Recent U.S. Wage Gains Are Not A Source Of Inflation
The upswing in U.S. wages is now catching the attention of inflation vigilantes. Inflation hawks point to data, presented in Chart 1, as a source of inflation that is on the verge of accelerating. They point to the steady decline in the unemployment rate and the tightening labour market conditions as the reasons behind the recent increase in nominal wages. The crossover of these two variables --- the unemployment rate and wage gains-- signal that the Federal Reserve must turn its attention towards a faster return to “normalization “of interest rates to head off a real problem in the not too distant future. The Fed must not get behind the curve is a familiar refrain.
Chart 1 U.S. Unemployment Rate and Nominal Wage Gains.
In defending a gradualist approach to rate increases, Fed Chairperson, Janet Yellen, claims that wages have risen “only modestly”, in a speech on January 19th. She continued to argue that economic expansion “seems unlikely to pick up markedly in the near term” and that many sectors are operating well below capacity. She feels comfortable that the Fed is on top of the inflation issue, not behind the curve. Let us consider whether her comfort level is justified.
Unit Labour Costs (ULC) is the best way to measure the staffing cost facing each firm. Numerically, it represents the hourly cost in wages against the hourly worker output, i.e. productivity. For the first three quarters of 2016, ULC increased at 1.5 per cent, essentially in line with the PCE index. Thus, real wages have essentially been flat for 2016. Nominal wage increases are not a source of concern.
Chart 2 Unit Labor Costs in United States
Another way to examine this whole issue is to look at the relationship between wages and productivity growth. Chart 3 maps out the growing gap between overall productivity growth and the pay of the vast majority of workers. Essentially most of the productivity growth did not flow to workers, but remained with the corporations in the form of greater profits. This divergence of pay and productivity has meant that there is considerable room for higher pay levels without generating inflation.
Chart 3 Average Real Wages and Productivity
Since increases in average wages lag the growth in labor productivity, workers have experienced a declining share of national income. In fact labour’s share of national income has steadily fallen from 70 per cent in 2000 to 63 per cent in 2015. It seems that the distribution of national income will likely remain unchanged.
Wages have been held in check for many reasons that have become all too familiar: the spread of globalization; the decline in union bargaining power; the rise of e-commerce; automation; and other technological changes. Despite the political rhetoric of the day, globalization and technological change are going to continue to keep the pressure on wage levels and, in turn, on the rate of inflation.