Beyond the Headline: Weak Wages

The Facts

Since the Friday morning release of the December Employment Situation by the Bureau of Labor Statistics, economists have generally come to the same conclusion: hiring continues to remain strong but wage growth data continues to be a reason for concern.  Non-farm payrolls increased by 252,000 in the month of December and, along with upward revisions in the October and November reports, was a major factor in the 0.2% fall of the U3 unemployment rate to 5.6%.  However, what is now troubling economists goes beyond the headline number as they are beginning to increasingly rumble about anemic wage growth, which in fact contracted by $0.05/hour or 0.2% in December.

The Fed

Tim Duy, a frequent contributor to University of Oregon Professor Mark Thoma's economics blog Economist's View, discussed the jobs report within the context of expectations of future Federal Reserve actions.  Duy utilizes multiple graphs depicting select economic indicators that paint a picture of the current labor market, including eight indicators which have been noted by Federal Reserve Chair Janet Yellen.  While almost all of the indicators show a clearly improving labor situation, in his last graph (below) he notes that wage growth "nosedived during the month".  He goes on to explain:

Bottom Line: Generally a very solid report.  But the wage numbers present a dilemma for the Fed.  Simply put, no wage growth means the Fed can't be particularly confident that inflation will trend toward target.

As economists and participants in financial markets from all over the world attempt to look into their crystal ball and predict the future of Federal Reserve policy, Duy believes that the Fed's plan might become more murky if wages continue to stay stagnant.

The Reasons

But what has caused these stagnant wages?  In the article Hiring Booms, but Soft Wages Linger, Jeffrey Sparshott gives multiple reasons for the tepid wage gains.  First: underemployed and discouraged workers.  Sparshott identifies the falling labor force participation rate, which currently stands at 62.7%, and an elevated U6 unemployment rate, which takes into account part-time and marginally attached workers.  Both of these indicators show that there may not be enough competition within the labor force to drive up wages across the board, contrary to what the strong headline U3 unemployment rate might suggest.  Employers are able to access this "shadow" labor supply in greater numbers than in previous hiring cycles, which will continue to keep wages low despite the falling unemployment rate.

The second explanation that Sparshott offers for sluggish wage growth comes from the distribution of jobs that were created since the recession.  He analyzes the mix further:

Lower-paying positions in the retail, temporary-help and leisure and hospitality sectors have seen some of the strongest job growth, while better paying construction and manufacturing sectors have been slower to make gains.

One of the worst hit areas of the economy during the downturn was housing, which lead to a large contraction of the labor demand in the overall construction market.  As Sparshott points out, this labor market continues to show only slow gains, and the simple shifting proportions of high to low paying jobs has caused the average as a whole to remain immobile.

The Solutions

Both of the issues that Sparshott raises have simple solutions.  To the first issue, the solution is one word: time.  As long as hiring continues to be strong, this "shadow" labor supply will eventually fully acclimated back into the labor force, cutting off employers relatively cheap source of labor.  The passage of time will allow the supply and demand to clear within the labor market and return to wage pressures that are considered "normal" within the context of near natural rate unemployment.

The second issue also be solved by time, but with the additional requirement of economic growth and stability.  In my opinion, one of the main reasons why the construction and manufacturing sectors have yet to show strong rebounds in hiring is due to the relatively slow and shaky economic recovery that the United States has experienced.  While we have reached five and a half years since the end of the recession, there has remained a constant threat that a shock could push the economy back into a contractionary mode.  Now, however, the economy seems to have re-gained its foothold.  With consumer confidence at recent highs, continued strong hiring numbers, and solid recent GDP reports, it suggests that the US Economy can withstand external shocks going forward.  As this strength continues, employers within the construction and manufacturing sector should have the confidence to make the investments and commitments necessary to ramp up business, and most importantly, hiring.