There are many puzzles that befuddle
economists. One is why productivity is so low. Another is the
return of the old Greenspan conundrum of why long-term interest rates do not
increase as the Fed raises short-term rates. As the monthly
non-farm payroll report approaches, it may be useful to consider another
conundrum. Why is wage growth so lackluster despite the dramatic decline
in unemployment?
note by economists at the San Francisco Federal Reserve from March offers a
different perspective on the puzzle. It acknowledges that the labor
market is near full employment, which some other economists doubt to explain
the absence of stronger wage pressure. However, the San Fran economists
suggest that it is the changing composition of the labor market that is constraining
wages.
Specifically, the San Fran economists argue
that higher wage earning baby boomers are
retiring, and lower wage workers, squeezed by the recession and
financial crisis, are gradually returning to work. Simply put, there
are fewer high wage earners and more
lower wage earners. Hence, the rise in average earnings is muted even though the labor market is near
full employment.
They argument is that during the recession and
financial crisis, labor income held up better than would have been expected. Aggregate measures of
wage growth were flattered by a disproportionate dismissal of low-wage employees. The economists note
that the impact was made greater by the simultaneous drop in new hiring.
New hires are more likely to accept pay offers less than the median.
Therefore, the slower hiring during the crisis and aftermath generated a higher
average wage.
This process is has gone into reverse during
the recovery and expansion. Wages
of continuous employed full-time workers helps push up wage growth; so do those
who change jobs and stay there for over a year. However, the net impact
of the movement in and out of full-time
employment weakens wage growth. The logic is
that exiting workers from higher wage levels are replaced by those earning less than median wages.
The San Fran Fed economists argue that in
recent years the main drag on wages comes from the shift from part-time to
full-time employment and between those not in the labor market and full-time
employment. They note that about 80% of the workers moving from
part-time to full-time positions get below median wages. Almost the same
amount (79.3%) of those going from outside of the labor market to full-time
positions receive lower than median wages.
The inescapable conclusion of the economic
note is that changes in the composition of employment can help explain what
appears to be counter-intuitive wage dynamics. What the economists
describe seems typical of the business cycle, but the magnitude of the
2008-2009 downturn and the retiring Baby Boomers amplify the forces. A
key takeaway is that wage growth during periods of composition flux may not be
a good measure of the slack in the labor market.
US headline CPI converges to core CPI.
Core CPI converges with wage growth over time. However, the San Fran Fed
economists caution: ” As long as employers can keep their wage bills
low by replacing or expanding staff with lower-paid workers, labor cost
pressures for higher price inflation could remain muted for some
time. If, however, these lower-wage workers are less productive,
continued increases in unit labor costs could be hiding behind the low readings
on measures of aggregate wage growth.”
In fact, unit labor costs have been trending
gently higher. Over the past 12 quarters, through Q1 17, unit labor
costs have risen at an average annualized rate of about 2.32%. Over the past eight-quarter, unit labor cost has risen an average of 2.61%. Over the
past four quarters, the pace has accelerated to 2.80%. The preliminary
estimate for Q1 17 was 3.0% rise in unit labor costs. This may be revised a bit lower later this week
following the recent upward revision to Q1 growth.