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Auto enrolment could slow the UK economy in 2018

Higher employee and employer contribution rates from April 2018 could suck purchasing power out of the economy.

I watched Dunkirk last night and one scene in the film neatly captures an unseen threat to the UK economy at present. In the scene, soldiers who have escaped the horrors of the beach are seen on board a destroyer drinking tea and congratulating each other they’re free from Stuka dive-bombers. But they’re not safe, as the cry “torpedo in the water” shouts out.

The analogy with the contemporary economy is that in the wake of The Great Recession, and the debates over the impact of extraordinary monetary policy and fiscal austerity, we have ignored a threat that has been sitting in wait submerged.

The threat was the pension auto enrolment submarine launched in 2012. It fired its first torpedo when the employer and employee minimum contribution of 1% each was introduced for large employers. The torpedo missed its mark and its effect was unseen amidst the explosions from the banking crisis all around.

But now the submarine is moving into position to fire multiple torpedos with no sign whatsoever of evasive action by policymakers. Next April the torpedos will be in the water and armed.

For employers, the minimum contribution of 1% of salary rises to 2% next April and 3% the following year. For employees, the contribution rises from 1% to 3% next April and 5% the following year. And the number of employers and employees is huge. According to the latest numbers from The Pension Regulator (July 2017), 8.3 million employees working for over half a million employers, have a workplace pension as a direct result of auto enrolment. This figure will continue to grow as new micro and small businesses are added.

For all those contemplating the disappearance of the Phillips Curve and the absence of a negative relationship between unemployment and wage growth, here may be part of the answer. There is a big difference between wages and wage costs.

The UK unemployment rate stands at 4.5%, the lowest figure since 1975. Earnings, including bonuses are rising just 1.8%. In real terms headline earnings growth is falling, given CPI inflation of 2.6%. This is the view from employees. From an employers perspective however what matters is total wage costs not wages alone. Add in the costs of auto enrolment to headline wage growth and the story changes. For firms auto enrolled who weren’t previously, there is another 1 percentage point to add to 1.8% earnings growth. This unseen threat will explode next April when the employers contribution rises to 2% and 3% a year later. Throw in the introduction of the National Living Wage at £7-50 per hour in April 2017 and the need for employers to seek restraint in the wage component of total wage costs becomes obvious.

The impact on employees however will be even greater. Already reeling from a 0.8% fall in real earnings growth, auto enrolled employees will see their contribution triple to 3%. And if that doesn’t sink them the 5% follow-up torpedo will smash into them a year later.

Auto enrolled workers – often on low incomes – are already experiencing falling real wage growth and their ‘take home’ pay is set to fall by a further 4% between now and April 2019. This is a political and economic storm in waiting.