Growth in America
Unless wages grow, America’s economic blip could become a trend
Apr 11th 2015
THE people of Royersford are feeling pinched. In the Main Street Café, in the town centre, a man complains that his pension payments will soon be frozen. Sheena, a waitress, says business is brisk, but rues the “teeny tiny” pay rises she and her friends have received. The worries of those in this Pennsylvanian borough are familiar across America. Although it has chugged along far better than other rich countries, the world’s largest economy still fails to instil confidence in its workers. Add to this sour economic data from the beginning of 2015, and some question the strength of the American recovery. Wages hold the answer.
GDP is made up of four things: government expenditure, net exports, investment and consumer spending. One component, government largesse, is doing better. After years of weighing on growth, higher spending is now helping the economy.
The other components tell another story. Start with exports (see chart 1). On a trade-weighted basis, the dollar has appreciated by 13% in the last year. America is not especially exposed to the vagaries of international trade—exports of goods and services equal just 14% of GDP, compared with 26% for the euro zone. But the dollar’s recent rise, which makes American products less competitive on world markets, has been so dramatic that problems are emerging.
Paul Ashworth of Capital Economics, a consultancy, is expecting a 14% annualised, inflation-adjusted decline in exports over the first quarter of this year. With the euro zone expected to grow by just 1.4% this year, and the Canadian economy also slowing, demand for American wares from important trading partners threatens to be lacklustre.
Businesses are already feeling the pain. A third of the sales of companies in the S&P 500 index come from abroad. Corporate profits fell by 1.6% in the fourth quarter of 2014 and were 6.4% lower than in the same quarter of 2013. As profits have been squeezed, so investment, the third component of GDP, has stalled.
Figures released at the end of March show that orders for “durable” goods—things that last a long time, like industrial machinery—dropped by 1.4% in the previous month. “Core” orders of durable goods (which exclude transportation equipment) have fallen every month since October. And with the oil-price slump, spending on energy projects has crashed. Declining investment in mining will wipe 0.8 percentage points from GDP growth in the first quarter, say researchers at Capital Economics. Steven Ricchiuto of Mizuho Securities, an investment bank, expects corporate investment to drop: “Companies are not in a mood to add to capital stock.”
All this sounds bad. However, the American economy lives or dies by what happens to consumer spending, which makes up the lion’s share of GDP. If buoyant, it could prevent the economic blip from turning into something more serious. Economists had expected strong consumption growth in 2015: Americans have seen a windfall from a halving of the price of oil and outstanding consumer credit has grown for 42 straight months. Despite that, consumption growth has slipped.
Unusually bad weather earlier this year partly explains what is going on. A freezing winter forced Americans to stay indoors instead of going to the shops. But the biggest thing working against stronger and more sustainable consumption growth is pay. In Royersford’s part of Pennsylvania, real hourly earnings fell by 1% last year. Down the road from the café (and past a few vacant lots) in Sweet Ashley’s Chocolate, the shop’s owner says that she would like to hire, but can only afford to pay the minimum wage. One of her friends has three jobs, one of them full-time, to make ends meet. Across America, median inflation-adjusted wages are no higher today than they were when the financial crisis hit (see chart 2).
Economists struggle to explain why wages have not taken off. The most recent jobs report, for March, was muted, but that served to highlight just how robust the data have been over the past two years. The unemployment rate stands at 5.5%, below its historical average. Economists expect that wages should rise faster in such circumstances, since employers have to compete for workers. A research paper from the Federal Reserve Bank of Chicago estimates that, if real wage growth had followed its historical relationship with the unemployment rate, by mid-2014 it would have been 3.6 percentage points higher than it actually was. Three big things, though, have held back pay: changes to America’s unemployment-insurance system, the behaviour of firms, and the persistence of labour-market “slack”.
America’s unemployment-insurance system underwent a big change at the end of 2013. Before then, the average American could get 53 weeks’ worth of unemployment benefits; in three states they could get 73 weeks’ worth. Congress then decided to make benefits stingier: the average limit dived to 25 weeks, cutting off 1.3m Americans immediately. With nothing to fall back on, the wage expectations of many unemployed people fell, says Iourii Manovskii of the University of Pennsylvania. Employers in some sectors quickly took advantage of this newly cheap pool of workers. A big chunk of the 3m extra jobs created during 2014 were in poorly paid industries (see chart 3).
Even firms in typically well-paying sectors are being tight-fisted with their workers. A recent paper by Mary Daly and Bart Hobijn, both of the Federal Reserve Bank of San Francisco, looks at the problem of “nominal-wage rigidity”. The paper argues that when the financial crisis hit, employers found it difficult to reduce the cash value of the wages paid to their staff.
(Foisting a pay cut on your entire workforce hardly boosts morale.) Inflation was too low to take a big bite out of real wages by keeping nominal wages flat. Instead, employers fired their least productive workers, keeping the best ones happy. That helps to explain why, counterintuitively, median wages did well even as unemployment shot up. Now, to compensate for the high wages paid to those staff that got through the recession, firms are willing to offer new recruits only low wages. The survivors do not see raises, either.
reasons” (PTER)—fell much more slowly than the official unemployment rate following the recession (see chart 4). The same goes for “discouraged” workers, those who want a job but say that there is no point in looking. Though few in number, their involvement—or not—in the labour market can sway wages. Both measures have fallen since the recession ended, but are still much higher than before the crisis.
According to a Chicago Fed paper, the PTER rate is a particularly important determinant of wage levels. It finds that a 1% increase in the PTER rate is associated with a 0.4% fall in real wage growth, even after controlling for the effects of other measures of unemployment. The impact is especially strong for worse-off workers. David Blanchflower of Dartmouth College and Andrew Levin of the IMF found similar results in a paper published in March. When the PTER rate is high, workers may feel unable to ask for higher wages, since what they really want is more hours. Nervousness about asking for more pay may ripple through the labour market, says Daniel Aaronson of the Chicago Fed.
Economists also debate the effect of America’s “participation rate”, defined as the number of people in work or actively looking for jobs as a proportion of the population over 16. Now at 62.7%, it has been falling for over a decade. It is 3 percentage points lower than in mid-2009.
Some economists argue that a low participation rate is bad for wages. A pool of idle workers, though not officially looking for jobs, stops those in work from pushing for better pay, since they are worried that their employers will replace them. And if wages do rise, those out of the labour force can simply rejoin it, pushing them back down. However, this assumes that low labour-force participation is down to economic conditions. A paper by the Brookings Institution, a think-tank, disputes this. It posits that the falling participation rate among working-age people mainly reflects structural factors, such as technological changes that push some workers out of the labour market permanently.
The Brookings research also tackles the question of why the participation rate fell so sharply around 2007-08. The recession had an impact, but demographic factors may have been more important. About that time, the first baby-boomers turned 62, the minimum age to receive retirement benefits.
Using similar reasoning, the paper suggests that the participation rate will fall further in coming years. If its explanation is right, then as the economy improves wages should grow, since there will be fewer workers willing to be sucked back in to the labour force.
If so, the latest data suggest pay could be about to take off. One survey found that 70% of American companies expected to increase wages by at least 3% in the year from March. Pay rises are hitting the headlines: McDonald’s boosted the wages of its burger-flippers on April 1st.
Where big business leads, others will follow. The boss of Comfort Keepers, a social-care provider a short drive from Royersford, notes employees at Walmart, a supermarket, are getting a pay rise, a move he may be forced to emulate. David Doyle of Macquarie, a bank, says that the change in average hourly earnings of private-sector workers during the first quarter of this year was the fastest since the recession. If healthier wage data keep coming, interest-rate rises from the Federal Reserve will soon follow. That would suggest that America’s economy, despite the blip, is on the way back to normal.