Wages Aren’t Nudging, Much Less Pushing

For economists, debating whether wage growth causes inflation, or inflation causes wage growth is much like asking what came first, the chicken or the egg.

While there is variation from industry to industry, on average here in the US, labor costs (wages) account for about 40 percent of total business costs. When labor becomes more expensive, businesses push those higher costs through to consumers, resulting in higher prices and wage-push inflation. An excellent example of that phenomenon was the rising cost of American automobiles as labor unions successfully pushed for higher wages in the 1970s and 80s. But where the idea of wage-push inflation falls down is the timing of when most wage increases occur and what happens when they do.

According to the most recently released data, average hourly wages for American workers held steady at $24.31 last month and have increased just 1.9 percent over the previous year. After adjusting for inflation, real wages are up by just 0.5 percent over the same period.

The primary reason for the sluggish growth is the fact that while the US unemployment rate is falling – it has declined from a high of 10 percent in October 2009 to its current level of 6.3 percent – most of that decline is due to workers dropping out of the labor force rather than finding new jobs. As a result, there is still a lot of slack in the labor market with the U6 measure, which includes disaffected workers, currently at 12.3 percent.

Wage growth typically doesn’t occur until the labor force is tight enough that employers must begin offering higher wages to attract and retain qualified workers. Historically, that has typically occurred when the headline unemployment rate reaches about 6 percent. However, we really don’t have much modern experience with the broader U6 rate being this high so, for now at least, it appears as though there are enough workers that can be lured back in to keep wages down. Hence, the tepid post-recession wage growth and the reason they aren’t likely to start a rapid upward spiral anytime soon.

In fact, wages are still down from the end of 2008 and are essentially flat over the past decade. If you stretch the view out over an even longer term, wages essentially peaked in 1973 on an inflation-adjusted basis. In the late 1960s the wage share of US national income was at 57 percent but has since fallen to 49 percent despite a five-fold increase in prices.

The case of American automobile workers is also an excellent example of why wage-push inflation isn’t usually a huge concern. What began happening in the 1980s? Americans started buying more foreign made automobiles, with import sales overtaking domestic auto sales for the first time in August 2007. In this era of globalization, consumers talk with their wallets and that played a large role forcing the government’s hand in bailing out the US automobile manufacturers.

So when it comes down to it, while wage growth does typically correlate with inflation, it usually isn’t a causative factor. Rather, wages tend to rise when the economy is already relatively healthy and you would expect inflation to pick up regardless, but wages are an excellent indicator of when we should start worrying even more about the coming inflation.