Broken Britain: How the wage squeeze left us being treated as a developing country

Economists say the UK is only just emerging from 'the biggest wage squeeze in Britain since the Napoleonic wars'

“It’s just not logical,” says Bethany Forster*,a compliance officer at a high street bank,who is planning to return to work in September following the birth of her third child. She and her husband recently ran the number and are now wondering whether it will be worth the effort. 

The couple,who live in London,estimate their childcare bill for the coming academic year will be roughly £20,000 and they will therefore need to earn nearly £40,000 before tax and national insurance to pay for it. Forster has three children: one at school,one at preschool and a baby who will start nursery in September. She’s planning to work only four days a week,so the expected bill doesn’t even cover full-time places. 

Part of the reason she is going part-time is in a deliberate attempt to keep her income below £100,000. Any higher and she would start losing her tax-free personal allowance and,as the highest earner in her household,her qualification for childcare support. If that went,she calculates she’d need to be earning £56,000 gross. “It’s a quadruple whammy: if I went full-time I would be working more for less net money and paying more in childcare while seeing less of my children.”

Forster is not alone. “I have lots of friends,colleagues and other mothers in my baby group who are in the same position,” she says. “Leave aside the fact that we are well paid and in a fortunate position,it makes no sense for the country.

“We’re well-educated people who are,let’s not forget,one of the last cohorts that got a lot of government support through university. We’re now in our 30s or early 40s. We’re reaching the high-points of our careers,our peak productivity and should be driving the economy. And yet the system makes it harder for us to do so.” 

The complicated contortions Forster and her husband must go through are a small illustration of the strange effects,distortions and disincentives in the UK tax system. Economists argue these have contributed to almost two decades of flat-lining productivity and a massive wage squeeze. And is,in turn,simultaneously both one of the causes and one of the effects of an economy that is patently not firing on all cylinders.

Recent figures showing that real average weekly regular earnings grew by a healthy 2 per cent in last year might have provided temporary cause for optimism. The bad news,however,is that the rise almost exactly matches how much pay increased over the previous 16 years combined. That’s right: after growing by an average of 33pc a decade between 1970 and 2007,real wage stagnation set in after the financial crisis, rising by just 2.2 per cent between February 2008 and February 2024. In total,not per year.

This tells you a lot more about the last two decades than it does about the last 12 months; the recent uptick is the most slender of silver linings. We are only just emerging from “the biggest wage squeeze in Britain since the Napoleonic wars”,according to Torsten Bell,the chief executive of  the Resolution Foundation. 

And the good news is only in aggregate. Those at the bottom end of the pay scale have been helped by steady increases in the National Living Wage,which increased by 9.8 per cent to £11.44 an hour in April. Those a little further up the ladder are still going backwards. Last year,British graduates in their early thirties,for example,were in real terms being paid a staggering 16 per cent less than 2007 levels. 

Even more worryingly,there are signs the recent bump in wages may be a blip rather than the start of a sustained recovery. Even as pay rose last year,productivity – measured by output per worker – was falling by 0.6 per cent. And economists agree that,ultimately,productivity growth is the main driver of wage increases.

Inflation has gnawed away at the value of benefits for households on low incomes. The permafrozen tax thresholds have hit higher earners.The UK has just taken one faltering step forward but may be about to take several back again. That will result in this country falling further behind in the pack of rich nations. 

“It seems that the recent increase in wages is a cyclical phenomenon driven by labour shortages as a result of Brexit,people dropping out of the workforce following the pandemic and a rebound in growth,” says the economist Julian Jessop. “We will not get a structural,long-term increase in wages until there is sustained productivity growth.” 

There is a long-running and,at times,quite arcane debate about whether Gross Domestic Product (GDP) is the best way to measure the economic performance of a country. Whichever side you come down on,it’s clear wage growth is far more relevant to most people and has a more direct impact on living standards. 

Wage growth also helps boost the economy because it means people have more to spend,while pay packets are the main source of tax receipts for the Treasury. 

Those that feel worse off are right to do so. For the first time on record,living standards will be lower at the end of this parliament than they were at the beginning. According to official data,real disposable income fell by 1.8 per cent per person in the four years to the end of last year. 

This is,of course,not entirely the Government’s fault. We have had three huge economic shocks in the past 15 years – the financial crisis,the Covid pandemic and energy price spike following Russia’s invasion of Ukraine. Two of those have happened since the last general election. 

But it is also true that the UK has suffered more than other similar countries. The average salary in the US was just more than £52,000 last year,according to the US Bureau of Labor Statistics,while in the UK it was £35,000,according to the Office for National Statistics. This is not a direct apples-for-apples comparison. US workers get fewer holidays and less in benefits. 

However,and this is the key point,the gap is widening. During the two decades in which UK wages flatlined,those in the US grew by 20 per cent. “The big picture is that we are all harder up than we thought we were going to be,” Bell told the BBC’s Today programme podcast. 

Economists love comparing different countries to try and gauge their relative performances. Such beauty contests (or,more recently,ugly baby competitions) usually have little bearing on most people’s lives. However,the gap that is opening up between UK wages and those earned by workers in other countries is now so big that people have started to notice.

Speaking to The Telegraph earlier this month,Alexandra Marshall Grant described how she transferred from her firm’s London office to Charlotte,North Carolina in September 2022. The move was motivated by a clear-eyed view of which was the real land of opportunity and resulted in a salary rise of 54 per cent.

Amber Peacock,a pharmaceutical sales executive,started job hunting in the US when her husband secured a green card and the pair relocated from Edinburgh. She found she would have been able to get a job doing “exactly the same thing,same hours,same commitment,same responsibility” but for double - if not triple - the salary (although she ultimately decided to become self-employed). 

US companies have also noticed the growing difference in wages on either side of the pond and are outsourcing white collar jobs to the UK. Last month,The Wall Street Journal,wrote an article about how surging wages in the US and a tight labour market has resulted in companies outsourcing many roles to Britain. The headline was: “The British Are Coming for Your White-Collar Job”.

Nick Bloom,a Stanford University economics professor who studies outsourcing,told the paper: “The strength of the [US economy] over the last 15 years has pushed wages up and made it more attractive to offshore. If you’re based in New York or San Francisco it’s now going to be cheaper to offshore to northern England than to Mississippi or Alabama.”

While it is encouraging that the UK is picking up these jobs,resulting in a healthy boost in services exports to the US,it also illustrates where the country is in the global economic pecking order. From a US perspective,the sharp fall in sterling since Brexit has made UK staff even cheaper. The value of the pound has fallen by 15 per cent compared with the dollar since 2016. 

A lot of film and TV production is moving from the US to the UK because wages are way cheaper in Holywood,Belfast,than Hollywood in Los Angeles and it is not unionised. The chief executive of one cybersecurity software told the WSJ almost all of his software engineers are based in the UK even though almost all the company’s revenue comes from the US.

Gregory Thwaites,research director at the Resolution Foundation,says: “The UK can take a leaf out of the emerging markets playbook and look to attract jobs from other developed nations because wages are lower or it can boost productivity and compete with other countries on the quality of its goods and services. The first option is definitely not the better way to go.”

What’s putting such a squeeze on pay packets? There are,a range of factors. 

UK wages have also been hit by low interest rates in a very specific and poorly understood way. As well as wages,companies have other employment costs such as National Insurance and pots of money to cover maternity and sick pay as well as pensions. These “employer social contributions” add about 20 per cent to the wage bill and have roughly tripled in the past three decades,according to the Resolution Foundation.

The biggest factor here is low interest rates,which create a funding gap in defined benefit pension schemes that have to be plugged by higher contributions from the company. Many of these schemes are now closed to new members. So,companies have effectively been holding off giving pay rises to existing employees (the vast majority of whom have much less generous defined contribution pension) so they can afford to pay the pensions of those who are retired or close to it.

Thwaites argues that one of the reasons wages are now rising is that,interest rates are going up,pension deficits are falling,companies are spending less topping up their schemes and can therefore afford greater pay increases.

The UK’s convoluted tax system does little to help matters. The Office for Budget Responsibility has described “the growing disincentives to work provided by frozen tax thresholds”. This issue occurs right up and down the payscale. Analysis by Bloomberg found that once taxes are added to lost benefits,some of those re-entering the workforce can be walloped with effective tax rates of 69 per cent.

There are also weird anomalies for high-earners. In theory,workers pay the 20 per cent basic rate of income tax on earnings between £12,571 and £50,270,the 40 per cent higher rate between £50,271 and £125,140,and the 45 per cent additional rate on anything more than than £125,140. But for every £2 earned above £100,the personal allowance of £12,570 is reduced by £1.

This means that those earning between £100,000 and £125,140 are actually paying an effective rate of 60 per cent. What’s more,if the highest earner in a household is paid £99,999 a year they are entitled to 30 hours of free childcare a week. But should their salary rise to £100,001 the benefit evaporates into thin air. 

Stuart Adam,a senior economist at the Institute for Fiscal Studies,has branded the fact that some parents will be worse off earning £130,000 than they would be earning £99,000 as “absolutely insane”. No wonder there is increasing evidence of some people reducing the number of days they work or finding other ways to deliberately reduce their wage. 

However,all other things being equal,the main driver of wages is the aforementioned productivity. The Nobel Prize-winning economist Paul Krugman once wrote that “productivity isn’t everything,but in the long run it is almost everything … a country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker”. 

The slowdown in productivity since the financial crisis is a global phenomenon and common to all rich countries (which tends to be defined as the OECD nations minus Turkey and Mexico). But the UK appears to have been hit harder than most: it went from leading the pack on productivity growth in the first decade of the century to limping along at the back today.

Last week,the International Monetary Fund put out its annual report on the UK economy. One graph is particularly telling. It shows that average annual productivity growth before 2008 was 2.2 per cent – the highest among G7 countries. After 2008,it was 0.4 per cent – one of the lowest.

Economists have spent the best part of the past two decades scratching their heads and trying to come up with answers to the UK’s so-called “productivity puzzle”. Thwaites’ best guess is that the answer is a little like Agatha Christie’s Murder on the Orient Express – all the various suspects are guilty. 

The UK’s outsized finance sector got whacked by the 2008 crisis,manufacturing has suffered as global trade integration stalled,and there’s been a drop off in “dynamism”,which can best be described as the process by which resources are allocated to their most productive use. 

Some economists believe that low interest rates have allowed struggling companies to remain in business for too long,preventing the renewal of Schumpeterian creative destruction. And an older workforce is more likely to sit tight in their current roles rather than seek a higher salary at another company. The political chaos following the Brexit referendum resulted in a period when companies were less inclined to make big investments and there were fewer start-ups. 

“The impact of relatively low rates of investment and high service delivery pressures,notably in health,on economic potential is beginning to show (for example,via an uptick in long-term illness-induced inactivity),” concluded the IMF’s recent report. “Finally,ageing and policies to rein in immigration will constrain total hours worked going forward,creating additional headwinds to growth.”

Add it all together and you get a whole lot of sluggishness. UK productivity last year was 24 per cent lower than it would have been had it continued climbing at the rates seen before the global financial crisis. In other words,this country has lost almost a quarter of what could have been.

This,perversely,provides one of the few bright spots for the British economy. “One of the silver linings of the great wage stagnation of the last 20 years is that the UK now has great catch up potential,” says Thwaites.

However,he adds that wage growth won’t just happen if we wait long enough; something needs to change. “If we improve the trade and cooperation agreement with Europe,overhaul planning and fix the pension system then hopefully that will help trigger a reset.”

Jessop argues that,although the hit to UK productivity was undoubtedly the result of a contraction to the country’s financial sector after the crisis,this was exacerbated by an increase in regulation and a large increase in the role of the state. He therefore believes cutting red tape,rolling back the state and reforming taxes will help the UK regain its animal spirits.

There is also the hope that technology,if handled correctly,could dig the country out of a hole. Some economists believe the rapid development of Artificial Intelligence (AI) may spark a new industrial revolution.

A study by Goldman Sachs suggested AI could increase productivity growth in the US by as much as 1.5 percentage points each year over the next decade. The UK could achieve productivity gains of between 0.9 per cent and 1.5 per cent a year,according to the IMF. 

As with prior industrial revolutions,this will likely result in huge disruption. Many jobs are at threat of being replaced in part or in full by AI. But the lesson of history is that big technological leaps eventually end up creating more new roles than they destroy. 

And,crucially,these jobs of the future tend to be better paid. 

*Names have been changed 

Your input is shaping how we report on this series. Please use the form below to send us your stories of Broken Britain and what other fractured institutions,infrastructure and phenomena we should be shining a light on.

Next week,we tackle the growing blight of litter in the UK,which readers have highlighted as one of the problems that most typifies the idea of Broken Britain. Share your stories below...