By: David Sinclair and Ben Franklin

A short term rise in wages may be on the cards but the long term economic challenges from population ageing run deep.

Today’s Metro front page splash reports that “Lidl will become the first supermarket in the UK to pay employees a minimum wage recommended by the Living Wage Foundation.” It is great news for employees in this traditionally low paid sector.

Wage growth has been extremely tight over recent years and growing numbers of people are suffering in work poverty. But is Lidl’s promise to raise wages a sign of things to come?

Labour shortages and pay rises
The challenge facing firms to recruit new labour is set to get tough. Recent data on the labour market suggests we may have returned to so called “full employment” – a situation where substantial gains in employment and falls in unemployment are unlikely because all those that can work are now in work. Indeed, the UK’s unemployment and economic inactivity rates have now fallen back to their pre-crisis levels. This shift will mean firms will have to think carefully about where they are going to find additional workers from or alternatively identify ways to increase the productivity of existing staff or both. Suffice to say that in this environment, workers have greater bargaining power over wages due to the difficulty facing employers of finding new labour.

What might be the consequences of this trend?

A UK wage rise is long overdue but in the absence of rising prices, and with workers having stronger bargaining power, wages are starting to rise. Indeed, even after adjusting for inflation, wages have increased by around 3% between May and July this year. We may be starting to see the reversal of many years in which real wages fell in the wake of the financial crisis.

Older workers become increasingly important in this context. Firms will place increasing importance on retention – because they are less able to replace staff – and when recruiting will look outside of the UK born 18-64 labour market. This means a greater reliance on those over 65 as well as migrant workers to plug skills gaps.

Earlier this year we published research supported by CIPD which revealed the UK could face serious skills shortages over the next 20 years if employers don’t change their approach to workforce planning, and particularly the challenge of retaining and ultimately replacing retiring employees. The situation was particularly acute with regards to the Education and Health and Social Care sectors – both of which rely heavily on workers over 50 but have a relatively poor record of holding onto those employees as they reach the twilight of their careers.

Employment numbers and rates for older workers have been increasing. This week’s employment statisticsrevealed an all-time high number of employees between the ages of 50-64 (8.26 million) and there were 200,000 more people in this age group in work than a year ago. And there are also now nearly 1.2 million workers over the age of 65 (also a record for the UK).

Could population ageing lead to rising wages over the longer term?

As well as wages rising in the near term, a new research paper from Morgan Stanley and Charles Goodhart argues that population ageing will result in wage growth over the longer term too. Economists love to talk up the negatives of population ageing (including yours truly) so it is great have some strong research that bucks the trend. In short, population ageing is expected to limit the supply of available workers, which will make investment in capital (that’s machinery, technology etc. which drives up productivity) relatively more attractive and ultimately to wage rises.

Will the economic effects of population ageing be positive after all?

The impact on wages is just one potential effect of a shrinking labour force. It does not change the central economic challenge posed by ageing – the ability of governments to maintain spending on a swelling number of older people at a time when growth in tax revenues slows due to a stalling working population.

To illustrate this point, the chart below shows a representative distribution of spending and tax revenues in the UK by single year of age. The crucial point is unless substantial gains are made to increase the prevalence of work at older ages, over the long run, the UK’s level of indebtedness will rise even if the Government manages to implement its proposed spending cuts.

Representative age profiles of tax and spending per capita

How do we address the challenge of population ageing?

Against such strong demographic headwinds, we need to take a long term view. A starting point may well be to think about how we drive up long-run productivity of the workforce and of public services more generally. In particular, the official forecasting agency the Office for Budget Responsibility thinks that rising productivity in the health care sector could make the most significant difference to the UK’s public finances over the next 50 years. As we have blogged previously, if productivity in healthcare increases by 2.2% per annum over the period, debt as a proportion of GDP would be just over 80% by 2060. But if health productivity rises in line with the long-run trend (1.1%), debt would rise to over 180% of GDP – a whopping great difference.

In short then, along with considering many other areas, we need to bring in some radical thinking about the future delivery of health services as well as public services more broadly – and the sooner we do it the better. This was a central theme of our recent major publication Creating a Sustainable 21st Century Healthcare System, which has explored innovations in health care systems around the world.

Sensitivity of net debt projections to health productivity assumptions