What’s Happening With Wage Growth?
Wall Street economists insisted for months that the labor market couldn’t possibly get tighter without triggering wage inflation. “We are at full employment,” Deutsche Bank Securities headlined a note to clients in October. “Leading indicators of inflation flashing red,” it wrote days later. “On the cusp of full recovery,” Goldman Sachs wrote in December. “Wage inflation continues to gain traction,” JPMorgan Chase economists said in January.
Then came February, and Wall Street’s much-anticipated wage pressure was nowhere to be seen. Even though employers added a more-than-expected 227,000 workers in January, average hourly earnings rose just 0.1 percent. Forecasters struggled to make sense of why Americans’ pay had barely risen at all. “What happened with wages?” asked economists at Bank of America Merrill Lynch.
It’s hard to blame the economists for overestimating wage growth; they’re applying the time-honored law of supply and demand. It stands to reason that when workers are in greater demand, they’ll be able to hold out for better pay. The mystery is why that hasn’t been happening in the U.S., at least not as much as most experts expected.
The pay-growth puzzle bears on the vitality of the U.S. economy in coming years, to say nothing of the vitality of the Donald Trump presidency. If wage inflation really does threaten to overheat, the Federal Reserve under Chair Janet Yellen will feel obliged to raise interest rates to slow down the economy. That will prevent Trump from making good on his campaign promises to raise the growth rate to 3.5 percent, 4 percent, 5 percent, or more. If there’s no wage inflation brewing, on the other hand, the Fed can afford to hold back, economic growth can accelerate, and the Republicans should do well in the 2018 midterm elections and beyond.
No matter what you think of Trump, you should be hoping that the U.S. economy isn’t, in fact, already bumping up against its speed limit. Because if it is, it means that speed limit is distressingly low—and American living standards can improve only at a snail’s pace. Output dropped sharply during the last recession. Instead of springing back like a yo-yo, it’s drifted upward at a meager 2 percent a year. If the economy had grown since the end of 2007 at the average pace it did from 1947 to 2007, it would be 22 percent bigger than it is today. That’s a difference in annual gross domestic product of more than $4 trillion.
The minuscule 0.1 percent increase in hourly earnings in January is, in this context, a strange mixture of good news and bad news. It’s bad news because it means long-suffering workers still aren’t getting the substantial raises they need to pay their bills. Labor has been getting a smaller share of the national income, while the share going to capital owners (business owners and shareholders) has been rising. And consumers can’t buy more stuff if they aren’t being paid more. The good news is that the small increase shows the economy can easily employ more people, and generate more goods and services, without overheating.
It’s possible, of course, that the earnings growth number was a fluke. Economists found numerous reasons to play it down after its release by the U.S. Bureau of Labor Statistics on Feb. 3. For one thing, a lot of the January employment growth was in lower-paying jobs such as retail, leisure, and hospitality, which put a drag on average hourly earnings. For another, wages in the high-paying financial sector fell 1 percent—a rare and unexplained drop that might well be reversed in February.
Those who believe wage inflation is threatening point out that the labor market has indeed tightened over the past year by many measures. Earnings are up 2.5 percent over the past 12 months, and surveys of companies and consumers show the highest expectations for wage gains since the last recession. About half of small businesses report there are few or no qualified applicants for job openings, up from a quarter that said so in 2009. And people are voluntarily quitting jobs at a prerecession pace—something that could force employers to jack up pay to hang on to valued workers. “There are no good reasons why wage inflation should slow down now, because the economy is at full employment,” wrote Torsten Slok, Deutsche Bank Securities’ chief international economist, in an e-mail.
It’s dangerous, though, to dismiss anomalous numbers just because they don’t appear to fit with economic theory. It might be that the tiny earnings gain in January wasn’t a fluke after all, but rather an indicator that workers still lack bargaining power. David Weil, a Boston University Questrom School of Business economist who worked in the U.S. Labor Department under President Obama, says wages are suppressed because corporations have “fissured”—shunted their low-wage employees to outsourcers who pay them even less.
One sign of slack is that companies haven’t been adding overtime hours, which they tend to do when they can’t hire as many workers as they need. Another strong indication of slack is that the unemployment rate ticked up to 4.8 percent in January, from 4.7 percent in December, as people flooded into the labor market searching for work. The rate of participation in the labor force, which fell sharply from 2008 through 2013, has stopped falling despite the retirement of many baby boomers. “It’s far from obvious to me that we’re on the cusp of an imminent breakout of wage growth,” says Joseph LaVorgna, chief U.S. economist for Deutsche Bank Securities, parting from his colleague Slok.
In other words, Trump may be onto something in averring that the economy still has room for growth. He’s not one to comb through the BLS website to deepen his understanding of the economy. During the campaign he called the official unemployment rate that the BLS publishes “one of the biggest hoaxes in American modern politics.” That said, the president is “absolutely right in saying that the labor market has much more slack in it than the Fed and other commentators are thinking about,” said David Blanchflower, a Dartmouth economics professor and former Bank of England policymaker, on Bloomberg TV before the latest unemployment report.
Yellen could yet prove to be one of Trump’s most important allies in the fight for growth—even though he alleged during the campaign that the Fed was more political than Hillary Clinton. Blanchflower’s comment about “the Fed and other commentators” isn’t fair to Yellen, who’s pushed back against economists who warn that the central bank will invite inflation if it doesn’t aggressively raise interest rates to slow growth. “A natural question is whether monetary policy has fallen behind the curve,” she said in a speech at Stanford in January. “The short answer, I believe, is no.”
Economics makes strange bedfellows. Liberals who backed Obama’s demands for fiscal stimulus are now worrying that Trump will somehow engineer a growth spurt that will carry Republicans past Democrats in the next one or two election cycles. “Nobody I know in Congress doesn’t want job creation, but who gets the credit? That’s hard on them,” says Leo Hindery, a Democrat who’s managing partner of private equity firm InterMedia Partners in New York. Democrats are left warning that stimulus, especially if it’s in the form of tax cuts for the rich, will be a “sugar rush” that will leave ordinary Americans worse off.
When it comes to economic data, it can be difficult to separate what people believe to be true from what they want to be true. “People need to be a little more scientific and a little less political in the nature of their interpretation,” says Robert Johnson, president of the left-leaning Institute for New Economic Thinking. “It’s times like this when people are least scientific.”
—With Patricia Laya