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Markets and Economy

What Drives Wages?

Some skeptics say wages are growing slower than expected in today’s tightening labor market—but who determines what’s expected? Commercial Banking’s Head Economist breaks down what drives wage growth and living standards, and why innovation eventually could boost worker productivity and wages.
November 16, 2018

With the unemployment rate currently around 3.7 percent and recent corporate tax cuts expected to help boost worker pay, some skeptics say wages are growing slower than expected. This expectation is likely driven by memories of the past, which are not the best reference point.

In the past, wages grew faster partly because inflation was higher than it is today. Unions often negotiated packages that were out of line with fundamentals and proved to be inflationary—when companies had greater market share, they could raise prices to recoup the cost of collective bargaining agreements. But today’s marketplace is a lot more competitive, thanks to waves of deregulation from the mid-1970s to the mid-’80s. As a result, businesses today have to be more disciplined in managing costs and profitability.

That provides a roadmap for what could be considered normal wage behavior. In a stable inflation environment, real wages would generally be expected to rise in line with the growth of labor productivity. Hourly compensation today is rising almost 3 percent annually, 1 percentage point faster than inflation.

Ultimately, wages and living standards are driven by productivity, but this can be difficult to measure. Workdays invariably include some idle time or inefficiency. This has become a bigger challenge today, because digital technologies are blurring the boundaries between work and leisure. At the same time, productivity growth has been volatile. It was slow in the ’70s, fast in the late ’80s and ’90s, and has since slowed down again. These growth periods generally coincide with advancements in technology such as computers or the Internet.

Moving forward, productivity will likely continue to get a boost from new technologies. Automation will start taking the place of routine work through artificial intelligence, machine learning and new autonomous technologies. Employees will find more opportunities available to them, but they’ll need to develop new skills to achieve them. All of that will be challenging. But eventually, these productivity-enhancing technologies will help make each worker more productive—ultimately, boosting worker pay.

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