The economy added 138,000 jobs in May, and while that total may have fallen short of expectations, it was sufficient to push the headline unemployment rate down to 4.25 percent, its lowest point since May 2001. Yet despite steady above-trend employment growth, wages have remained relatively stagnant, rising at only a 2.5 percent to 3 percent annualized pace over the past year.
Slow wage growth when the labor market is tight seems to defy the fundamental laws of supply and demand, but five key factors explain the current trend.
When the labor market tightens, competition among companies looking to hire typically accelerates wage growth. But the economy has yet to reach maximum sustainable employment, when an overly tight labor market will begin to generate inflationary pressure.
Full employment, or the non-accelerating inflationary rate of unemployment (NAIRU), isn’t fixed. It’s moved significantly lower as the economy matures and the workforce becomes more flexible. An unemployment rate between 5 percent and 6 percent accompanied inflation in the 1970s and 1980s. In the 1990s, unemployment fell close to 4 percent before the labor market truly began to tighten.
It’s possible that today’s labor market has become more efficient, and employers won’t feel the pinch from a scarcity of available workers until the unemployment rate pushes lower.
Because the official unemployment rate only counts people who are actively searching for a job, millions of discouraged workforce dropouts, students and involuntary part-time workers aren’t considered unemployed. A broader measure of unemployment shows the labor market has been working through a considerable amount of slack that isn’t reflected in the headline unemployment rate.
The labor market is rapidly returning to normal, but hidden unemployment has delayed its tightening and likely contributed to slow wage growth in recent months.
Benefits like health insurance and retirement contributions account for approximately 30 percent of total employee compensation. The cost of these non-monetary benefits has risen almost 4 percent over the past year, and this stealth pay raise has contributed to slow growth in take-home pay.
Worker productivity strongly influences pay trends—historically, wage growth has been strongest when unemployment is low and productivity is surging, like in the late 1990s. Throughout the recovery, official measures of worker productivity have been flat, and employers may not be able to raise wages when output per hour is only climbing at a 0.76 percent annualized pace.
Finally, it’s important to remember that paychecks are staying ahead of inflation. People who are nostalgic for the steady pay raises of the 1970s and 1980s have forgotten how quickly inflation began to erode the value of their higher wages.
When today’s tame inflation is taken into account, wage growth looks more respectable. Real wages rose at a respectable 2 percent annualized pace when inflation fell near zero after energy prices collapsed in 2015. Inflation has recently climbed back toward 2 percent, and wages should begin to accelerate accordingly.
The labor market is steadily moving toward full employment, placing wages on an upward trajectory. Several factors have combined to temper the rate of wage growth, but as the economy continues adding jobs and inflation normalizes, workers can expect their paychecks to grow more quickly in the near future.
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