Behind the Slow Pace of Wage Growth

Behind the Slow Pace of Wage Growth
Filippo Occhino
Federal Reserve Bank of Cleveland, 04.09.2015

Despite continued progress in the labor market, wages have been rising slowly. In 2014, total nonfarm payroll employment rose by 3.1 million and the unemployment rate declined by 1.1 percentage points to 5.6 percent, indicating that the labor market was improving. Meanwhile, average hourly earnings and compensation per hour rose only by 1.8 percent and by 2.5 percent, respectively, a smaller increase than one might expect after 5 years of economic recovery. In this article, we look at some factors behind the slow pace of wage growth, including slow productivity growth and labor’s declining share of income.

One reason wages have been rising slowly is that prices have been rising slowly. Low inflation, however, does not explain the trend in wages completely. Even after subtracting the effect of inflation, wages have been rising slowly. In 2014, real average hourly earnings and real compensation per hour rose, respectively, by only 1.2 percent and 1.3 percent.

In fact, real wages have been rising slowly for several years. Measuring from the end of the Great Recession, real wages have barely risen—real compensation per hour has risen only by 0.5 percent, much less than at this point in past recoveries. The lack of strong wage growth has been one factor that has held down the growth of income, consumer spending, and the recovery.

Some temporary factors may explain, in part, weak real wage growth during the recovery. For instance, Daly and Hobijn (2015) suggest that many firms were not able to reduce wages during the Great Recession, so they compensated by not raising wages as fast during the recovery. This factor, however, became less and less important over time as the recovery continued to progress.

Another factor that may have held down wage growth during the recovery is a change in the composition of jobs and hours—a relative increase in  lower-paid jobs and hours may have depressed the average wage. Data, however, suggests that a change in the composition of occupations did not have a strong effect on the average wage: The employment cost index for total compensation—an index that tracks the cost of labor for a fixed composition of occupations—has risen by 11.5 percent during the recovery, which is similar to the growth in average hourly earnings and compensation per hour, which have risen, respectively, by 11.3 percent and by 11.5 percent. Also, Elvery and Vecchio (2015 , Table 2) find that the effect of the change in the mix of occupations on the change in the average wage between 2010 and 2013 was small (and actually positive). Similarly, Mancuso (2015) finds that shifts in industry composition do not explain much of the weakness in wage growth during the recovery.

Some longer-term changes in the economy have likely played a larger role in depressing real wage growth. The first is the slowdown of labor productivity in the last decade. Productivity growth in the nonfarm business sector has averaged only 1.46 percent since 2004 and 0.85 percent since 2010. As the growth of labor productivity is a key determinant of real wage growth in the long run, the slowdown of productivity has probably helped to depress wage growth.

Other long-term changes in the economy, including the evolution of the technology used to produce goods and services, increased globalization and trade openness, and developments in labor market institutions and policies, have caused labor’s share of income to decline at a faster pace since 2000 than in previous years, and in doing so they have likely held down real wage growth. After declining at an average rate of 0.1 percent per year from 1960 to 2000, the labor share has declined more rapidly since 2000, on average about 0.5 percent per year (see Jacobson and Occhino, 2012). In an accounting sense, the faster decline since 2000 has subtracted about 0.4 percentage points per year from average real wage growth relative to the period before 2000.

Going forward, wage growth will likely pick up in the short run, as inflation rises and labor market conditions strengthen further. In the longer run, whether average real wage growth remains lower than in the past will depend on whether trend productivity growth continues to be low and whether other fundamental economic forces cause further declines in the labor share of income.

Reference

Susan Fleck, John Glaser, and Shawn Sprague (2011). “The Compensation-Productivity Gap: A Visual Essay.” Bureau of Labor Statistics, Monthly Labor Review.

Senior Research Economist

Filippo’s primary areas of interest are monetary economics and macroeconomics. His recent research has focused on the interaction between the risk of default in the corporate sector and the business cycle.

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