Market Bulletin August 21, 2015 The wage puzzle In brief Structural, not cyclical, factors are largely responsible for the lack of wage growth in recent years. These factors such as the retirement of baby boomers, the continued fall in union membership, growth in part-time workers and a slowdown in productivity cannot easily be fixed by monetary or fiscal stimulus. U.S. wage growth has also failed to respond to falling unemployment due to temporary forces, such as the plunge in inflation and pessimistic attitudes on the economy, which should fade in the months ahead. As these influences wane and as the unemployment rate continues to decline, wages should move higher. The lack of wage growth does not appear to justify the Federal Reserve s (Fed) near-zero interest rate policy. We expect the Fed will, in the absence of further shocks, initiate the first rate hike in more than nine years in September. Dr. David P. Kelly, CFA Chief Global Strategist Abigail B. Dwyer Market Analyst U.S. wages A failure to launch The July U.S. jobs report was solid and largely in line with expectations. Yet despite a steadily improving job market, both labor force growth and wage growth remained weak. We have argued in the past that most of the labor force problem is structural rather than cyclical. That is to say, it is largely due to the retirement of baby boomers, a surge in disability benefits and a growing number of Americans who are essentially excluded from the job market due to prior felony convictions, educational deficiencies and issues with addiction. All of these are important issues and deserve the government s urgent attention, but, unlike a general lack of economic demand, they cannot be fixed by monetary or fiscal stimulus.
Wage growth also remains very weak with wages of production and non-supervisory workers up just 0.1% in July compared to June, and up just 1.8% year-overyear. This is remarkably different from the last three economic expansions. The July jobs report showed only a marginal drop in the unemployment rate from 5.28% to 5.26%. However, the last three times the unemployment rate hit 5.3% on the way down, wage growth was much stronger, achieving year-over-year gains of 3.3% in November 1988, 3.4% in June 1996 and 2.6% in January 2005 (Exhibit 1). Wages have failed to respond to falling unemployment EXHIBIT 1: UNEMPLOYMENT AND WAGES, SEASONALLY ADJUSTED 12% 10% 8% 6% 4% 2% 50-yr. average: 4.3% Unemployment Wage growth 50-yr. average: 6.1% Oct. 2009: 10.0% Jul. 2015: 5.3% Jul. 2015: 1.8% % '65 '70 '75 '85 '95 '05 '15 The chart above and the charts, graphs and tables herein are for illustrative purposes only. So why are wages so weak this time around? Statistical analysis suggests that, as in the case of labor force participation, the problems are largely structural or due to factors that are mostly independent of demand in the economy. This is important because, if the Federal Reserve recognizes this, it may well decide that the lack of wage growth is not a sufficient reason to maintain a zero interest rate policy and thus begin a very long-awaited monetary tightening in September. THE RETIREMENT OF HIGH-PAID WORKERS Generally speaking, older workers get paid more than younger workers. While the government does not publish a statistic on the median age of workers, it does publish employment by age cohort (Exhibit 2). From this, we can estimate a median worker age (Exhibit 3). The estimated median age rose from 37.9 years in January 1980 to 42.5 years in December 2009, or 4.6 years in total, and from December 2009 to July 2015, it rose to 43.0 years or only half a year. The earlier aging of the workforce was due to the aging of the baby boomers and its sudden slowdown in this decade reflects the first wave of baby boomer retirements. Wages rise with age and experience EXHIBIT 2: AGE DISTRIBUTION OF EMPLOYMENT, HOURS AND EARNINGS Age Employed % Average weekly Average workweek Average hourly cohort population Employed earnings hours earnings 16-19 4,666 3.1% $ 376 27.5 $ 13.7 20-24 14,043 9.4% $ 489 35.4 $ 13.8 25-34 32,652 21.9% $ 721 40.7 $ 17.7 35-44 31,261 21.0% $ 896 41.4 $ 21.6 45-54 32,574 21.9% $ 925 39.9 $ 23.2 55-64 25,138 16.9% $ 925 39.3 $ 23.5 65+ 8,492 5.7% $ 883 31.3 $ 20.3 2 THE WAGE PUZZLE
The median age increase has stalled in recent years EXHIBIT 3: EMPLOYED POPULATION-WEIGHTED MEDIAN AGE 43.5 42.5 41.5 40.5 39.5 38.5 37.5 36.5 Jan. 1980: 37.9 Jul. 2015: 43.0 A slower aging workforce implies slower growing wages EXHIBIT 4: CONSTANT DOLLAR IMPACT OF CHANGE IN AGE ON COMPOSITION OF WAGE RATES 20.6 20.4 20.2 20.0 19.8 19.6 19.4 19.2 19.0 Jan. 1980: $19.24 Jul. 2015: $20.37 So what has this done to wages? Again, the government doesn t make this particularly easy to estimate as it publishes only weekly, rather than hourly, earnings by detailed age cohort. Nevertheless, using some data from the Current Population Survey and some from the American Use of Time Survey for 2014, we are able to estimate average workweeks and thus average hourly earnings by age cohort which are also shown in Exhibit 2. From this, holding wage rates by age cohort at constant July 2015 levels, we can estimate the impact of the change in the age structure on wages in America over the past 35 years, illustrated in Exhibits 4 and 5. Overall, it appears that shifts in the age mix of workers added roughly 0.19% to yearover-year wage gains from 1981 to the end of 2010 and have subtracted roughly 0.06% from year-over-year wage gains since then. The age mix is now detracting from year-over-year wage gains EXHIBIT 5: YEAR-OVER-YEAR % IMPACT OF CHANGE ON AVERAGE HOURLY EARNINGS 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% -0.1% -0.2% -0.3% 1981-2010 Avg.: 0.19% 2011-2015 Avg.: -0.06% 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 J.P. Morgan Asset Management 3
THE CONTINUED FALL IN UNION MEMBERSHIP Another smaller structural factor in holding down wage growth in recent years has likely been the demise of unions. History suggests that unions may be better at getting wage increases for their members than individual workers who negotiate on their own. As evidence, over the past five years, the employment cost index for wages of unionized workers rose 0.3% per year faster than for their non-union brethren. However, union membership has been in a steady decline in the private sector, representing 12.9% of workers in 1988, 10.2% in 1996, 7.8% in 2005 and just 6.6% last year (Exhibit 6). Workers have been losing bargaining power EXHIBIT 6: ANNUAL PRIVATE SECTOR UNION MEMBERSHIP, % OF EMPLOYED 18% 16% 14% MINIMUM WAGE STAGNATION In addition, the last rise in the federal minimum wage occurred over six years ago, on July 24, 2009, when the rate was raised to $7.25. While state minimums have risen since then, a population-weighted average of minimum wages across the 50 states has still grown far slower over the past six years than in recent decades (Exhibit 7). This factor should not be overstated since, according to the Bureau of Labor Statistics, fewer than 4.0% of hourly workers were paid at or below the federal minimum wage in 2014. However, increases in the minimum wage can also have an impact in boosting the incomes of workers at close to the minimum. Lack of minimum wage increases is hindering wage growth EXHIBIT 7: REAL FEDERAL AND STATE POPULATION-WEIGHTED MINIMUM WAGES $8.5 $8.0 $7.5 $7.0 Real weighted-average minimum wage 2014: $6.88 12% 10% 8% $6.5 $6.0 $5.5 2014: 6.6% $5.0 Real federal minimum wage 2014: $6.57 6% '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13 Source: BLS, J.P. Morgan Asset Management. Real wages are found by deflating minimum wage by year-over-year CPI. Data are as of August 1 Characteristics of Minimum Wage Workers, BLS Reports number 1054, April 2015. 4 THE WAGE PUZZLE
MORE WORKERS ON PART-TIME HOURS One other structural factor suppressing wage growth may be the expansion of the number of workers working in a part-time capacity (Exhibit 8). Some of this is due to the changing nature of work and households. The growth in benefit costs for full-time workers, which has led many employers to expand part-time hiring, particularly in the retail, food services and hospitality industries, has also contributed. While part-time hours may suit many employers and some employees, the reality is that in the first quarter of 2015, part-time workers were receiving only 51.0% of the wages of full-time workers and wages for parttime workers had risen at an annualized rate of 1.0% over the prior five years compared to 2.7% in the case of full-time workers. More workers are working part time EXHIBIT 8: PART-TIME WORKERS AS A % OF EMPLOYED POPULATION 18.5% 18.0% 17.5% 17.0% 16.5% 16.0% 15.5% 15.0% Average: 16.6% Jul. 2015: 16.7% A LACK OF HEADLINE INFLATION To this point, all of the factors we have mentioned have been structural. The current rate of inflation, by contrast, is a hybrid from the perspective of the business cycle. It is low, which is partly due to a lack of wage pressures and some remaining slack in the economy. In addition, the low inflation rate reflects global commodity prices, which are clearly being determined by more than the U.S. cycle. Statistical evidence suggests that the headline rate of inflation is important in determining wages since many employers regard wage increases as essentially cost-of-living adjustments. If inflation is low, businesses feel more justified in denying wage increases and workers feel less justified in demanding them. In fact, since 2002, statistical analysis suggests that a one percentage point increase in year-over-year CPI headline inflation has been associated with a 0.17% increase in annualized average hourly earnings. As a result, the collapse in year-on-year CPI inflation from 2.0% in July 2014 to a 0.2% in July 2015 (reflecting the plunge in oil prices) may have reduced the year-over-year growth in average hourly earnings by 0.3% (Exhibit 9). Low inflation has reduced the urgent need for wage hikes EXHIBIT 9: HEADLINE CPI, % CHANGE VS. PRIOR YEAR, SEASONALLY ADJUSTED 16% 14% 12% 10% 8% 6% 4% 2% % -2% -4% Jul. 2015: 0.2% Source: BLS, FactSet, J.P. Morgan Asset Management. Data are as of August J.P. Morgan Asset Management 5
A LACK OF PRODUCTIVITY One other part-cyclical/part-structural reason for a lack of wage growth is very weak productivity growth over the past decade (Exhibit 10). This likely reflects slow economic growth overall, but it may also be due to a slowdown in the growth of investment spending (since it is hard for workers to be more productive without more and better equipment). It may also reflect the continuing transition of the economy from manufacturing to services. Whatever the reason for lower productivity, it could be that cost-conscious firms are reluctant to grant pay increases to workers when productivity growth is slow. Consequently, as is also shown in the exhibit, there appears to be a significant correlation between the slowdown in productivity growth and the slowdown in real wage growth in recent years. Low productivity growth hasn t justified wage hikes EXHIBIT 10: REAL WAGE GROWTH AND PRODUCTIVITY, % CHANGE VS. PRIOR YEAR 12% 10% 8% 6% 4% 2% % -2% -4% -6% -8% Real wage growth Sources: BLS, J.P. Morgan Asset Management. Real wage growth is calculated as % change in average hourly earnings less % change in headline CPI. Data are as of August ATTITUDES ABOUT THE ECONOMY Productivity Another hybrid explanation for low wage growth is the fact that attitudes about the job market rather than raw job market statistics, may be more important in determining wage gains. Every month as part of a survey on consumer confidence, the Conference Board asks consumers whether jobs are plentiful or hard to get in their local area (Exhibit 11). A diffusion index based on the answers to this question is actually more predictive of wages than the measured unemployment rate itself. Consequently, it may well be that a continuation of a recession narrative long into the expansion, by Federal Reserve officials as much as by anyone else, may have convinced both workers and employers that it wasn t yet time for a pay increase. Pessimism regarding the job market is stalling pay increases EXHIBIT 11: UNEMPLOYMENT AND JOBS PLENTIFUL DIFFUSION INDEX 165 145 125 105 85 65 45 Jobs hard to get - jobs plentiful diffusion index Unemployment Sources: BLS, Conference Board, J.P. Morgan Asset Management. Data are as of August 11% 9% Overall, this analysis suggests that wage gains probably will increase in the months ahead for cyclical reasons as the unemployment rate falls further, more part-time workers find full-time jobs and attitudes about the economy improve. In addition, as oil prices stabilize or rise, headline inflation should rise, providing a further boost to wages. However, any residual weakness in wages is likely due to structural factors rather than cyclical weakness and hardly justifies the maintenance of the easiest monetary policy in a century in a fundamentally healthy economy. 7% 5% 3% 1% 6 THE WAGE PUZZLE
CONCLUSION There is no doubt that the lack of wage growth in recent years has been both puzzling and disappointing. Many have suggested that it points to continued slack in the labor market. However, a closer analysis of labor market trends suggests that wage weakness is largely due to structural changes in labor force demographics, the decline of unions, an increase in part-time work and stagnating productivity. These structural problems cannot easily be fixed by monetary or fiscal stimulus. In addition, there are temporary forces such as the plunge in year-over-year CPI inflation and unreasonably pessimistic attitudes on the economy that should fade in the months ahead and this, combined with a continued decline in the unemployment rate, should push wage growth higher. While wage growth is far from posing an imminent threat of inflation, the lack of wage growth in recent months does not appear to justify a continuation of the easiest monetary policy in the past century. This being the case, we believe the Federal Reserve should, in the absence of further shocks, initiate the first rate hike in more than nine years when its Open Market Committee meets in September. J.P. Morgan Asset Management 7
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