Why Wages Aren’t Growing

It’s a global problem. Shareholders and managers—and the demise of unions—may be to blame.
Photographer: Jansucko/Getty Images

The very first thing any college freshman learns in Economics 101 is the law of supply and demand. When people desire more of something but its availability is limited or constrained, its price goes up. There may not be another economic rule more basic and logical.

Yet Japan, that land of eternal economic mystery, is apparently defying this most sacred principle. The problem is wages. Japan’s labor market is the tightest it’s been in decades. The unemployment rate has sunk to only 2.8 percent, the lowest in 23 years, while the number of available jobs compared with applicants has reached levels not seen since the early 1970s. Add in an aging, shrinking workforce unable to generate many reinforcements, and simple mathematics leads to the conclusion that wages should be increasing—based on current market conditions, by at least 2 percent a year.

But they’re not even close to rising at that rate. Growth of worker compensation has been minimal this year. In July, base pay rose a mere 0.5 percent from the year earlier, while total earnings, which includes bonuses, dropped by 0.3 percent. Although very recently some signs have emerged that wages may be set for a pickup, workers are far from getting the gains you’d assume the market is signaling they deserve.

Japan, as usual, is an extreme case but not an isolated one. Wage growth in much of the world has been subdued, even as the global economy has stirred to life. In the U.S., where unemployment has dwindled to the lowest level in 10 years, at 4.4 percent, workers aren’t much better off. Average hourly wages inched up 3¢ in August from the previous month. In the euro zone, hourly wage growth in the second quarter showed some improvement, with a 2 percent increase from the same period a year earlier. But overall labor costs aren’t growing nearly as quickly as they did in the years before the 2008 financial crisis, even though Europe is enjoying a surprising revival.

The dearth of wage increases is a serious problem for the global economy. Economists have proffered all sorts of complex explanations for the glacial pace of recovery from the Great Recession, including insufficient fiscal spending and excessive government regulation. Some have even argued that the world has slipped into a long-term cycle of meager growth. But one often overlooked factor is the plight of the wage earner. Employees working 9 to 5 have simply not benefited as they should have from improvements in economic performance or corporate profitability. Without fatter paychecks, the average household can’t spend more, and that’s bad for growth. Yes, it’s really that simple.

Sure, people are better off today than they’ve been since the 2008 financial crisis tanked the global economy. Household incomes in the U.S. jumped by a respectable 3.2 percent in 2016, adjusted for inflation, according to a report earlier in September from the U.S. Census Bureau. Yet that’s not because of wages. The same report revealed that median earnings of full-time workers didn’t materially change in 2016 from the year before. Thanks to the buoyant job market, Americans are simply working more. Federal Reserve data, meanwhile, shows that wage growth—while improved—still badly lags the pace achieved during other periods of low unemployment.

Nor can brighter data erase the fact that workers have been suffering for a long, long time. For instance, when inflation is factored in, median weekly earnings in the U.S. in the second quarter were a paltry 5.7 percent higher than a decade earlier. In an April study, the International Monetary Fund concluded that the share of national income paid to workers has been falling since the 1980s across advanced economies. Even in the emerging world, some countries, most of all China, have seen meaningful declines in this ratio as well, even as poverty has been significantly reduced. That means wages haven’t kept pace with gains in productivity, as economics says they should, and that a greater amount of income is being earned through the use of capital. In other words, investors are winning out over workers.

The Great Recession, of course, set worker welfare back badly. But the roots of wage stagnation run much deeper. In part, the problem has been caused by the globalization of the labor force, which pits workers in one country in more direct competition with workers in other countries, often with large differences in wage levels. Laborers also find themselves competing against human-replacing machines. The IMF study estimated that half the decline in workers’ share of income in the developed world can be attributed to advancing technology. Unions have also been defanged in many countries, stripping the proletariat of its ability to call for increases in wages. In 2016, 6.4 percent of private-sector wage earners were members of unions in the U.S., a drop from 16.8 percent in 1983. Individual countries also suffer from their own specific wage-destroying dynamics. In Japan, for instance, one cause of stagnant wages is a dual-track labor system in which corporations have hired more and more workers in often poorly paid part-time positions, undercutting the bargaining power of the country’s formerly fierce unions.

These factors have undermined the influence employees have within their own companies. As a result, managers are more likely to reward themselves and their bosses—the shareholders—than the rank and file. A July report from the Economic Policy Institute found that the chief executive officers of America’s largest companies made an average of $15.6 million in compensation in 2016, or 271 times the annual average pay of ordinary workers. Although that gap has narrowed over the past few years, it’s still astronomically larger than the 20 times recorded in 1965. More broadly, studies have shown that the gains made in wages have often been skewed toward the top of the pay pyramid, which means those toiling at the bottom are even worse off than the general statistics show.

The big question is: How do we give wage earners a square deal? That’s challenging, because the forces suppressing wages are unlikely to abate. We can’t turn back the clock to a time when labor markets were more localized, despite President Trump’s efforts, nor can we halt the innovation that will bring advances in robotics and information technology.

Yet we’re not helpless, either. Harry Holzer, a senior fellow at the Brookings Institution, suggests that steps can be taken to fill well-paid jobs that are sitting empty in the U.S. because of a lack of skilled workers. Companies, he says, should be encouraged to partner with community colleges to train the poorly skilled, start apprenticeship programs that provide on-the-job training, and hire the long-term unemployed or former felons.

But efforts have to go further than that. Another step would be strengthening the voice of labor, which means restoring some power to unions to stand up for workers’ interests. There is a clear link between unionization and bigger paychecks. A 2013 analysis by the U.S. Bureau of Labor Statistics showed that unionized workers got larger wage increases, earned more money, and had better access to corporate benefits than nonunionized workers. On top of that, the Economic Policy Institute in a 2016 research paper made the case that all workers would gain from unions, even those who aren’t members, because higher rates of unionization would boost wages overall by setting pay standards employers are compelled to follow.

For unions to regain ground, governments will have to give them a nudge. Former U.S. Secretary of Labor Robert Reich recommends Washington make it easier to form unions, impose harsher penalties on companies that fire organizers, and banish “right-to-work” laws in states that allow workers to benefit from unions without paying dues, considered a back door to weakening them.

Yet another possibility for increasing wages can be found in an old capitalist concept: performance-based pay. Advocates of free enterprise like to say hard work should be rewarded, but in today’s corporate culture, that simply isn’t the case. While CEOs are often compensated, at least in part, on their companies’ overall success, regular employees, who arguably are as responsible as executives for that success, are often not. According to a 2017 report from PayScale Inc., which specializes in compensation data, three-fourths of executives, directors, and managers in surveyed companies were given bonuses, while less than half of hourly workers were. Linking compensation to contribution isn’t only fair, it also would likely boost loyalty and productivity.

If executives don’t cooperate with such schemes, policymakers may have to force them. One idea is to use tax policies to encourage management to share profits with employees. South Korea is engaged in just such an experiment. In 2015 the finance ministry, fed up with big companies hoarding cash, imposed a tax penalty on those that failed to spend a certain percentage of profits on investment, dividends, or wages. It’s hard to tell if this policy has had the desired effect. But the Korean government is doubling down on the strategy. The new administration of President Moon Jae-in has promised to enhance tax incentives for companies that boost employment and raise wages.

Free marketers may balk at such a proposal. And perhaps with more time, tightening labor markets will give wages more of a lift. But the long-term trend is so disheartening that more action is necessary. We must strike a new balance between labor market flexibility and worker protection. In an increasingly high-tech world, where skills and talent will determine companies’ futures, far-sighted executives should seek practices that fairly compensate—and thus retain and groom—good workers. If not, weak wages will drag us all down.

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