Real wages, productivity, and corporate profits

Real wages – which are adjusted for changes in prices, unlike ‘headline’ nominal wages – are an important driver of living standards. The measure of prices used in calculating real wages depends on whether they are viewed from the perspective of firms or households. Employers are interested in the real product wage – the total compensation of employees, relative to the price of the output they produce. Employees are concerned with the real consumption wage – the total compensation they receive relative to the price of the goods and services they consume.^a

Changes in real wages are closely linked to productivity growth since, in equilibrium, workers’ pay is closely related to the marginal product of their labour. Whether real wage growth is above or below productivity growth is a key determinant of changes in profitability for firms. When growth in the real product wage outpaces productivity growth, profit margins are squeezed, and vice versa. Profits as a share of GDP typically decline when margins fall, and rise when they increase.^b This also has an effect on the rate of return on corporate capital and can influence firms’ investment decisions.^c

To illustrate these dynamics, Chart C breaks down the relationship between the real product wage per hour, output per hour (a measure of labour productivity) and the profit share of GDP over four distinct periods:

• In the decade leading up to the financial crisis (1998 to 2007) growth in both productivity and real wages was strong. Output per hour rose by around 2.1 per cent a year on average, but the real product wage grew faster at an average of 3.2 per cent. Real labour costs rising more quickly than the output that those workers produced implies firms’ profit margins were pressured over this period and, partly as a result, the profit share of GDP fell by 2.8 percentage points.
• In the financial crisis and its aftermath (2008 to 2019), output per hour growth fell significantly to only average 0.3 per cent per year. Growth in the real product wage was weaker still at an average of 0.1 per cent. This 0.2 percentage point differential implies a modest boost in firms’ profit margins, as low real wage growth kept labour costs constrained. This contributed to the profit share of GDP increasing by 1.8 percentage points over that period.^d
• From the pandemic, through the subsequent energy price shock, to the present (2020 to 2025), real product wage growth has outpaced productivity, growing annually at 0.6 per cent on average compared to output per hour growing at 0.4 per cent. This means that firms have effectively absorbed more of the effect of recent shocks than workers, squeezing profit margins and contributing to the decrease in the profit share by 0.8 percentage points between 2020 and 2025. This is unlike the aftermath of the financial crisis when a larger share of the effect of the shock was passed onto workers, potentially reflecting looser labour market conditions over that period.
• Over our forecast (2026 to 2030), we expect real wage growth to be slightly below productivity growth. We anticipate the real product wage to grow at 0.7 per cent on average between 2026 and 2030, below average output per hour growth of 0.9 per cent. This would result in a partial reversal of the differential over the past five years, implying a rebuilding of firm profit margins which have been squeezed. It would also increase the rate of return on capital and make more investment profitable. In terms of fiscal implications, this leads to labour income growing more slowly than profits, pushing down on growth in receipts as the former has a higher effective tax rate than the latter.

Chart C: Real product wage, output per hour, and profit share of GDP

Note: The fourth quarter of 2025 is a forecast.

Source: ONS, OBR