October 28, 2014

October 28, 2014 | Commentary on Labor, Unemployment, Jobs

Why Has Wage Growth Stagnated?

By many measures the labor market is improving smartly. The unemployment rate dropped to 5.9 percent in September—not far from the level many economists consider typical during normal economic conditions. The number of job vacancies has jumped almost one-fifth since the start of the year, while employers have created 2.6 million net new jobs over the last 12 months. Nonetheless, polls show Americans remain deeply concerned about the economy. A hefty majority tell Gallup pollsters they consider the economy to be “getting worse.” Polls also find economic concerns topping voters’ anxieties. Why the dichotomy between the economic statistics and popular perception?

In part it’s because these figures do not tell the full story. The economy remains in worse shape than the headline figures suggest. Many analysts have discussed how much labor force participation fell during the downturn. Millions of Americans no longer count as unemployed because they have become so discouraged, they’ve stopped looking for work. Analysts have paid much less attention to another problem—anemic wage growth.

Inflation-adjusted wages have hardly changed since the recession ended. Between July 2009 (the start of the recovery) and August 2014, real wages grew 1.4 percent. That’s total growth, not annual growth. After factoring out inflation, average hourly earnings have increased just 33 cents over more than five years. Small wonder many Americans feel getting ahead has become harder.

Why has wage growth dropped so sharply? Economists have several theories:

Reduced Labor Demand.
Essentially, blame the business cycle. Wages have stagnated because the lackluster economy has made businesses less interested in hiring. With sales low, companies see little need to add to their payrolls. Simple supply and demand predicts that reduced demand for labor will lower its price—wages. The media most commonly cite this explanation, and it contains much truth. The recession and weak recovery almost certainly depressed wages. However, labor demand has clearly improved in recent years. Job openings surged in 2014 to levels not seen since 2006 and 2007. Wages have scarcely budged. Reduced labor demand cannot explain that.

Increased Labor Supply. Changes in labor supply can. When labor supply increases, employment rises and wages fall. And Federal Reserve economists estimate that the expiration of long-term unemployment insurance (UI) benefits at the end of 2013 increased labor supply. The longer benefits had led the unemployed to search longer for better offers. This put upward pressure on wages, which discouraged companies from creating jobs. Their model predicted that ending extended UI benefits would cause wages to fall and job openings to rise. Indeed job openings increased in 2014 by almost exactly the amount this model predicted.
However, labor supply can explain only some of the wage stagnation. This economic model projected that extended UI benefits account for virtually all the elevated unemployment during the recovery. Even conservative economists consider that implausible; the model may overestimate how much UI benefits affect job creation. Moreover labor supply decreased throughout much of the recovery; increased supply can only explain recent changes.

Obamacare. Labor demand can increase without workers’ pay rising if hiring becomes more expensive. Employers will pay more, but workers do not see that money in their paychecks. Indeed, Obamacare appears to have made employing workers considerably more expensive. Accounts of the healthcare law raising hiring costs fill recent Federal Reserve Beige Book reports. Polling finds two-fifths of employers who offer health coverage say the law has raised their costs. Surveys conducted by the New York, Dallas, and Philadelphia Federal Reserve Banks also find the healthcare law hurting businesses. Federal policy has made hiring workers more expensive—and that money comes out of workers’ wages.

Which of these explanations explains the wage slowdown? Probably all three. It will take more time and data to determine which has played the largest role. In the meantime, workers who believe the economy remains far from a recovery have a lot of justification for feeling that way.

 - James Sherk is a senior policy analyst in labor economics at The Heritage Foundation’s Center for Data Analysis.

About the Author

James Sherk Research Fellow, Labor Economics
Center for Data Analysis

Related Issues: Labor, Unemployment, Jobs

Originally appeared in The Federalist