Why wages have lagged behind global jobs recovery
In a world of sluggish economic growth, two conflicting trends puzzle policy makers: Why are companies hiring so aggressively and why haven't wages until lately risen more rapidly?
From Tokyo to London, jobless rates have kept falling even as labour market indicators suggest economies are nearing full employment. The US unemployment rate edged up to 4.7% in December as more workers entered the labour force, but remains close to a nine-year low of 4.6%. In Japan, at 3.1%, it's around its lowest level since the early 1990s. The UK jobless rate was 4.8% in the three months to October, close to a four-decade low, despite the country's historic vote to leave the European Union last June. Even in the 19-nation eurozone, the unemployment rate has hit a seven-year low of 9.8%.
It's common for firms to hire large numbers of workers early in an economic recovery, to deal with backlogs of orders. That tends to slow productivity growth. But companies have been adding workers for much longer than expected, economists say, and productivity has remained subdued for an extended period as firms eschewed capital investments.
"It's very hard to rationalize why businesses are adding so many workers...throughout advanced economies at a time when growth [has been] near zero or even declining," said Adam Posen, president of the Peterson Institute for International Economics in Washington. "It's very cheap to substitute capital for labor, in part because of what central banks are doing." Low interest rates make it cheap to invest in labour-substituting equipment.
Policy makers, particularly in Europe, have been taken by surprise. The Bank of England said in mid-2013 it would consider raising interest rates when unemployment fell to 7%, but had to backtrack after hitting that level in six months. The European Central Bank says it was caught out in recent years by a stronger than expected rebound in employment relative to economic growth.
Normally, economists expect wages to rise as the unemployment rate falls, and as inflation and productivity increase. But those relationships appear to have broken down: Wage growth in the US and Japan since 2007 has been as much as 1 percentage point per year less than standard economic models would suggest, said Oxford Economics, a consultancy firm.
Wage growth only recently appears to have picked up in the US Average hourly earnings rose 2.9% in December from a year earlier, greater than the 2% average that prevailed during much of the expansion. Still, it's too early to say if that will be sustained and other US wage measures are less robust.
Wages in 22 advanced economies grew by an average 3.7% a year between 1995 and 2007, but by less than 2% a year between 2008 and 2016, Oxford Economics calculates.
The Phillips curve, which reflects an inverse relationship between wages and unemployment, appears to have stopped working in many places.
Economists suggest a range of possible explanations.
First, the types of jobs created since the crisis aren't the same as those lost beforehand. While jobs were lost primarily in the construction and manufacturing sectors, they have been added in the services sector, says Stefano Scarpetta, an economist with the Organization for Economic Cooperation and Development, a think tank for advanced economies. In the euro area, nearly all of the 3.2 million positions created since the recovery were service-sector jobs, primarily in trade, transport and business services, according to the ECB. Many of these positions tend to be harder to substitute with machines, and don't pay so well.
Second, workers' bargaining power may have been eroded due to general economic uncertainty, labour-market reforms and intensifying global competition from China and elsewhere. Workers in new service-sector jobs may not be organized into unions, reducing the pressure for wage hikes, said Christopher A. Pissarides, a Nobel Prize-winning economist at the London School of Economics. Employees have also been changing jobs less frequently, which is associated with weaker wage growth.
Third, some firms may not have been able to reduce labour costs as much as they wanted after the crisis, and therefore dragged the adjustment out over time. ECB officials pointed to such "pent-up wage restraint" at their October meeting, according to the minutes. Public-sector pay has also been squeezed as governments tightened their belts, pulling down average wages and perhaps weighing on private-sector pay by proxy.
Fourth, the changing makeup of the labour force may have artificially supported wages after the recession, but subsequently held them down. Since low-wage workers were disproportionately fired, and firms slowed new hires –who typically earn less – average wages held up, according to researchers at the Federal Reserve Bank of San Francisco. As the economy has strengthened, lower-wage workers have been re-entering the workforce. Meanwhile, highly-paid baby boomers have started to retire, putting downward pressure on wages.
All that means wage growth may be a poor indicator of job-market strength. A better measure, the Fed researchers argue, is the pay of workers continuously in full-time work, ignoring those entering and leaving the labor force. That indicator, which is tracked by the Atlanta Fed, suggests wage growth has been about 1 percentage point per year higher since 2014 than is indicated by average hourly earnings.
Some economists expect wages to rise more strongly as labor markets tighten further and postcrisis ripples dissipate. The latest US report on wages suggests that's the case. But with productivity growth still weak, a wage boom at this stage of the expansion doesn't look to be in the offing.
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