

Whatever level a young person enters the workforce at, there needs to be opportunities for them to make progress.

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Making Britain work for everyone: Facing up to challenges in our labour market

Annex – Research methodology

The CBI commissioned two pieces of research to provide the evidence base for this report. Dr Abigail McKnight (LSE) was commissioned to provide an evidence base on the labour market outcomes for different groups of workers. Oxford Economics was commissioned to provide an evidence base on the evolution of the cost of employment, the evolution of the share of business income going to workers and trends in income inequality.

Dr McKnight used the Labour Force Survey to track the movement of individuals between employment, unemployment and inactivity and to measure wage growth between 1997 and 2013. In the Labour Force Survey individuals are tracked for five consecutive quarters, allowing a comparison between their position in one year and in the same quarter the following year.

This analysis revealed which groups of workers were more successful at remaining in employment and increasing their hourly wages. To begin to understand some of the drivers behind these differing outcomes, Dr McKnight used (1) a probit regression model with average marginal effect estimates to test factors associated with continued employment; and (2) a linear regression model to test the factors associated with real hourly wage growth.

The final part of this analysis took the individuals that were employed when they first completed the survey and were also employed in the same quarter a year later and divided them into five groups (quintiles) based on their hourly pay. Dr McKnight compared which hourly pay group individuals started in and compared it to which wage group they were in a year later as a measure of short term mobility.

Oxford Economics used: • O NS System of National Accounts (SNA) data to examine aggregate trends in the share of business income going to workers • O ECD labour share data to compare trends in the UK to developments in other countries • E urostat Index of Labour Cost (ILC) to compare trends in non-wage compensation across industries • O NS Annual Survey of Hours and Earnings (ASHE) data to explore the distribution of wages overall and across industries • O ECD inequality measures to compare wage inequality internationally • O NS ASHE data to measure the real wage growth of different income groups • O NS’s Blue Book for historical data on social insurance and pension costs.

Making Britain work for everyone: Facing up to challenges in our labour market

References

1 Calculated from ASHE, median gross weekly earnings for full time employees, deflated by CPI inflation 2 NOMIS 2014, Labour Force Survey, 2013 UK data 3 P Gregg & E Tominey, The wage scar of youth unemployment, 2004 4 Resolution Foundation, Starting out or getting stuck?, 2013 5 CBI, Engineering our future, March 2014; CBI, Building on progress, June 2014 6 The period analysed was before the introduction of the Agency Workers Regulations. At that time the government estimated that temporary workers were paid, on average, 96% of the pay of comparable permanent employees 7 In the 1980s recession employment fell 2.4% and GDP fell by 4.6% 8 We exclude self-employment income from our calculation to negate the distortive effect of not being able to apportion wages for workers and company profit 9 ONS, Labour market statistics, April 2014 10 CBI, On the Up – CBI/Accenture employment trends survey 2013, December 2013 11 ONS, Labour market statistics 12 OECD 90:10 income ratio, after tax 13 Own analysis with data from the EU KLEMS database

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For further information on this report, or for a copy in large text format contact: Matthew Percival Senior Policy Adviser T: +44 (0)20 7395 8161 E: matthew.percival@cbi.org.uk

June 2014 Š Copyright CBI 2014 The content may not be copied, distributed, reported or dealt with in whole or in part without prior consent of the CBI. Product code: 10537

www.cbi.org.uk