Sunday, April 27, 2014

Earnings: Why Low Inflation Might Not be a Bad Thing

Earnings play a special role in many debates, including conclusions drawn about income distribution. Recent studies have been published yet lead to more than one conclusion about income growth. This is because there is more than one way to measure income. Some data include government workers. Others don’t. Some data include employee benefits while others don’t. Some data include social benefits and taxes while others do not include these. Most studies look at households at a point in time. Other longitudinal studies trace households over time. So it is pretty clear that depending on the income indicator you choose, you can come away with some very different conclusions about who earns what.

Today I want to focus on a popular indicator published regularly by the US Bureau of Labor Statistics (  ) – Average Hourly and Weekly Earnings of all employees on private non-farm payrolls. These earnings include wages, salaries, and benefits of workers – workers in what we generally consider to be the business sector of the county. It does not include workers in government or on farms but it does encompass both manufacturing and services employees. How much do these workers earn in total? How much of those earnings are from company benefits like pensions and health insurance? How have these earnings changed over time? What implications can be drawn from past changes?

Two tables at the bottom show us changes in earnings during the 10 year period from 2003 to 2013. The first table shows the data in nominal terms. The second focuses on the buying power of these earnings by removing the impact of inflation on earnings. But before we get into all that – as of December 2013, earnings were:
            Wages and Salaries       $21.77 per hour
            Paid Leave                       2.21
            Supplemental pay              .77
            Insurance                        2.84
            Retirement & Savings      1.53
            Legally mandated
            (e.g Social security)         2.45
            Total Earnings           31.77 per hour
My post looks at a decade of changes in these earnings per hour figures. The tables below divide the changes in three time periods with respect to the last recession -- before, during, and after. Earnings in the private sector show that the recession hasn’t ended. In real terms, total earnings have been stagnant during the recovery while wage and salary income per hour has declined. The leading component of earnings is health benefits. Is this stagnancy the result of the recession or other longer-term factors?

Surprising is that not much has changed in the buying power of earnings in the private sector. While it is true that in terms of nominal value earnings took a hit in the recession – so did prices and therefore the post 2007 time period does not look much different than the booming period that came before it. Real wages and salaries declined by about 1% per year during the strong growth years before the recession and continued that pace in the 6 years thereafter. So even when things seemed to be good for labor – they weren’t.

The only part of earnings that differs from this static pattern is health-related benefits. While total benefits were growing at 0.3% before the recession, real health-related benefits were growing by eight times that much or 2.4% per year. After the onset of the recession total benefits grew by a little less than 0.2% per year while health-related benefits were increasing by almost 2% per year. The recession did not slow the pace of health benefits.

The economy was blazing before the recession. On April 1, 2007 the unemployment rate bottomed at 4.5%. It previously peaked at 6.1% in 2003. The 4.5% shows that despite many adverse long-run trends, the US economy was capable of creating jobs. As recently as 2007, there was little national priority or serious concern about the employment effects of globalization, industrialization, and demographics. It was all about the economy stupid! From 2003 to 2007, the annual growth rate of the economy averaged more than 3 percent per year. Similarly from 1992 to 2000, the US economy grew rapidly and the unemployment rate fell to 3.8% in April of 2000.

The key takeaway is that we always have long- and medium-term headwinds – but the key driver of unemployment in the USA has for a long time been the strength of the economy – economic growth. And the same goes for earnings in the private sector. Since 1986, the growth of earnings has been essentially trendless with an average growth of about 3% per year for almost 30 years. Earnings growth picked up to almost 4% per year when the economy was growing rapidly –at the end of the 1980s, end of the 1990s, and around 2007. Earnings then slowed considerably during slow growth periods and recessions – falling below 3% growth in the early 1990s, early 2000s and then more recently.

As our data below shows, employment has been slow to resume growth and with that has come subpar improvements in earnings.  The reason is that this recovery has had strikingly anemic economic growth. The past data suggests that once economic growth returns to normal, so will employment and earnings. So while raising the minimum wage sounds hopeful the truth is that this will have little impact on earnings or economic growth. What we really need is a pro-growth economy hitting on all cylinders.

But even growth won’t solve all earnings problems when measured in buying power. Real wages have barely budged in the last 30 years. The problem in that regard is inflation. Since high employment and strong growth often bring higher inflation – a higher earning does not necessarily buy more.  Between 1980 and 2013 earnings grew by 194%. Prices as measured by the CPI grew by 183%. The Fed says they are not worried about inflation in the US now. But it seems to me that stronger growth coupled with low inflation might be the best thing they could do for the average private sector worker. Unfortunately policy is not headed in that direction. The Fed seems to be saying that inflation is too low right now. We'd be better off if Janet Yellen took her foot off the pedal and allowed earnings to rise relative to inflation. 

Tables. Earnings in Private Industry
Average Annual Rates of Change, 2003 to 2013
Before, During, and After the Recession
In current Prices
                             03-07    07-09      09-13
W&S                     3.3          1.9          1.8
Non-Health          3.8          1.0          2.4
Health                  5.8          3.8          3.5
Total                    3.7          1.9          2.0
In Constant Prices**
                            03-07    07-09      09-13
W&S                   -0.1        0.4          -0.2
Non-Health          0.4        -0.5          0.4
Health                  2.4          2.3          1.5
Total                    0.3          0.4          0.0
**CPI                  3.4          1.5          2.0


  1. Dear LSD. I take from talking heads that generally upward pressure on labor costs is the primary cause of inflation (An assumption on their part or fact?)—relative to other costs; commodities, for example. And that as long as unemployment remains high (due to lack of yob creation) inflation is not a problem. If the labor cost pressure: inflation relationship is factually true then the govomit/Fed have an effective indicator of impending inflation such that it can pursue appropriate actions. Yea, like painting by the numbers . . . . .

    If labor cost pressures occur then one would have to conclude it results from supply and demand—that the rate of job creation outpaces the rate of labor supply depletion. A corollary then being that the economy is/could be hitting on all cylinders. But if the new jobs are low-paying (and/or part-time) those workers’ spending power will not have improved much since inflation might move up along with job creation/demand for labor—thus negating the benefits of higher wages. The key is creating good-paying yobs, but we know that neither the Fed nor Obummer and his not-so-magic-yob-creating-laser can do that. It seems the plight of the average worker’s spending/buying power will remain a plight.

    “ . . . . stronger growth coupled with low inflation might be the best thing they could do for the average private sector worker.” They (folks newly in office after Nov. ’14) need to focus not only on growth but the right growth. But, since we’ve vigorously chewed this issue before, we know that higher wages/wealth creation (and therefore buying/spending power) are positively correlated to edukation—a longer-term proposition. Seems the plight of the average worker will be a long-term blight.

    Wish I had time to say more, but gotta go—there’s a fish sandwich and cold beer beckoning from south Florida.

  2. Charles, I hope to buy you a beer in Florida. Labor costs are generally what I would call an intermediate variable. They don't usually cause much of anything -- except to be part of a chain reaction. So I wouldn't usually say that wage costs cause inflation. Inflation (and wage cost) is caused by excess demand for goods and services -- and permanent changes in that are usually the result of errant monetary and fiscal policy. When I talk about policies that raise growth but not inflation -- that would have to be something in the area of supply-side policy. One purpose of this post is to dispel the notion of crappy jobs. If we got growth without higher inflation the average worker's wages would rise -- just as they did in the last 50 years. Growth is the obvious answer but unfortunately our government is filled with too many politicians who cater to extremist myths.