Tuesday, September 4, 2018

Wages, Employment and the Plow Horse Economy

Today's blog is about employment. For most of us, employment is a love/hate thing. No matter how exciting and challenging a job might be, there are days when you would prefer to pull the covers over your head and just chill as the alarm clock ticks on and on. But we know that if we do that every day, we might tire of watching Kelly Rippa and various other morning talk shows.

Work not only gets us out of the house, it gives us a paycheck. And that's the point of this exercise today. Last week I pondered why wages had been growing so slowing in the last decades especially when labor productivity was growing much faster. I was stumped. But then after a generous glass of JD, I got into a conversation with a neighbor and may have discovered at least one reason for the sad behavior of wages in the USA.

If productivity is rising, firms have more than one way to react to that happy outcome. They can enjoy the profits associated with the stronger productivity. Second, they can split the proceeds with their workers. Third, they can do neither and take the opportunity to exploit their new efficiencies by hiring more workers and beating the crap out of their competitors.

There are many factors that might cause firms to choose among those and other alternatives. Stockholders usually enjoy a nice dividend check, especially in January when they have to pay for the holidays. Workers just love a bonus or a pay increase. Honey, now we can afford the monthly payments on that new Lada SUV we always wanted.

What about the third choice? Why make existing workers and owners unhappy by hiring even more workers? One answer -- that came after the above mentioned JD (or two?) -- is that the choice may be affected by the firm's expectations about future economic growth.

We know that ever since the global recession of 2008-9, many people lost faith in the resiliency of the US economy. Some thought that the recession proved that capitalism had peaked. The rush to government control and regulation reinforced the idea that capitalism was breaking down. Even without such extreme beliefs, many simply saw reasons why economic growth might never return to those heydays when the economy could muster 3% or more growth each year.

Even in 2018, there are many dour forecasts that after a tax-induced sugar high, the economy will fall back into 2% growth. Imagine a mindset since 2001 that simply wasn't very sure that even moderate economic growth would return. Brian Westbury of First Trust named this situation the new Plow Horse Economy, with no intended insult to plow horses.

With such a dismal forecast, it might make sense for companies to do things that are reversible. They wanted to take advantage of the short-term strength of the economy, and they could do that by hiring more workers. When stagnation returned, they could reduce employment levels as necessary. They would not be stuck with higher permanent wages.

The behavior of wages and employment seem compatible with the above hypothesis. Last week I showed how average annual real earnings of the business sector barely rose in the years between 2001 and 2018. The graph below shows no similar phenomenon in hiring. The chart plots annual changes in employment (all employees of non-farm businesses) since 1939. The number 4,000 on the chart is in thousands so that represents a one-year increase of employment of 4 million workers. While that change didn't happen very often, we can use that as a benchmark for the largest one-year changes in employment.

We can also see that employment is banged around by recessions -- the vertical shaded areas. Ten times in the graph, employment declined from one year to the next. (An employment decline is a negative value on the chart.) Notice that employment dipped by 6 million workers in the latest recession.

The 2 million mark is interesting. Until 1965, the US economy did not have many years when employment increased by more than 2 million jobs. Between 1965 and 1998, it was common for the US economy to create more than 2 million jobs. The graph looks pretty messy right before and after the recession, but notice that in all 6 years (2012 to 2017) after the recession, the economy again produced more than 2 million jobs. 2018 will continue that record. The average change of those 7 years (2012 to 2018) will likely be around 2.54 million jobs per year.

It's interesting that the average increase in employment (leaving out the decreases in recessions) was about 2 million jobs from 1965 to 2001.

The point? A simple explanation for wage sluggishness might be companies preferring to weather the current economic environment by hiring workers rather than paying them more. But this could change. Wages have been responding to tighter labor markets in the last few years. But much depends on expectations about the future. Are we on a sugar high? Or will we return to historical economic growth? If and when expectations turn more positive, we should see those wages returning.


  1. What would be interesting to know is whether the make-up of the average annual new employment is changing such that the jobs being added are (1) low wage, (2) part-time, (3) limited hours to limit benefits, etc. Would seem to me that the characteristics of incremental employment would be more critical than just the addition of raw numbers of workers. As always, appreciate your efforts to enlighten!

    1. Thanks Ed. It makes sense that once labor is so scarce that much of the new labor would be used around the fringes. But clearly wages are beginning to rise and labor is getting more clout. We should be happy to have the employment gains. It sure beats the opposite.

  2. Seem the drop the most of all of the drops in proportion to the total. Much of that may have been do to the elimination of human jobs at a much higher rate since AI did not exist in any large way prior to 1995. also those added job's income did not change much over those years which in contrary to the standard labor model. Which in turn means the overall buying power was not as much and consumers are now turning to credit to pay for the basics. My home town has this problem with rent and mortgages being just slightly above the affordable level.

    1. I think you should try to see the part of the glass that is half-full. All of what you say is true but it is almost always possible to find weaknesses in even the best employment reports. And of course, not every town shares in the best times. I'd say Florida is more threatened by algae now than employment problems.

  3. Dear LSD. Yes, it’s quizzical that wages haven’t risen faster given the thousands of job openings unfulfilled. But it’s not that folks on the sidelines are waiting for higher wages to take the jobs; it’s that many don’t have the skills, experience, and education employers want. It’s not a matter of simple supply and demand—the quality of the supply isn’t there.

    I think your proposition that employers prefer adding labor as a variable cost rather than committing to higher wages for permanent employees makes sense—also given that some Fed members see the economy slowing to ≈ 2+%. It’s likely wages won’t increase markedly until the labor supply acquires the skills, experience, and education employers want. But until then hiring the less skilled/experienced/educated at the margins might be a practicable strategy in the short-term to meet demand. However (like on the other hand ), should economic growth continue to outpace 2-3+% the labor supply/demand doo-da likely will force wages up and unemployment further down—and employers will experience increased training/retraining costs in addition to higher wages—a double whammy sparking inflation.

    Anyhoo, I think you’ve set a nice table for subsequent blogs as the worm turns.

    1. Thanks Tuna. Blogspot seems to have fixed the comment function and I am now being notified when people and large fish leave comments. This wage thing is definitely going to be with us for a while. It is definitely a hard nut to crack. It is refreshing, however, to see slow wages gains associated with low unemployment. That is better than low wage gains and high unemployment! And as you say, there is some evidence that wage gains are improving.