COVID and Wages in UK – Large cuts may come if you are younger and work in a small firm

The Covid-19 pandemic is turning into a global recession – probably the biggest drop in economic activity since the Great Depression of the 1930s. The latest forecasts put UK and US GDP both down by about 10% in Q2 2020 (40% on an annualized basis). GDP is an important measure of economic wellbeing, but the key way workers feel aggregate fluctuations is through their pay packets. In this piece, we will draw on our ongoing work on the impact of aggregate shocks on individual workers to analyse the likely effects of the current crisis on aggregate earnings, and most importantly to identify groups of workers who are most exposed to aggregate risk.

Our analysis is based on over 3 million earnings observations drawn from more than 400,000 UK workers between 1975 and 2016. We estimate a set of ‘exposure parameters’, which are essentially estimates of how earnings of different type of workers are impacted by changes in GDP. These figures are similar to those estimated in the US and other countries, so these results are broadly applicable.

We assume a plausible year-on-year GDP decline of 10% and predict how the current crisis will affect workers. We stress that this is a period of immense uncertainty and one in which unprecedented policy responses make forecasting difficult. However, we argue that in terms of understanding which types of workers bear the brunt of aggregate fluctuations, it is instructive to investigate past fluctuations in GDP.

On aggregate, feeding a 10% decline in nominal GDP through our GDP sensitivity estimates, we estimate a fall in real weekly earnings of about 3.5%. This would be a significant shock to household incomes. But, as will be shown below, this is very unevenly spread across different workers.

The impact is likely to be worse for younger workers in smaller firms

In Figure 1 we plot the estimated changes in weekly earnings by age group and firm size. There is a clear age profile in earnings responses to GDP changes. The earnings of workers under 35 are the most responsive. For these younger workers, on average a 10% drop in nominal GDP corresponds with a 3.8% fall in real weekly earnings. For those aged 45-55, the fall is 3%. Younger workers typically see higher wage growth than older workers, but here we see that this is very much dependent on economic conditions. Even more concerning for the youngest workers is the substantial literature demonstrating a lifetime penalty from entering the labour market in a recession.

Chosen excerpts by Job Market Monitor. Read the whole story @ COVID-19 and wages: prepare for large cuts if you are younger and work in a small firm | British Politics and Policy at LSE