PUZZLING WAGE STAGNATION

PUZZLING WAGE STAGNATION

In the wake of the Great Recession, countries around the world have been following a long and bumpy road to recovery.  Over the past decade, there have been stops and starts, good news and bad news; and governments, businesses, and individuals alike have alternately been woefully anxious and blissfully optimistic about the likelihood of success in their futures.  Brexit is currently complicating matters and blurring the picture of recovery in the UK, but there are still some signals about where we stand.

There are three primary indicators of the economic health of a country: one is unemployment levels, one is growth in GDP, and the third is the rate of inflation.  It takes not only a healthy economy but also solid fiscal and monetary policy to maintain the delicate balance between these three indicators.

One of those indicators has suggested nothing but good news in western economies over the past few years – unemployment.  In Britain, current unemployment levels of 4% are lower than at any time since 1974.

The U.S. is currently enjoying a similarly low rate of unemployment, and while most countries are experiencing decreasing levels themselves, few are quite as low as in the U.S. and Britain.  This may be a function of very little government employment regulation of hiring and firing; in comparison, France, which has an unemployment rate twice as high as Britain, has strict labour laws that cause employers to think long and hard about hiring a new employee they won’t be able to get rid of easily if need be.  Low unemployment in Britain may also be a function of the extra attention the government has paid to make sure the unemployed are actively seeking work.

Now for a refresher in the most basic tenet of economic theory: the laws of supply and demand.  Most specifically, we are concerned here with the supposed fact, treated akin to the theory of gravity, that a decrease in supply causes an increase in prices as those in demand to compete to acquire a piece of the meager supply.  In recent years, labor is that meager supply.  And the price of labor is wages.  In theory, therefore, a decrease in unemployment (in essence, a decrease in the supply of labor available for hire to businesses), should result in an increase in wages, the price of labor.

This is where the confusing part comes in.  While the Conservative Party may attempt to claim victory over the Great Recession with a 4% unemployment rate, real wages are STILL lower than they were when the Recession began.

The same phenomenon is being seen in the U.S. and Germany, but not nearly to the same degree.  Britain’s unusually low wage growth may be due to a number of factors: businesses aren’t investing much in automation to improve productivity, which in turn drives wage increases; there is a shift in labor to lower-productivity jobs (as measured by contribution to GDP); the power of unions has been severely diminished; the public-sector has been placing caps on government employee wage increases, decreasing the competition with businesses over labor; and fewer welfare benefits are being offered, making workers less likely to bargain for higher wages in fear of the alternative.

Economists in Britain used to think that inflation would push up wages as soon as unemployment dropped below the 6.5% mark.  At the current level of 4%, if wages were following norms from a decade ago, Britons should be seeing 5% wage increases each year.  Instead, pay raises hovered around the 2.5% mark this spring.

So, what happened?  Is everything we ever learned about economics wrong?  Should we continue to expect up to be down and down to be up?  Maybe not.  Maybe the relationship between labor supply and wage growth still holds, and we’ve just got to tweak our measurements as well as our expectations.  While 4% unemployment seems low, it belies the existence of under-employed part-time workers.  And wages may climb, but maybe not quite as much as we’ve grown used to, and maybe the climb will lag a bit behind the decrease in unemployment.

As a matter of fact, new figures were released in the first week of October indicating that wage growth through August not including bonuses had reached 3.1%, a new 9-year high, at least for nominal growth if not real wage growth adjusted for inflation – that still sits at a depressing 0.6%.  If bonuses are included, the rate is only 2.7%, just a smidge above general price inflation.  But that could just be an indicator that executive bonuses, not necessarily overall wages, are being restrained.  So, maybe that’s all both good news and bad news?

As Andy Verity, economics correspondent for the BBC, sums up the most recent figures, “If you’re a half-full person, well we’re up by about £25 per week on average since the squeeze on living standards was at its tightest back in 2014.  But if you’re half-empty, we’re still earning about £20 a week less than we did 10 years ago when the global financial crisis struck.”

BREXIT STOCKPILES

BREXIT STOCKPILES

Uncertainty surrounding the upcoming Brexit in March of 2019 is causing a tremendous amount of trepidation in a variety of business sectors.  Supermarkets are not one that I had expected to hear much about.  But supermarkets are front and centre, being called upon by the government itself to prepare for impending doom.

That impending doom is a no-deal Brexit.  With the current deal on the table being debated not living up to expectations and unlikely to win a vote next week, a no-deal Brexit is, while still unlikely, on everyone’s mind as the worst possible scenario come March.

If deals on trade and freedom of movement are not concluded by the time Britain leaves the EU officially next year, increased border security between the UK and its neighbours will naturally result.  The borderless EU will now end at the UK border.  In the case of increased border checks between the UK and France, Britain expects its main trading route between the Calais port in France and Dover in southern England to become excruciatingly inefficient.  MPs are expecting the volume of trade entering the UK via this trade route to be a mere 13% of its current level if Brexit does end up preceding any deal being struck with the EU.

That means supermarkets will experience great difficulties in getting shipments of goods to stock and re-stock their shelves.

So, what is the government suggesting? Stockpiling.

The country’s four largest grocers – Tesco, Sainsbury’s, Asda, and Wm Morrison Supermarkets – have told their suppliers to stock-up as a preventative measure against empty shelves in the wake of a no-deal Brexit or hard Brexit.  They anticipate 47% fewer goods coming through the Calais trade route, and they anticipate empty shelves within two weeks of the official Brexit date.

Supermarkets are already in a highly competitive industry.  Sainsbury’s is jumping on the edible insect trend before its competitors do.  Asda and Sainsbury’s are working on a merger to take place in 2019 that will save the newly combined company about £500 million in back-end operating costs like purchasing and distribution and grocery chains throughout the UK have been working hard to become greener and energy efficient.

But supermarket efforts to stockpile are being met with increasing levels of frustration.  There is currently a shortage of food warehousing space in the face of such increased demand from all of the supermarkets.  That, of course, means the price of what little warehouse space remains available is increasing.  Even packaging costs, like cardboard and plastic cases, are increasing.  In times of crisis, everyone looks for someone to blame, and in this case, many grocers are entertaining the rumor that Amazon has booked available space even if the spaces it books remain empty, just so it can enter the food market in the UK in the near future.  With possible food shortages on the horizon, this would be nearly unforgivable – if it’s true.  Amazon has now become the boogeyman of the supermarket industry.

The stockpiling strategy is being promoted by the Department of Health, which is creating contingency plans in the case of a no-deal or hard-deal Brexit.  One plan is to ensure that six weeks’ worth of priority goods, especially medicines, are stored up before trade access is severely disrupted for up to six months.  Other measures include increasing port capacity, getting more cargo space, acquiring refrigeration units, and flying in medicine on planes for quick delivery.

It can’t be argued that the Department isn’t acting responsibly and cautiously to prepare for the worst, but it does feel a bit like the UK is preparing for war or natural disaster, not just a move toward greater sovereignty.  One official suggested possible rationing isn’t too far-fetched an idea right now.  Of course, if the worst does happen, some things cannot be stockpiled – primarily, fresh produce – signaling a possible increased reliance on canned goods and almost certainly less product diversity.  All of this is eerily reminiscent of eastern Europe as it existed under Communist rule.

All-in-all, times of crisis bode disaster for some industries while boding well for others.  Owners of warehouse space and suppliers of packaging materials should fare well in the current climate, with demand, and therefore prices, on the rise.  Storage prices rose by 15% per pallet over the last few weeks, and chilled storage space is all taken.  Ports and cargo plane service operators should also be in a good position to take advantage of the increased demand for their services.  Even canned goods suppliers could enjoy an uptick in business.

The picture is less clear for supermarkets.  Some that do a lot of exporting are stockpiling in those countries to make sure their external markets are also somewhat protected.  And those that moved early to secure temperature-controlled warehouse space will be able to stockpile the most and keep their shelves full the longest.  Even what exactly to stockpile is a strategic move right now that takes a good deal of forethought about consumer needs.  This could spell disaster for the supermarkets that lose this war; consumers could very well make a permanent shift to new supermarkets in the aftermath of Brexit.

TAXATION IN THE NEW WORLD

TAXATION IN THE NEW WORLD

The tax strategies of US-based tech giant, Apple, have been in the headlines and under scrutiny in Europe for a few years now.  But the time has come to pay the piper. The Register has reported that Apple, as of September, has now paid the €14.3 billion, mandated by the European Commission, in back taxes and interest to the Irish government.

The whole affair started after Tim Cook of Apple testified to a US Senate subcommittee that the company did pay an effective tax rate of under 2% in Ireland.  The European Commission smelled blood in the water and quickly swooped in to investigate.  After looking into the tax rulings Ireland had given Apple Operations International (AOI), Apple Sales International (ASI), and Apple Operations Europe (AOE), the commission found that the emerald isle had provided huge tax breaks to Apple in exchange for the jobs it created for its local residents according to the Irish Times.

In the global and highly digital economy we find ourselves in today, it is often tricky to determine where in the world a company incurs most of its marketing and selling expenses, where it earns most of its profits, what countries are providing what supporting services to them, and what constitutes an official presence in a country.  Perhaps the marketing personnel are in the US, but they are paying for ads in France; perhaps they are selling more devices to customers in Germany, but more software to customers in the UK; perhaps they utilize a small shipping office serviced by the roads in Poland, but they have a massive plant serviced by the same length of roads in China.

If costs and benefits have to be allocated to various countries in which a company operates, how do they determine what costs and benefits belong where?  This can be a nightmare for corporate accountants and lawyers.  And yet, it can also present an opportunity for the company to take advantage of the allocation method that benefits them the most.

How to calculate the profits attributable to Apple’s tax base in Ireland is at the heart of this case.  Apple Sales International had a branch in Ireland that was essentially a distributor for Apple products.  Ireland’s Revenue department ruled that ASI, as a whole, should record 12.5% of its operating costs as the profits for the Irish branch.  The other 87.5% would belong to a head office.  This head office also resided in Ireland, but it was not considered a taxable entity by the Irish.  Up to this point, the reasonability of Apple’s profit allocations would seem debatable.  What really clinched their culpability in the eyes of the Commission was the fact that no employees worked out of the “head offices”.

Transfer pricing is how related companies charge each other for goods.  In principle, namely the Treaty on the Functioning of the European Union, transfer prices should be set as if the two companies were unrelated and operating at an “arm’s length” from each other.  Setting transfer pricing in any other manner to capitalize on some type of tax or other benefit for the parent company is not acceptable according to this Treaty.

This is what the European Commission charged Apple was doing, and Ireland was allowing.  The result, they maintain, is an unfair amount of profits retained by the company, and an unfair amount of corporate tax withheld from the host country.

Seamus Coffey, in the Irish Examiner, has a different theory.  He posits that corporations are, in fact, paying their fair share of taxes and that governments of other countries in which the corporations operate are simply out to get a bigger piece of the pie.  Governments around the world are targeting large, headline-grabbing, multinational corporations to take to task. The Irish Examiner noted in subsequent investigations, these governments neglect to mention the vast sums of money the companies may have paid to countries from which more of their profits were actually derived and attributable to.

Apple, for example, has paid an effective tax rate of almost 25% when counting profits paid everywhere.  The European Commission simply wants Apple to pay Ireland closer to that 25% rate than the .05% they claim has been paid.  And when these foreign governments win, it rarely increases the overall tax rate paid by the company; instead, it simply shifts some of it from another country to their own.  Seamus explains that the majority of Apple’s profits should, rightly, be paid to the U.S.  Simply selling hardware from the Irish branch does not constitute much profit-making activity.  But designing the hardware, producing it, branding it, and marketing it does.  So, should more taxes be paid where the company incurs more costs?  Or, should more taxes be paid where the customers buy more products?

Like I said, in our highly global and digital world, complexities abound.  A new era of international accounting and taxation rules need to be set, and they will be.  But for now, the waters are still muddied, and until treaties and legislation are rewritten to catch up to the world we live in, governments around the world will fight to get their piece of the pie.

Ultimately, the settlement paid by Apple will be held in escrow until all appeals have been exhausted – appeals from Ireland, not just Apple.

Executive pay dispute continues

Executive pay dispute continues

The UK is cracking down on exorbitant executive pay.  Ever since Theresa May made this a central issue in her 2016 campaign for office, businesses have been anticipating an ongoing battle, some proactively making internal changes of their own, and others preparing to lobby in defence of their current practices.  Some new rules about executive pay disclosure have now been set to take effect in the near future, but further reform is still on the table, and businesses are digging in their heels.

Trends in Executive Pay

In 2016, the average take-home pay was £4.5m for top executives in publicly traded companies.  In comparison, the average worker earned just £28,200, about 160 times less according to the BBC (BBC, 2018).  The highest-paid boss in the UK, Sir Martin Sorrell, CEO of WPP, brings in a whopping £48m as reported by the Guardian.  In a telling symbol of the public’s distress regarding massive amounts of money given to corporate executives, the third workday of the year has been dubbed “Fat Cat Thursday”. The BBC noted that on January 4th in 2018, top execs have already earned what the average employee will earn all year.

The general secretary of the GMB union, Time Roache, said, “It’s in everyone’s interest to tackle this inequality. The money earned by ordinary workers is not spent on luxury yachts or hoarded away in tax havens – it is spent in the high street and in the communities in which they live and work”.

Reforms Made to Date

Rules forcing large public companies to publish executive pay levels were rolled out in 2013.  This provided a bit more transparency to shareholders, employees, customers, and government entities alike.  Shareholders also began voting on executive pay every three years, but those votes were not legally binding for the companies, Farrell reported in the Guardian.  These reforms were considered mere tokens by many, and public outcry over excessive executive pay packages continued into 2016.

Theresa May promised more reform would be forthcoming during her 2016 campaign. Just by virtue of the increased likelihood of government intervention hinted at during that campaign, and perhaps somewhat attributable to the token 2013 reforms, an immediate impact was seen on business practices throughout the country. Farrell noted in 2016 alone, average pay for top executives decreased by 19% from the year before, including all bonuses and other incentives.  And salary increases of over 3% were cut in half.  Yet, executive pay that would take an average worker about 160 years to make still didn’t seem like quite enough had been done to address public concerns.

November 2016 Green Paper Proposals

In further efforts to rein in business excesses, a green paper suggesting a variety of additional reforms was published in November 2016.  Stewart of the Guardian noted. that according to political opponents, these plans ultimately lacked the teeth threatened during May’s campaign.  The green paper did suggest publishing ratios of executive pay to employee pay, but it also warned about misconstruing this information, even though the average chief executive was earning 128 times the pay of the average staff member.  The paper also suggested annual binding shareholder votes on executive pay, requiring companies to set caps on maximum executive pay, including employee representatives on company boards, and holding large private companies to the same standards like publicly traded companies on the stock market.  But within each of these categories, a range of options was politely suggested rather than adamantly insisted upon.

Theresa May in a Difficult Position

Theresa May’s party receives some major backing from big businesses. Under their influence, she has softened her stance on employee representation on boards, drawing criticism from worker unions.  On the other hand, about 900 public companies will have to start publishing AND justifying, the chief executive to average worker ratios in the near future, so May is facing criticisms from the corporate world, as well.

Others look to be taking up the mantle in May’s wake.  In November 2018, an independent report presented to the Labour party made some startling suggestions for further reform.  The report suggests banning all stock options as part of executive compensation packages to force companies to act more in the interest of long-term company prosperity.  It also recommends that customers, in addition to shareholders and employees, should be able to veto pay packages for top execs in order to keep them focused on customer needs and quality rather than just profits.  It also calls for a total ban on golden parachutes bequeathed to parting execs.  To further levels of transparency, this report even says that companies with over 250 employees should report the names of everyone, not just executives, that earn over £150,000 per year according to the Financial Times.

The Counterargument

Of course, opponents of any further plans to rein in corporate excess levy some harsh criticisms.  They feel these proposals are outright attacks on capitalism and will seriously hamper corporate decision-making, effectively crippling the free market and severely damaging economic growth.  According to the critics, shareholders and boards of directors are already in a position to ensure appropriate compensation practices. But if the Labour party, which came very close to winning the 2017 election, supports radical reformations, businesses can’t afford to discount them entirely.

Sam Dumitriu of the Adam Smith Institute think-tank makes an interesting point, Not only do CEOs make crucial, business-altering decisions on a daily basis but if they are paid at lower levels in the UK than they could command elsewhere, UK companies may lose top executive talent to the US and Europe.

Brexit uncertainty continues to loom large across the business sector.

Brexit uncertainty continues to loom large across the business sector.

An aura of uncertainty weighs heavily on the business atmosphere in the UK right now.  Brexit is fast approaching, and the full impact on currency values, foreign trade, and the labour market won’t be known for some time.  But as we near the end of UK membership in the European Union – the divorce becomes final on March 29, 2019 – the signals of what’s to come are becoming clearer, and anxieties are running higher.

UK citizens voted in 2016 to leave the EU primarily because they thought not enough was being done to curb immigration, which they felt was increasing at a far too rapid pace and threatening UK jobs and livelihoods.  That sentiment is being felt by citizens of countries around the world, with commensurate increases in feelings of nationalism and isolationist political rhetoric.  The UK’s vote to leave the EU, after decades of EU membership, feels akin to Texas leaving the United States.  But the implications of leaving the EU were not fully understood or even considered prior to the Brexit referendum being put to a vote.  One of the many consequences that will need to be dealt with? After Brexit, the UK will no longer adhere to the EU Freedom of Movement Act, an act which allows all EU citizens to freely work and/or live in any fellow EU member country.  Instead, Britain will need to come up with its own immigration policies.

UK Reliance on EU Workers

Businesses are lobbying hard during the debate over what the new immigration policies should be.  The Confederation of British Industry (CBI), representing 190 thousand UK firms, is trying to make sure Theresa May is fully aware of the UK’s heavy reliance on EU migrant workers before drastic and potentially destructive actions are taken by the government to turn these workers away at the border.  As just one example, the service industry accounts for over 80% of the UK economy.  And a huge amount of the workers in those service industries are EU migrants: 41.6% of packers/bottlers/canners/fillers, 39.6% of food/drink/tobacco operations, 26.7% of valets/vehicle cleaners, etc.  What would UK firms do without those employees?  The labour market is already tight with an unemployment rate of around 4%.  It’s not as if UK workers are, in fact, competing with migrants for these jobs. Kotoky of Bloomberg noted that the tight labour market is already driving wages up at the fastest rate since 2008.  That has a huge impact on firms’ bottom lines.

EU Workers in the UK Decline at Record Pace

Citizens in other EU countries are already anticipating the likely impact Brexit will have on their lives if they depend on being able to work in Britain, and they are understandably being proactive about acting in their own self-interest. Reports from Bloomberg show in the third quarter of 2018, there were 5% fewer EU nationals working in the UK than a year ago, the biggest decrease on record.  After also accounting for the EU migrants that have left the UK so far, net migration from the EU to the UK is now over 60% lower than before the Brexit referendum took place in 2016.  Some argue that increased immigration from countries outside the EU has offset this decline.

Post-Brexit Immigration Plans

The general idea behind May’s proposed immigration plan is to prioritize high-skilled workers over low-skilled workers trying to work in the UK from abroad, regardless of their country of origin according to Bloomberg.  That means EU citizens will no longer be given precedence over other countries’ migrants to the UK, a point that May is hammering home at every opportunity.  It’s not surprising that this would leave a bad taste in the mouths of potential EU migrants and driving down those net migration numbers.  After decades of enjoying free movement in and out of the UK, EU workers are essentially writing off the UK as an option.

Outlook

The consensus seems to be, after Brexit becomes official in March of 2019, that UK businesses, and subsequently the country as a whole, will suffer from declines in economic performance, labour market shortages, and skills mismatches.  The director of the Confederation of British Industry, Carolyn Fairbairn, said the new policy would affect a wide range of businesses and erode public confidence.  Businesses are complaining that they will not be able to fill low-skilled jobs if May’s new immigration proposals are approved and implemented according to reports from the Guardian.  May’s response?  Businesses need to train UK workers to fill those gaps.  That sounds nice in theory, opening up opportunities to the young and unemployed by providing them with the training needed to fill labour gaps in low-skilled jobs.  But there are two major problems with that theory: 1) employment is already low – that pool of young or unemployed workers waiting for jobs does not exist, and 2) training any potential UK workers that are on the market would be a huge added expense to businesses.  This plan only seems feasible if the government is also willing to subsidize these training programs.