A wage rise? Yes, but ...

Performance-related schemes are likely to be the key to successful pay deals, says Adair Turner

We all wish to see a more prosperous Britain, and one where all of us have a share in that prosperity. But how is prosperity to be achieved and how is it to be shared? In the past we have tended to let our aspirations run away far ahead of reality, so that periods of economic growth and rising real incomes have led to wage/price spirals which undermine that growth.

Thus, we were once a country renowned for its strike record, double-figure wage settlements and inflation rates. We were all too familiar with the boom and bust of the UK economy. In recovery, we came to expect unemployment to fall, but prices and wages then to rise at an accelerating pace. But we also knew that in recession, unemployment would usually rise while moderation of wage rises would come only slowly. As a nation we took one step forward and then one back.

Now, however, Britain's economy and workforce is more competitive, flexible and innovative. We are experiencing stable economic growth, with a reasonable chance of inflation staying within the Government's 1 to 4 per cent band, and probably below the 2.5 per cent target, on a sustainable basis. And there is growing evidence that the tendency towards a price/wage spiral has been broken in this most recent recovery. We have now seen unemployment falling consistently for 28 months, but with low inflation and low average earnings increases. All of this is good news and a break with the past.

However, we have also seen a significant fall in the share of national income accounted for by wages and salaries. For many people, real earnings after tax may well have declined in the past couple of years.

Looking forward, we cannot assume, and indeed should not expect, that that trend will continue. We all want rising national income per capita, and that should mean - over the long term - rising real earnings. There is nothing unsustainable about rising real earnings provided that they are earned by increases in productivity achieved by profitable companies.

But if the vision should be one of medium-term real-income growth, the potential for an upward pay spiral should never be forgotten or underestimated. If we simply return - as the economy begins to deliver real-income growth - to the environment of across-the-board pay settlements, pay rounds and going rates, we will recreate the inflationary spiral and undermine the very growth we are now achieving.

The challenge is therefore to develop a framework for remuneration that delivers real-income increases on average and over the medium term, but does so in a non-inflationary fashion. Such a framework needs to reinforce the steps many employers have already been taking to link individual pay to individual, team and company performance, so that the link between wealth creation and earning increases is clear.

Profit-related pay schemes and employee share-ownership schemes, already in place in a growing number of companies, are among the mechanisms by which such links can be achieved. Pay schemes that reward personal development and team contribution also have a role to play.

Such approaches are mechanisms to give individuals a sense of opportunity, of participation in a company's and in the economy's overall success, and to ensure that "flexibility" is seen as a source of potential benefit rather than a threat to individual security. They also need to be placed within a context of effective workplace communications and of an approach to training that gives employees the chance to flourish in a world of rapidly changing skill demands. Together, these are mechanisms to give people a "stake" in the overall economy, and this form of stakeholding is one that business can certainly welcome.

For in the long term, business cannot flourish without the broad mass of people also enjoying the benefits of economic success. But it is vital, as we achieve that economic growth, that we do not then undermine it by reverting to inflexible and formulaic ways of setting wages unrelated to economic affordability.

The writer is director-general of the Confederation of British Industry.