PMC Weekly Review - May 25, 2018

A Macro View: Wage Growth in a Full-Employment World

Though it occurred more than a decade ago, the Great Recession has left painful memories for Americans who lost jobs, homes, savings, and wages. According to the Center on Budget and Policy Priorities (CBPP), approximately 8.7 million jobs were lost from December 2007 to early 2010, with the unemployment rate peaking at 10%. Though slow to recover, the economy has regained those jobs, and the Federal Reserve (the Fed) has achieved its goal of full employment, defined as 5%.

With the hard hit to the US employment market, it is no wonder that the Fed has been so focused on job gains as a key indicator of economic health. Recently, the US unemployment rate ticked down to 3.9%, as the economy added an average of 191,000 monthly nonfarm payroll jobs over the rolling 12 months ended March 31. Given the steady improvement and full-employment situation, many economists, institutional investors, and the Fed have shifted their focus to how the average employee is faring in terms of wages and compensation.

Nominal wage growth is a critical measure of the state of the economy, as the majority of Americans depend on a paycheck alone. Nominal wages are the gross amount of money a worker receives from their employer, and in turn, translate to real wages, which measure the amount of goods and services that can be bought at given prices. In other words, real wages consider inflation. Wage growth from the most recent jobs report released in April showed a 2.6% change from April 2017, a step in the right direction, but less robust than most economists would like to see, especially with 3.9% unemployment. What’s more, adjusted for inflation of approximately 2%, workers have hardly seen a bottom-line increase. To put the recent April figure into context, hourly wage growth in tight labor markets (defined as between 3.5% and 4.5%) since the mid 1960s has averaged around 4%. In times of high inflation, such as in the 1970s, hourly wage growth was even higher. Many economists have speculated on why it has been more sluggish than in past recoveries, with two prominent culprits being slow productivity gains and slack remaining in the employment market.

Productivity, or the amount produced by an employee per hour, often has been an input to the earnings equation. As workers’ productivity increased, and therefore their output, so did their wages. But market forces, such as automation and increased global competition, have weighed on productivity and wage growth. In the past, technology changes enabled employees to produce more, whereas technology now is replacing jobs altogether. Additionally, companies increasingly are outsourcing work to other countries, where labor is cheaper. As a result of these two factors, US output has increased, but wages for employees have either decreased or disappeared entirely.

Another potential explanation to the wage-growth puzzle considers the baby boomers. It is estimated that 10,000 baby boomers a day are turning 65, the eligible age for retirement. Many of these retiring baby boomers hold manager and supervisor roles that pay aboveaverage wages, so the percentage of higher-earnings exits from the employment market is larger than in the past. Though this may leave opportunities for others to move up the ladder, the work is often replaced by lower-paid employees. Also, those moving from part-time to full-time work, or those re-entering the market from a period of unemployment, are filling vacancies that pay less. Consequently, this phenomenon has put downward pressure on wages.

Like most economic issues, a confluence of factors likely is contributing to slow wage growth, which has made it difficult for some economists and policy makers to propose a solution. Others believe we should accept the state of current wages as the new normal. However, even if we see slow but steady wage growth continue in an upward trajectory, it could spark the next leg of positive stock market performance. After all, we are a consumption-driven economy that depends on the stability of consumers and their buying power.

Ali Caffery​
Portfolio Manager


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