Written by Christopher Dang, Economic Development Research Intern | What is the real impact of stagnant wage growth?
Great news everyone, wages across the US are rising at speeding rates!…right? The government has been showcasing various data sources that show that wage growth rates have been growing at a rapid pace. However, things may not be moving as fast as they are making it out to be. It turns out that measuring wage growth is not as black and white as it may seem.
A major struggle that comes with measuring wage growth is that there are multiple ways to do it. One of the more common ways of measuring growth rates is the employment cost index, which considers the cost of labor for businesses in each quarter. As of 2018, wage growth has hovered a little over 2.7%. Although it seems quite subpar to the growth target of 3.5-4%, this has been the highest it has been since 2008. However, this measure projects a nominal growth rate, meaning that these numbers are not adjusted for inflation. When you take inflation into account, it paints a substantialy different picture for the changes in real wage.
Though real wages are growing, it is not nearly as much as the ~2.7% nominal growth rate that government officials are boasting about. Orley Ashenfelter, an economics professor at Princeton University stated that “Nominal wages are increasing, but not at a very fast rate – and prices are increasing nearly as fast, so real wage growth is below 1% year on year…this is a shade more than the past.” When taking into account inflation, real wages are only growing at a marginal rate. The graph below highlights the slight difference in real wages between 2017 and 2018.
This leads to the big question that economists debate over, “Why aren’t wages growing as fast as they should be? What is causing it to stall and when will it start to pick up?”
There has traditionally been an inverse relationship between wage growth and the unemployment rate. As the unemployment rate falls, wage growth increases and vice versa. However, this has not been the case following the Great Recession. Average wage growth had slowed less than expected during the recession and has stalled during the recovery. The Federal Reserve Bank of San Francisco contributes the sluggish wage growth to the reconfiguration of the labor force. Higher-wage baby boomers have been retiring at masse, while lower-wage younger generations have been entering. The two occurring simultaneously can partly explain the lagging wage growth.
Additionally, The Federal Reserve Bank of Kansas City weighs in on the dilemma by suggesting that it may have to do with wages having to respond not only to current labor market conditions, but also to how much wages were able to adjust in the past. For example, firms that were not able to lower wages during the recent recession, may be compensating for that loss later by reducing raises as the economy recovers. In support of this explanation, the Kansas City FED has also stated that there is a relationship between wage growth today, and the nominal wage rigidities from the previous year (the share of workers with zero wage change last year compared with two years ago). They conducted a linear regression between nominal wage rigidities a year ago and wage growth today to prove their point. The results imply that a one percent change in nominal wage rigidities is associated with a ~.26 percentage point change in nominal wage a year later when considering the current and prior state of the labor market. These findings unfortunately indicate that wage growth is unlikely to ramp up within the next year.
Despite having many explanations for potential causes of the slack in wage growth, people are more concerned about when the lagging real wage growth will start picking up the pace. Unfortunately, many economists fail to agree on future projections. Some argue that we should see a boom in wage growth this upcoming year, while some are saying that it is highly unlikely.
The one thing that remains certain between both parties is that we need it to rise sooner rather than later.
