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Will Wage Growth Remain Stagnant?

Summary

The labor market is tightening, yet wage growth has not yet increased as expected

Key explanation to stagnant wage growth is low productivity growth, which comes from a skills mismatch

Economists have differing views on future of wage growth: low vs increasing

The labor market has significantly recovered from the effects of the financial crisis. There are more job openings than at any time since at least 2000, and unemployment is very low at 4.7%. Many economists view the labor market and the wage growth as intimately linked; as the labor force tightens, wages should rise. However, wage growth has remained relatively stagnant since the recession while the labor market has substantially improved. Why has wage growth not increased as expected, and are we at an inflection point in wage growth, or will it continue to remain low?

One explanation is the decline of labor unions in the US. Economists state that “general economic uncertainty has helped undermine labor market reforms, making it harder for workers to form unions and demand higher wages”2. With labor union participation rate nearly half of what it was 30 years ago, and still declining, it is no surprise that companies have less incentive to increase wages as quickly as it did pre-recession.

Most economists agree, however, that the key explanation is that productivity growth and inflation have both been very stagnant as well. The lower inflation prevents companies from increasing wages without losing profits. At the same time, low productivity growth shows that each worker has been producing little more per hour than they had in the previous year1. Chief economist at Wells Fargo stated that “With both productivity growth and inflation continuing to prove sluggish, it is not altogether surprising that wage growth has disappointed”3.

Why has productivity growth remained so low, keeping wage growth down? Signs point to an increasing skills mismatch in the marketplace, where companies are finding it increasingly difficult to find employees with the skills they require. One piece of evidence of this mismatch is that recruiters have had tremendous wage growth in the last year, faster than any other profession1. This mismatch keeps productivity growth low, which then restricts wage growth in companies. A solution to this problem is to train people more to develop new skills. However, this is a slow process and will not make a dent in the mismatch in the short-run1.

The question on many economists’ minds is whether wage growth will continue to remain tepid or not. Diane Swonk, a veteran economist from Chicago, believes that with the tightening of the job market is reaching a breaking point, and that we should see wage growth finally catch up soon. She stated that “this is a turning point for the overall economy”4. Robert Johnsons, CFA and director of economic analysis for Morningstar, concluded that “wages [are] moving sharply higher” and that “wage growth may be in the process of accelerating”5. Others argue that it is unlikely productivity growth will have any drastic change in the coming months, and with inflation remaining low and the fed increasing interest rates, all signs point to wage growth remaining low as it has in the past3.

1. AQR Macro Wrap-Up - “The Skills to Pay the Bills” by: AQR Capital Management

2. Forbes - “Four Reasons Wage Growth is Lagging Behind the Jobs Recovery” by: Erik Dolan-Del Vecchio

3. Wall Street Journal - “U.S. Jobs Growth Picks Up, but Wage Gains Lag Behind” by: Jeffrey Sparshott

4. New York Times - “Recovery Finally Yields Big Gains for Average Worker’s Pay” by: Nelson Schwartz

5. Morningstar - “Rays of Hope in This Week’s Economic News” by: Robert Johnson

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.