Why aren't wages rising faster even with low unemployment? Trade war, weaker economy are among reasons
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By all rights, U.S. wage growth should be kicking into a higher gear amid falling unemployment and intensifying worker shortages.
Instead, annual pay increases have slowed this year. Salary gains, which generally had been modest since the economic expansion began in 2009, finally edged over 3% in August 2018 and peaked at 3.4% in February before dropping to a still-solid 3% the past couple of months.
The earlier increases coincided with a fairly steady decline in the jobless rate as employers paid more to attract a smaller pool of candidates. And the pullback in pay gains comes despite unemployment hitting a 50-year low of 3.5% in September.
“Wage growth has hit a wall,” Joseph Song, senior economist at Bank of America Merrill Lynch, wrote in a report.
Economists blame myriad factors, including President Donald Trump’s trade war with China and a slowing U.S. economy, weak productivity growth and meager inflation.
Accelerating earnings increases were expected to drive consumer spending, helping offset slower job growth and keeping the economy humming in the expansion’s latter stages. Three percent pay increases aren’t bad, but many analysts expected a march to 4% and beyond.
Here’s a look at several reasons behind the moderation in pay increases:
The economy and trade war
After growing at about a 3% annual rate in 2018 and early this year, the economy expanded at about a 2% clip in the second and third quarters. Song partly blames the trade war, which has curtailed U.S. exports to China, increased the cost of imports and created a cloud of uncertainty that has dampened business confidence and investment.
Also, global growth has been sluggish and the effects of the Trump-led federal tax cuts and spending increases are fading.
“It’s a story about a slowing economy,” Song said in an interview.
He notes that average earnings for workers who don't supervise others – everyone from factory employees to waiters and accountants – at least have held up, increasing 3.5% annually in October. That matches the post-recession high notched for all of 2018, but pay increases haven't climbed above that.
Meanwhile, supervisors’ yearly wage increases dropped to 1.8% in October and 2.2% on average this year, down from an average of 3% in 2018, according to Song’s analysis of Labor data. Managers’ pay includes incentive bonuses for meeting sales targets, Song says. Those, he says, have decreased – both because of a sputtering economy that has crimped corporate revenue and trade-related uncertainty that may have prompted firms to do away with some bonuses this year.
Less demand for workers
Besides hurting company sales, the slowing economy means there’s less need for businesses to hire workers. Employers posted 7 million job openings in September. That’s still historically high but it’s down from a record 7.6 million in November 2018.
“The impact of the slower global economy and the trade war has slowed demand for workers this year,” says economist Sophia Koropeckyj of Moody’s Analytics. That means employers can offer more modest wage increases to attract and keep employees. Average monthly job growth has fallen to 167,000 so far this year from 223,000 in 2018.
The unemployment rate is one measure of the supply of workers available to employers, but it doesn’t tell the whole story. Since the Great Recession of 2007-09, for example, many Americans have been working part-time even though they want full-time jobs. While the number of those workers has been falling, the decline has slowed the past year and the 4.4 million “involuntary part-time workers” remains higher than prerecession levels.
That provides employers a surplus labor supply, allowing them to convert part-timers to full-time status and tempering average wage increases.
Also, 63.3% of Americans were working or looking for jobs last month, up from 62.9% a year earlier and the highest since 2013. That bigger pool of workers similarly lets businesses dole out more measured pay increases.
Weak productivity growth
To bump up pay hikes, employers typically need to see healthy gains in productivity, or output per worker. As each worker produces more, a company’s revenue increasingly outpaces its labor costs, leaving it more money to pay its workers. But productivity growth has averaged just 1% annually during the 10 years since the recession, half the rate of the prior decade.
Although productivity growth picked up the first half of 2019, Oxford Economics largely credits the federal tax cuts and spending increases, which juiced economic output in the short-term. Productivity dipped in the third quarter for the first time in four years. To notch a more sustainable pick-up, companies must invest in labor-saving technology. Yet business investment in equipment such as computers and factory machines generally has been modest since early 2018.
While strong wage growth often ignites inflation, pay increases also respond to inflation.
“If inflation is rising, people are demanding higher wages” so they can afford more expensive products and services, Koropeckyj says. “But inflation has declined and so workers can’t make that case.”
After topping out at 2.9% in July 2018, the yearly increase in the consumer price index has been falling and clocked just 1.8% in October. Reasons for muted inflation include discounted online shopping, the more globally-connected economy and expectations of low price increases that become ingrained in retailers and employers, Koropeckyj says.
The retreat in price increases means that inflation-adjusted wage increases actually have picked up – to 1.4% annually in the third quarter from 0.37% during the same period a year ago, according to a Moody's analysis of Labor figures.
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Soft manufacturing wage increases
The trade war and slowing global economy have clobbered manufacturers even while the service sector has held its own. As a result, manufacturing wages grew just 2% last year, compared with 3.3% for all industries. The pace has picked up this year but from a low base.
Although factory employment makes up only 8.4% of all jobs, it can have an outsize effect on average U.S. pay because manufacturing workers earn higher salaries, says Joseph LaVorgna, chief economist for the Americas at research firm Natixis.
A pullback after the tax cut
The sweeping tax cut led many companies to share their tax savings with workers through higher pay or bonuses. That likely inflated wage growth in 2018, leading to a natural pullback this year, Song says.
So what's the prospect for faster wage gains?
Koropeckyj predicts steady increases of about 3% unless unemployment starts rising, as she forecasts by late next year. At that point, she expects pay to climb more slowly.
Song is more sanguine. He believes unemployment will continue to remain low, supporting solid pay hikes. And if the U.S. and China reach a trade deal that removes some existing tariffs and addresses issues such as China’s theft of U.S. intellectual property, that could ease business uncertainty and jolt wage growth, he says. Both sides say they're close to a Phase I deal, but details are in flux.
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