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A decade of uninterrupted real wage growth comes to a close

Real wages shrank by 0.7% year-on-year in June, even though average nominal wages rose by just over 8%. Real wages have risen most among low-paid worker groups in the recent term, while workers with higher pay at the time the Living Standards Agreement took effect have benefited less. The outlook is for real wages to keep deteriorating through the year-end before turning around as 2023 progresses.

The Statistics Iceland (SI) wage index was virtually unchanged month-on-month in June. The index, which captures regular wages per hour in the Icelandic labour market, has risen by 6.3% in 2022 to date. Between June 2021 and June 2022, however, it rose by 8.1%. The vast majority of wage-earners received two contractual pay rises over this period: a regular increase at the turn of the year and the GDP growth supplement that was added to monthly wages starting this April.

Even though pay increases were sizeable during the twelve months in question, they have been eaten up by inflation. June 2022 was the first month since May 2010 to see real wages contract YoY. According to the SI index, real wage growth was negative by 0.7% YoY in June, as inflation for that twelve-month period measured 8.8%.

Real wage growth varies across income groups

The Living Standards Agreement and the contracts based upon it are distinct from the wage agreements in recent years in that the former provided for unit-based rather than proportional pay rises over the term of the contracts. Furthermore, the unit increases were larger for the groups of workers who receive wages according to contractual pay rates than for those who receive more than the contractual rate. The objective was to boost lower-paid workers’ income proportionally more than the income of those who had higher pay at the beginning of 2019.

This seems to have played out as intended, and thus far, SI data do not show strong signs of wage drift among higher-paid workers trying to match the pay rise percentages guaranteed to low-paid workers under the Living Standards Agreement.

Itemised wage data from SI extend only through April 2022. They show clearly, however, that proportional wage rises in the private sector have varied significantly from one worker group to another. For example, managers’ wages rose proportionally the least in the twelve months through April 2022, or by 5.9%. They were followed by tradesmen (6.8%), specialists (6.9%), technicians and specially educated workers (7.1%), and office workers (8.1%). Labourers (10.6%) and general service workers (10.2%) received the largest proportional pay increases during the period.

As the chart shows, these percentages are reflected in the median wages of the groups in question, with higher pay going hand-in-hand with smaller proportional pay rises. If the months since April have followed this pattern, as we think likely, it can be concluded that labourers and general service workers are still making marginal real wage gains, while higher-paid groups have seen their real wages shrink in the past year.

Municipal workers stand out from the crowd

To an extent, the same pattern can be seen in a comparison of private and public sector workers’ wages. In April 2022, wage growth averaged 8.2% for private sector workers and 8.0% for State employees, while for municipal workers – who had the lowest median monthly pay of the three groups (ISK 665,000 in 2021) – the increase measured 10.6%. It is noteworthy that median year-2021 wages were higher for State employees (ISK 824,000) than for private sector workers (ISK 722,000), according to SI data. Furthermore, the shortening of the work week affected wage index calculations for different groups differently, with public sector workers generally benefiting more than private sector workers between March 2019 through September 2021.

GDP growth supplement to kick in again next year?

The purpose of the GDP growth supplement, activated for the first time in April 2022, was to allow wage-earners to benefit from increased value creation in the domestic economy. But there was a fly in the ointment: no one considered the possibility of a deep economic contraction in the year after the agreements were made. Iceland’s handsome GDP growth in 2021 therefore reflected a return to the economy’s pre-pandemic level of value creation rather than an increase in real terms.

The last increment of the GDP growth supplement will be activated in April 2023, even though the Living Standards Agreement expires at the end of October 2022. The supplement is based on the previous year’s calculated GDP growth per capita according to SI’s first figures. According to our macroeconomic forecast (published in May) and SI’s population forecast, GDP growth per capita will measure 2.7% this year, and next year’s GDP growth supplement will be the same as the one from this April: ISK 10,500 for workers paid according to wage scales and ISK 7,875 for others.

Real wages set to erode further in the near term

Inflation measured 9.9% in July and looks set to hover around 10% for the remainder of the year. We expect the CPI to rise by nearly 4% between now and the year-end, and as wages are not likely to rise steeply in the interim, general workers’ real wages will contract in the months to come. Our macroeconomic forecast assumes that real wages will contract by an average of 0.6% this year, but developments in inflation since that forecast was published suggest that they will contract somewhat more than this. If inflation indeed eases in 2023, this trend will reverse and the real wage growth that characterised the past decade will resume.

However, the results of the upcoming wage negotiations will be a major determinant of both inflation and real wage developments. And last but not least, the specific provisions of the wage settlements will affect how real wage growth is distributed across worker groups. During the term of the Living Standards Agreement, real wage growth has been concentrated among the lowest-paid workers, while those who were better paid at the beginning of the period have made smaller gains.


Jón Bjarki Bentsson

Chief economist