The mystery of the disappearing pay rise

It’s one of the most important questions in economic policy: if dole queues are getting shorter, then why aren’t pay packets getting fatter?

The mismatch between job creation and wage growth is investigated by Ernie Tedeschi for the New York Times:

“The government has several wage metrics that take different approaches, each with pros and cons. But virtually all of these agree that wage growth today is much slower now than it was on the eve of the 2001 recession, with its identical unemployment rate.

“This is, to put it mildly, a mystery. If workers are as scarce as the unemployment rate and many other measures suggest, employers should be raising wages to compete for them.”

There’s a near identical mystery in the UK: a rapid fall in unemployment since the end of the recession, but anaemic wage growth. Admittedly, there’s been a very recent uptick. However, improving on the record of the last 10 years is a pitifully low bar – in fact, “the worst decade for living standards for 200 years” (according to the BBC).

In trying to explain the American wage growth mystery, Tedeschi begins by eliminating suspects:

“We can rule out two possible reasons immediately. It wasn’t because of a decline in inflation, and it wasn’t because benefits like health insurance and hiring bonuses crowded out wages.”

Another line of inquiry is the possible influence of changes in the composition of the workforce. For instance, if average wage growth were being pulled down solely because people previously excluded from the labour market were now getting jobs, then that might be seen as a net positive. However, the slowdown appears to apply across different age, sex, education and ethnic categories.

Then there’s the concern around zero-hours contracts and other potentially exploitative forms of employment and ‘self-employment’. These surely can’t be good for workers’ pay, one might think. And yet, as Tedeschi notes, “wage growth is down since 2001 across all five wage quintile groups and across union membership”. Whatever’s going on, it’s not just happening to those at the bottom of the heap. 

Tesdeschi suggests that “employer concentration” (i.e. a workforce divided between fewer employers) may be limiting alternatives for workers – and therefore their bargaining power. The same could be said for the growing and often unjustifiable use of non-compete clauses in contracts.

A decline in the rate of productivity improvement may also be a factor, though it would have to be sufficiently generalised across the economy to explain such a widespread slow down in wage growth – i.e. this is not just about our failure to ‘skill-up’ blue collar workers.

To my mind, the strongest explanation offered in the article is one of “hidden slack” in the labour market. Job-creators aren’t just finding workers from the ranks of the officially unemployed, but also from other pools of potential employees:

“The unemployment rate counts only people either employed or actively looking for work — not those who give up looking. A rise in what economists call labor force nonparticipation — whether because of discouragement, school enrollment, disability or retirement — was a distinguishing feature of the Great Recession.”

Then there’s an increasingly mobile migrant workforce — and workforce-replacing options such as outsourcing and automation. To put it another way, there is a lot more ‘elasticity’ in the the supply of labour (and labour substitutes) than there used to be. So much so that long-established economic assumptions are becoming obsolete.

I would argue that all of this is further evidence of movement towards a post-scarcity economy. Situations which would have produced inflation in the past, such as ultra-low interest rates and full-employment, no longer do so because the old constraints on supply are weakening.

One might assume that scarcity is something that we’d want economic progress to abolish. However, the tendency of demand to exceed supply isn’t just the cause of higher prices in the shops, it’s also why wages go up.

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