Following the twin discovery that governments were composed of politicians and that politicians mostly don’t look much beyond the next election, the OECD created the International Futures Programme (IFP) to encourage long-term thinking. A few years later, the UK government decided to set up a foresight unit, and in 2004 I went as IFP representative to a meeting in London where holders of stakes in different industries discussed what strategic thinking meant to them. It was much as you’d expect, with the oil industry explaining that they worked on a 50-year horizon, the pensions industry even longer, the finance industry losing interest after two seconds and going to look for something more exciting… The one surprise was the chief economist of a big mining company. “We don’t bother with strategic planning” he explained. “We get all we need from geological surveys and the market. So if the price of copper, say, is going up, we dig till there’s none left then move elsewhere. If it’s going down, we lean on our shovels until it goes back up again”.
I’d like to say they went bankrupt shortly after, but looking at the company’s performance, this charmingly down to earth approach seems to work well. At least if you already own a big enough share of the things your business depends on and everybody else needs them. That is practically never the case though for any firm, or even for a country. So as a new OECD report on export restrictions points out, since “no country is self-sufficient in every raw material, it follows that virtually all countries are vulnerable to any attempt to restrict the export of at least some commodities.”
And yet, the use of export restrictions seems to have increased over the past decade. The OECD Inventory of Restrictions on Trade in Raw Materials lists over a dozen ways this can be done, but the three most common are making exporters apply for a permit, putting a tax on exports, and restricting the quantity of a product that can be exported. All raw materials sectors are affected, from minerals and metals to forestry and agriculture products.
Emerging and developing countries use export restrictions most, although they’re not the only ones. But their citizens can suffer the most. Oxfam puts it like this: “you might think that governments would take urgent action to address fragility in the food system. But […] Governments often exacerbate volatility through their responses to higher food prices. In 2008 the global food system teetered on the edge of the abyss as, one after the other, more than 30 countries slapped export restrictions on their agricultural sectors in a giddying downward spiral of collapsing confidence”.
So why do they do it? The idea is that by restricting exports, more of the product is available on the home market, making it cheaper than it would be otherwise for local firms, thereby helping them to grow and compete on world markets. (Except for the producer of the restricted commodity). This probably works wonderfully well in countries with large reserves of iron ore whose principal activity is manufacturing lumps of iron in home-made forges for the weightlifting trade. And on the assumption that all its trading partners let it do this and don’t put up the price of anything in retaliation.
Because once you start getting into more sophisticated products, the advantages of export restrictions disappear. These days, final products rely heavily on the so-called “intermediate products” used to make them, sourced from the world’s global value chains. They can be high-tech items such as computer chips or very low tech, like wood planks, but more often than not they’re imported. The new OECD report describes an analysis of the impact in a number of sectors of what would happen if export taxes were simultaneously removed on steel and steelmaking raw materials. It finds that “When regions that apply export taxes remove these in coordination with similar action by trading partners, their downstream industries actually benefit.”
In their report mentioned above, among the solutions Oxfam proposes in relation to food, are “increasing transparency in commodities markets, setting rules on export restrictions” (they also call for “an end to trade-distorting agricultural subsidies”). This sounds very similar to the OECD report’s call for “better control, and more transparent use, of export restrictions”. The OECD report goes further though and looks at what alternatives are available to countries thinking of applying (or lifting) export restrictions. Chile for example, rather than concentrating on downstream processing, promotes a range of less capital-intensive and less energy-intensive intermediate goods and services industries linked to mining operations, as do a number of other successful minerals-rich countries.
Finally, this just in. Since I started writing today’s post, I’ve learned that my intro about the different sectors is sooo 2004 and the miner and the trader can be friends. A bipartisan report is to be presented to the US Senate today and tomorrow on Wall Street bank involvement with physical commodities. I feel like quoting whole pages of it in full, but in essence: “Since 2008, Goldman Sachs, JPMorgan Chase, and Morgan Stanley have engaged in many billions of dollars of risky physical commodity activities, owning or controlling, not only vast inventories of physical commodities … but also related businesses, including power plants, coal mines, natural gas facilities, and oil and gas pipelines.”.
I used the copper example, and so do Senators Levin and McCain and their colleagues: “JPMorgan built a copper inventory that peaked at $2.7 billion, and, at one point, included at least 213,000 metric tons of copper, comprising nearly 60% of the available physical copper on the world’s premier copper trading exchange, the London Metal Exchange (LME).” I quoted the homely image of a man and his shovel, and the Senators quote how even these days, market making isn’t all laser beams to transfer data and fancy algorithms to do high frequency trades: “Goldman approved “merry-go-round” transactions in which warehouse clients were paid cash incentives to load aluminum from one Metro warehouse into another, essentially blocking the warehouse exits”. But where we talk abstractly about risk, our men on the Hill cite “injuries, an international incident, or worse”.
That’s the world some policy makers think they can manipulate with export restrictions.
International trade: free, fair and open? (OECD Insights)
Not much good has come from the Ebola crisis, save this: It has raised awareness of the fact that we already have a weapon in our hands that could help fight such epidemics – our mobile phones.
There’s already evidence to show that the idea can work. Following the earthquake and cholera outbreak in Haiti in 2010, for example, “call-data records” from mobile phones were used to track people’s movements, so allowing experts to “infer, with empirical data and in real-time, where people are, and how many, and where they are probably headed,” according to The Economist. That’s vital information in health crises, where epidemiologists need to know if people are moving into or out of highly infected areas.
The technique has been also been used to follow people’s movements in the wake of natural catastrophes, for example after the 2011 earthquake in Japan. And there’s growing interest in seeing how it could be used to track survivors of extreme weather events, such as Typhoon Haiyan in the Philippines, especially as climate change threatens to raise the frequency of such disasters.
But there’s a problem. Even if such tracking methods don’t involve eavesdropping on callers’ conversations, they do involve a breach of their privacy. And in the case of the Ebola outbreak, that seems to have been a major obstacle in preventing mobile operators from releasing their phone records.
There’s also the problem that for everyone involved – mobile operators, government regulators and researchers – this is still somewhat uncharted territory. There’s a general recognition that call-data records have potential to ease suffering during epidemics and after calamities but, as The Economist again notes, “the data are unlikely to be released without stronger leadership that brings together operators, regulators and researchers”.
Still, even if the Ebola crisis has highlighted what remains to be done, it’s impressive to see the ways in which mobiles are already being used to collect data in developing countries. Perhaps that shouldn’t be a surprise. After all, according to the International Telecommunications Union, mobile-phone penetration now approaches 90% in developing countries (and 69% in Africa). This doesn’t mean that nine out of ten people have handsets. But even setting aside all those people and businesses with second or third phones, it’s clear that unprecedented numbers of people now have a device in their pocket that’s not just a phone but also a powerful little computer.
That’s potentially important for developing countries, many of which lack the infrastructure and personnel to compile adequate statistics. As the World Bank’s Shanta Devarajan has noted, widely cited poverty data for Africa for 2005 relies on robust statistics from just 39 of the continent’s countries, with only 11 able to supply comparable data for the same year.
These data holes make it difficult to measure progress and to identify priorities for development. In response, there have been growing calls for a “data revolution”, which would require action on a range of fronts, including greater investment in government statistical offices in developing countries and making better use of “Big Data” and innovative technologies, like mobile phones.
Encouragingly, there are signs that some of this is already happening. For example, an SMS-based survey in Tunisia investigated remittances, an area where hard facts are notoriously scarce and where estimates of how money migrants are sending back home are just that – estimates. It found that more than a quarter of remittances are sent back by hand, more than the total sent via Western Union. Insights like that could help to provide more accurate data on what is an important source of income in many developing countries.
Mobile phones are also being used to “crowd source” data on price changes, which, as Gillian Jones reports, can be used to “compile near real-time consumer price inflation data”. Local residents take photos of price tags in shops and markets and send them to a central data store. There, they are analysed to provide data on price changes as well as scarcities. Field agents are paid a few cents for each photo they send, but that can add up to an income of as much as $25 a month. And how are they paid? Over their phones, of course.
Global Call for Innovations: The Partnership in Statistics for Development in the 21st Century (PARIS21) has launched a global call for innovations to highlight organizational approaches and new technologies to help realise the data revolution. It is seeking case studies in crowd sourcing; data management; monitoring and reporting; open data; real-time data; remote sensing; research standards; visualization; skills development; and technical infrastructure.
Clean water, cold vaccines, cell phones = a simple way to save lives (OECD Insights blog)
In today’s post, Michael Gestrin of the OECD Directorate for Financial and Enterprise Affairs looks at whether declines in the EU’s flows of foreign direct investment (FDI) simply reflect a particularly severe FDI cycle or whether there might also be structural factors involved.
At the start of the 2007 crisis, global foreign direct investment (FDI) stocks actually declined, and even today, global flows of FDI are still 40% below their pre-crisis peak. Generally, OECD countries were the sources of the biggest declines while many emerging economies experienced increases in FDI flows. Europe has been one of the worst affected regions. EU inflows are down 75% and outflows are down 80% from their pre-crisis levels.
Inflows into the EU are currently around $200 billion, down from $800 billion at the peak of the global FDI cycle in 2007 (see figures). Outflows are also currently around $200 billion, down from $1.2 trillion in 2007. For the rest of the world, a global economy “without” the EU is doing quite well. In this global economy, inflows recovered strongly starting in 2010 and reached new record heights in 2011, at just over $1.2 trillion. With respect to outflows, the FDI crisis was limited to a one-year decline of 20% in 2009. Although world-minus-EU outflows have not grown over the past three years, they have been at record levels.
Part of the strong performance of the world-minus-EU can be explained by the growing importance of the emerging markets, in particular China, as sources and recipients of FDI. In 2012, emerging markets received over 50% of global FDI flows for the first time, and China is now consistently among the world’s top three sources of FDI.
The crisis initially gave rise to a significant gap between the non-EU OECD countries and the rest of world with respect to both inflows and outflows, just as it did for the EU (see figures). A big difference, however, is that for the non-EU OECD countries the gap closed after only two years. While the EU and the world-minus-EU group have been going in different directions ever since the start of the crisis, the non-EU OECD group and its rest-of-world counterpart appear to have returned to a similar cycle after parting ways for a much shorter period during 2008-9.
Comparing the EU and non-EU-OECD shares of world inflows and outflows highlights the extent to which the positions of these two groups have reversed in recent years (see figures). At the turn of this century the EU accounted for over 50% of global inflows and 70% of global outflows. By 2013 both shares were down to 20%. Conversely, the non-EU-OECD countries have seen their shares of global FDI inflows and outflows recover to pre-crisis levels. This group overtook the EU in 2010 in terms of its share of both inflows and outflows, thus reversing the historical relationship.
Why? The greatest declines in inward FDI in the EU have been from within Europe itself (see figures). Before the crisis around 70-80% of the region’s inward FDI consisted of intra-EU investment. Today only 30% of inward FDI is intra-EU. This sharp decline in the share of FDI that EU countries receive from their EU neighbours also helps to explain the decline in outward EU FDI.
The decline in the share of intra-EU in total EU inward FDI would seem to suggest a lack of confidence on the part of EU investors in their own regional market. One tempting explanation for this is that these declines have been concentrated in a sub-set of EU countries that have experienced particularly difficult economic conditions (such as Greece, Ireland, Portugal, and Spain) during the crisis.
This has not been the case. The FDI crisis in Europe has been broad-based, with the bulk of the declines in FDI flows concentrated in the largest economies. France, Germany, and the UK accounted for 50% of the $600 billion decline in FDI inflows between 2007 and 2013. Over the same period, Greece, Ireland, Portugal, and Spain accounted for only $14 billion, or 2%, of the inflow decline. With respect to outflows, France, Germany, and the UK accounted for 59% of the $1 trillion decline between 2007 and 2013. Over the same period, Greece, Ireland, Portugal, and Spain accounted for 12% of this decline.
Part of the explanation for the decline in investment in Europe is linked to an increasing share of international divestment relative to international mergers and acquisitions (M&A, see figures). While pre-crisis levels averaged around 35%, they reached almost 60% in 2010-11 and now stand at around 50%. In other words, for every dollar invested, 50 cents is divested. Consequently, net international M&A investment in Europe is currently at its lowest levels in a decade, at around $100 billion.
The clear “leader” in this regard is the consumer products segment, with a divestment/investment ratio of 148%. This means that for every dollar invested in consumer products over the past six years, around one and a half dollars was divested. This is an example of investment de-globalisation. Domestic and international M&A in Europe have generally followed the same pattern: both are on track to reach their lowest levels in a decade (see figures). Conditions that are holding back international investment in Europe would seem to be discouraging domestic investment as well.
From a policy perspective, the challenges of breaking out of this regional investment slump are daunting but urgent. A useful starting point is the recognition that a supportive environment for productive international investment needs to reflect the evolving needs of international investors. Such a supportive environment has three dimensions.
First, investors generally favour predictable, open, transparent, rules-based regulatory environments, much along the lines put forward by the OECD’s Policy Framework for Investment. Where impediments to investment have not been addressed by governments this often has more to do with implementation challenges rather than disagreement over principles. For example, it is widely accepted that excessive ‘red tape’ is an obstacle to investment but in many countries this is still often cited by business as being one of the most important impediments to doing business. In Europe, many such impediments represent relatively easy opportunities for improving the regional investment climate.
The second dimension concerns important changes in the structures and patterns of global investment flows as well as in the way MNEs are organising their international operations. This is reflected in investment de-globalisation and “vertical disintegration” which has seen MNEs become more focused on their core lines of business over time and more reliant upon international contractual relationships for organizing their global value chains.
Finally, Europe would seem to be confronting a competitiveness puzzle in which declining competitiveness is discouraging investment, and declining investment is in turn undermining competitiveness. A few years ago, OECD Secretary General Angel Gurría outlined six policy recommendations for getting Europe back on a sustainable growth path that also hold for investment:
- Further develop the Single Market.
- Ease excessive product market regulation;
- Invest more in R&D and step up innovation.
- Make sure that education and training institutions deliver highly sought after skills.
- Increase the number of workers participating in labour markets and make markets more inclusive to address social inequalities.
- Reform the tax system, including by reducing the tax wedges on labour.
Today’s post is from OECD Secretary-General Angel Gurría.
Six years since the onset of the Crisis many advanced countries continue to face high unemployment, sluggish growth and weak public finances. Growth is also slowing down in emerging markets.
Meanwhile, as recent revelations have demonstrated, the frayed international tax system has long allowed multinationals to plan their way around paying corporate taxes. And bank secrecy has let individuals stash money undetected, and untaxed, in hidden corners of the world.
Such practices erode the integrity of our tax systems, damage the capabilities of our governments, diminish economic growth and corrode the trust of our citizens who are the vast majority of taxpayers. The way tax is levied and spent is one of the most important levers to address social inequalities, create jobs, pay for education, infrastructure and other public services and encourage investment in innovation.
The OECD has helped put the international tax system at the forefront of the international policy agenda. Our work has been endorsed by the G20, whose leadership deserves praise and recognition for giving top priority to calling time on tax havens and recognising that an international tax framework developed 100 years ago is no longer fit for purpose.
Accounting for almost 90% of the global economy, 44 countries including the G20 have tasked the OECD with finding ways to fix this situation. Our Base Erosion and Profit Shifting (BEPS) Project aims to ensure the rules governing these systems are transparent, and that multinationals cannot exploit gaps between national tax laws or artificially shift profits to low tax jurisdictions where no real economic activity takes place.
We’re moving fast. The first results of our BEPS project were released in September and we are on track to deliver the final package of measures a year from now. These efforts will neutralise the “cash boxes” companies use to keep trillions of dollars of profits offshore and free of taxation. They will also ensure that patent boxes can’t be used to shift profits to countries where no substantial activities are carried out to generate those profits. Countries have also been spurred into action: Ireland will put an end to “double-Irish” tax planning schemes and the Netherlands will renegotiate its tax treaties with developing countries to ensure they can’t be abused by multinationals to avoid paying tax. And the European Commission has launched high-profile state-aid investigations into tax practices by its members that could breach EU law.
We have also witnessed a sea change on the tax transparency front since 2009 when strict bank secrecy was still the rule in many countries. The Global Forum on Transparency and Exchange of Information for Tax Purposes now has over 120 members. The Forum has issued over 70 compliance ratings on its members and over 500 recommendations have resulted in changes to laws and practices that will improve tax transparency worldwide.
Implementing Automatic Exchange of Information (AEOI) is the next major objective. We have developed a new global standard in close cooperation with G20 countries and 93 jurisdictions have now committed to launching automatic exchange by 2017 or 2018. Only last month in Berlin, 51 countries and jurisdictions took the first step toward implementation by signing a multilateral agreement. Luxembourg, Switzerland, Singapore and many other financial centres are already on board, and more will follow. This robust standard will allow authorities to track income and offshore assets. These efforts are bearing fruit. Voluntary disclosures by tax evaders have already yielded 37 billion euros of additional revenue to OECD and G20 countries since 2009.
Extending the benefits of these changes to developing countries is a top priority. They have a big stake in this effort but lack the resources to crack down on their own. The OECD is involving them fully in shaping the new global standards. Initiatives such as our Tax Inspectors Without Borders are specifically designed to help developing countries prevent the erosion of their tax bases and the illicit outflow of revenues through tax evasion.
Now is the moment for governments to take action in a concerted international effort. Corporate profits must be based on the true cost of developing products and services, not on clever distortive tax arrangements that favour multinationals over domestic businesses. Too many multinationals are getting away with paying as little as 1% -2% on their global profits, and in some cases paying nothing at all.
Overhauling the global tax system and its practices is fundamental if we are to deliver stronger, cleaner and fairer growth for a post-Crisis world. What happens in the next 12 months, starting with the G20 Brisbane Summit, will be critical for the success or failure of this exercise. Making historic changes means taking tough decisions and takes political courage. In the current circumstances, nothing less will do.
Are you following the G20 leaders’ summit in Brisbane this weekend? The OECD Observer magazine is here to help. OECD Secretary-General Angel Gurría and Australian Treasurer Joe Hockey lead this fact-packed “300th edition” through the G20 issues on the table at Brisbane, with articles on growth (notably the 2% growth challenge), trade, gender and jobs. In our Ministerial Roundtable on employment, ministers from Australia, Germany, Korea, Spain and the US outline the actions they have been taking to create more and better jobs. Business and labour representatives add their perspectives. The edition also asks whether Europe can avoid deflation, and traces the fall in productivity growth across OECD countries since the 1960s. With Brisbane the focus of world attention, the OECD Observer casts a spotlight on Australia’s economy, and asks why the “lucky country” is also a happy one. We recount how Australia came to join the OECD (not as smooth a path as you might imagine), and outline the country’s future challenges in the Asian Century.
Today’s post is by Rolf Alter, Director of the OECD Public Governance and Territorial Development Directorate.
Six years have passed since the beginning of the global financial crisis, yet a large number of countries are still playing catch-up. The impact of the crisis, however, was not only national. Many regions are also struggling to return to the levels of prosperity that they enjoyed before the crisis. Going beyond national measures, an in-depth analysis of OECD regions reveals massive disparities within countries, with some regions faring much worse than others. OECD countries have always had some level of spatial inequality, but these disparities increased significantly since the onset of the crisis, and reducing them is now more than ever an imperative.
In order to address this challenge, the OECD established a framework to measure well-being at the local level. “How’s Life in Your Region?” presents an innovative set of tools to help policy makers benchmark the performance of their region in terms of the key indicators that define well-being for citizens. The ability to benchmark the performance of their region against other similar places should help them better target their policies and investments in order to have stronger impact on people’s daily lives.
This initiative responds to an urgent need for governments to learn lessons from the crisis. First, through its Better Life Initiative, the OECD explicitly recognises that there are indicators other than the usual economic measures (such as GDP) that capture the real aspirations and expectations of citizens. Moreover, well-being is defined by issues such as education, environmental sustainability, safety and housing that are essentially local in nature. To be effective in improving well-being, therefore, public policy needs to reflect the regional and local differences across these dimensions of well-being. The challenge that OECD has taken on is to identify a set of measures that capture well-being trends at the local level.
If used correctly, these well-being indicators have the potential not only to inform on what reforms should be focusing on, but also to track how well the implemented policies are performing. For example, the latest OECD Regional Outlook shows that in 10 OECD countries, over 40% of the national rise in unemployment since the crisis was concentrated in one region –underscoring the need to adopt a place-based policy approach to solving the severe labour market problems affecting that region.
The regional well-being initiative is a tool for government, but it is also designed to inform stakeholders outside the central government and in the non-government sector as well. While it can be tempting to leave policy makers the sole responsibility of improving well-being, it is much more effective to include various actors of society when it comes to building better communities: regional policy makers, but also the scientific community, the private sector, civil society and citizens. Regional well-being data can also be a tool to promote debate around policy choices. For that reason, the initiative also includes an effort to present data simply and clearly via the regional well-being data visualisation tool.
An example of this collaborative process can be found in Italy: when the province of Rome developed a well-being strategy in 2011, it held various meetings, forums and workshops with its constituents in order to help prioritise and determine the scale of the policy. A web-tool was created, allowing citizens to select the well-being dimensions that mattered the most to them, and ensuring that the feedback process was maintained over time.
Designing and implementing a regional well-being strategy is an iterative process. Priorities have to be established, and indicators that correspond adequately to the objectives must be selected. Progress must be monitored over time by looking at the results of the policies put in place and their evolution. Engaging a large number of stakeholders from the beginning of the initiative allows for increased ownership of the project, and therefore better accountability, legitimacy and overall efficiency. The use of indicators helps to track progress and keep momentum among stakeholders who can see that the targets they set are being reached or that new solutions are needed in cases in which the targets are not achieved.
Fostering well-being at the local level is a way to build stronger and more sustainable communities. The OECD Regional Well-Being framework provides a tool to help governments at all levels design and refine the policies that will help achieve this goal.
The OECD was created in 1961, but you can trace its origins back to the First World War, the centenary of which we’re celebrating this year, and in particular to today, Armistice Day. The Great War didn’t end formally with the signing of the Armistice on 11 November 1918, but on 28 June 1919, with the Treaty of Versailles. A year later, Australian artist Will Dyson published a prophetic cartoon about the Versailles Treaty. In Dyson’s drawing, we see a baby behind a pillar with “1940 class” written above its head, and Clemenceau, the French President, is saying “Curious! I seem to hear a child weeping”. By the time that baby was old enough to join the army, the Second World War had broken out.
The Versailles Treaty was harshly criticised right from the start, not least by Keynes, who had attended the conference as part of the delegation from the UK Treasury. In fact his bestselling The Economic Consequences of the Peace is one of the reasons the Treaty has such a bad reputation. Keynes’s critique is twofold. His first attack is to a large extent moral and political. He accuses the Versailles agreement of betraying US President Wilson’s “Fourteen Points” on which the peace was supposed to be built, notably concerning the reparations the defeated nations had to pay and territorial agreements concerning colonies and the European mainland. His second criticism is more economic. For peace to last, he argued, Europe’s economies had to become more integrated, and the Treaty worked against this.
Will Dyson was almost right about when the Second World War would start, but Keynes was spot on, predicting that it would happen 20 years after the 1919 signing due to the despair and economic catastrophe the Versailles Treaty would contribute to. As the Second World War drew to a close, Keynes led the British Delegation to the Bretton Woods Conference in July 1944 that would shape the post-war economy. The leaders of the Allied nations were determined to avoid the mistakes of the past and realised that the best way to ensure lasting peace was to encourage co-operation and reconstruction, and not to punish the defeated. The Bretton Woods Agreement and the institutions created to administer it such as the IMF and World Bank Group were similar in many ways to what Keynes had proposed in 1919.
The politics and economics of the immediate post-war years would give birth to the predecessor of the OECD. As the Office of the Historian of the US Department of State reminds us, “Fanned by the fear of Communist expansion and the rapid deterioration of European economies in the winter of 1946–1947, Congress passed the Economic Cooperation Act in March 1948 and approved funding that would eventually rise to over $12 billion for the rebuilding of Western Europe.” The Organisation for European Economic Cooperation (OEEC) was established to run this “European Recovery Program”, better known as the Marshall Plan, in 1947.
While US financing was important, that $12 billion would be only worth around $120 billion in today’s terms, compared, for example, to the $700 billion the Emergency Economic Stabilization Act of 2008 authorised the US Treasury to spend on the bailout following the subprime crisis. It was actually by making individual European governments recognise the interdependencies of their economies that the US made its greatest contribution to the economic rebirth of Europe.
The success of the OEEC and the prospect of carrying forward its work beyond Europe led Canada and the US to join OEEC members in signing the new OECD Convention on 14 December 1960. Others followed, starting with Japan in 1964, and now 34 member countries worldwide regard it as normal to turn to one another, within the OECD, to help identify problems, analyse them, share experiences, and devise solutions. Another 100 other countries take part in OECD work.
Most of the areas the OECD works on – employment, growth, agriculture, and so on would be familiar to economists of Keynes’s generation, although the actual mechanisms have changed radically since the OECD was created, and even more so since Keynes went to Versailles in 1919. But if you look at the “Topics” menu on www.oecd.org, you’ll see one area that a specialist from a century ago would feel familiar with. While our trade specialists for example are dealing in new concepts like trade in value added, or the industry analysts are trying to understand the information economy, my colleagues at the Centre for Tax Policy are trying to demolish an international tax system that was conceived a hundred years ago and allows big companies and rich individuals to get away with paying little or no tax. That’s a war worth fighting.
It’s clichéd to say that the most certainty you can take from any economist’s prediction is that it will be mistaken, but many got their forecasts for 2014 horribly wrong. At the beginning of this year, commentators were fairly united in hailing the ‘year of the pay rise’, with most expecting the UK’s enduring real wage squeeze to finally turn the corner, and some predicting that pay would bounce back quite rapidly over the course of the year. Two thirds of the way through 2014 this has not come to pass and the outlook has been repeatedly downgraded. For example the Bank of England now doesn’t expect a return to real wage growth until the middle of next year. Looking back, many of us are left wondering why we were all far too optimistic.
In answering this question some have pointed to the fact that the official data looks worse than other pay surveys, with pay settlements, for example, running at or above inflation during 2014. A major difference between the official Average Weekly Earnings (AWE) series and other surveys is that AWE, as well as capturing year-on-year changes in employees’ pay, will be affected by changes in the overall shape of the workforce. Do such ‘compositional’ factors shed light on what’s been happening to pay of late?
New analysis by the Resolution Foundation comprehensively assesses the impact of the changing make-up of the workforce on wages since the mid-2000s. It looks across a number of job and employee characteristics, including sector, occupation, age, sex, qualification level and job tenure, in order to understand how much of pay growth is down to pay changes within groups, and how much is compositional – owing to a shift in the proportion of employees across groups. For example, as others have highlighted previously, recent increases in employment in lower-paid sectors and continued contraction in the finance industry are likely to have dragged down on average pay growth across all employees.
While changes in the industrial mix look to be putting downward pressure on average pay, other factors, such as strong full-time employment growth in the last 12 months, are likely to be pulling in the opposite direction. To disentangle the pushes and pulls our analysis looks at all factors together, controlling for the overlap between each, to understand the overall direction in which compositional changes are driving wages and the relative importance of different job and employee characteristics to this. The overall compositional effect is shown in the red bars in the the following chart.
We find that between 2006 and 2013 the compositional effect was always positive, acting as a boost to pay growth. This is to be expected due to long-run shifts in the workforce such as rising qualification levels – a compositional boost to pay could be regarded as a normal state of affairs. It’s sobering to think that, had it not been for these changes, Britain’s already huge pay squeeze would have been a third deeper.
However, recent months mark a departure from this trend, with the overall compositional effect turning negative for the first time in the period we’ve looked at. This is due to negative effects from factors including occupations, age and job tenure outweighing the positive impact of rising hours and qualification levels, as the chart below shows.
Some of these drag effects are probably part of a good news story – the entry and re-entry of younger and less experienced workers reflecting rapid employment growth and falling youth unemployment this year. With the UK’s employment rate having returned to its pre-recession peak these effects are likely to fall out next year – we may be observing the temporary ‘growing pains’ of recovery. By contrast, the drag effect of the shift towards lower-paid occupations – the largest single compositional factor affecting pay growth – is more worrying as it could represent a longer-term change in the labour market.
To return to our opening question, this analysis does suggest that compositional factors help explain why pay growth in 2014 has looked quite so bad. We find that without the reversal in compositional effects between 2013 and 2014, real pay in the first half of 2014 would have grown by a very modest 0.1%, rather than the 0.8% fall we’ve experienced. So there may be reasons to give those economists who called 2014 wrongly a break this time round, although 0.1% real growth hardly represents a boom.
This analysis shows the important role that the changing make-up of the workforce plays in our understanding of average pay growth, for which reason we’ll be keeping a close eye on these trends as more data becomes available. But it mustn’t hide the fact that a generalised and dramatic slowdown in pay growth within sectors and different groups of workers has been by far the biggest factor explaining falling UK wages since the financial crisis (shown by the decreasing size of the grey bars on the first chart). Ultimately, prospects for ending the pay squeeze rest on a return to productivity growth and the willingness of employers to ensure that workers obtain a fair share of these gains.