The unemployment rate in the US has dropped from a high of 10.0% in October, 2009, to its current rate of 4.1% for November, 2017. Over that time frame, the economy created a total of more than 17 million jobs. There is no debating that on the basis of aggregate employment alone, the recovery from the Great Recession has been a healthy one. Yet at the same time all those jobs were created, wage growth barely budged. According to the Bureau of Labor Statistics, average hourly earnings have risen just 2.2% annually since October, 2009 – barely enough to cover inflation. In fact, if we adjust for inflation, average hourly earnings grew at a paltry rate of just 0.5% annually over that time frame.
A central tenant of economics is that as demand increases and supply decreases, prices will rise. This has really not happened in the labor market. In fact, the lack of wage inflation over the past several years has many economists questioning an economic concept called the “Phillips Curve.” The Phillips Curve says that there is an inverse relationship between unemployment and inflation. In other words, as the ranks of the unemployed successfully land jobs, employers will have to pay more to fill their openings. And as wages rise, more widespread inflationary pressures begin to take hold throughout the economy. Simple enough, right? So why isn’t it happening?
Source: Bureau of Labor Statistics
While we’ve read about a number of possible explanations for the lack of wage growth, here are the most credible:
- Despite the drop in the unemployment rate, a significant amount of slack remains in the labor market. The excess slack is perhaps best illustrated by the drop in the Labor Force Participation (LFP) rate. The LFP rate measures the ratio of people either working or actively seeking work as a percentage of the Civilian Non-Institutional Population (total population less those under age 16, those who live in institutions, and those who are active-duty military). The drop in the LFP rate from a high of over 67% in 1997-1998 to the current 62.7% coincides with an increase in the number of people “Not in Labor Force” of about 28 million over the same time frame. Why have folks left the labor force in droves? Is it the result of structural changes, such as baby boomers retiring, or is it due to cyclical factors, such as frustration over the inability to find an acceptable job? It seems likely that at least some of it is cyclical. If so, wages may not begin to rise in earnest until the number of those willing to re-enter the work force falls to a more normalized level.
- US workers are increasingly competing in a global marketplace. Indeed, the new presidential administration was elected, to a certain extent, on the promise of stopping the flow of US jobs to foreign countries with lower wages and less regulatory oversight. Mr. Trump has lamented the unfair advantage that countries like China have due to its massive pool of unskilled workers. More stringent trade agreements in the future could help keep jobs in the US, raising wages in the process. However, enacting more protectionist trade policies does not come without significant costs.
- Third, it is undoubtedly the case that technology is increasingly replacing unskilled workers. Jobs are being replaced by automation, and these jobs will not return even if the Trump administration stems the flow of outsourcing. The unfortunate truth is that we have not done an effective job of educating and training our work force for the jobs of tomorrow. As a result, many employers are having trouble finding prospective workers with the skills necessary to succeed. Therefore, many of the higher-paying job opportunities are not being filled.
- Workers have become less willing/able to move to where the jobs are. The Financial Crisis wiped out a lot of home equity and forced many low- to middle-income families to dip into savings in order to meet daily expenses. This is especially true in our industrial heartland – the Mid-West. As a result of the financial hit these families have taken, many are unable or unwilling to risk the lost income and expense associated with moving to areas with more abundant job opportunity.
- Unions are less influential than they have been in the past. It goes without saying that it is harder to demand wage concessions without the power of collective bargaining.
What do we think? We think that there are both structural and cyclical factors, including the above, which are increasing the bargaining power of US employers and decreasing the bargaining power of US workers. However, the Phillips Curve is not dead. Now that much of slack in the labor force has been reduced, we think it is more likely than not that wages will start to increase at a faster pace. However, we do not think we are on the precipice of runaway inflation, the likes of which many expect to result from the recently enacted tax reform bill. Some believe that lower corporate tax rates will, in short order, lead to more job growth and rapidly rising wages. We are not in that camp. We do believe that some minor portion of the corporate tax-cut windfall will find its way to workers over the near term. However, employers are not simply going to increase payrolls and raise wages simply because they receive a tax windfall. Remember, companies have been generating record profits and cash flow in recent years, yet they have instead used the profits to buy back stock, raise dividends and make acquisitions. The tax changes do not really change that calculus.
Consider the announcement by AT&T last week that it will give $1,000 bonuses to over 200,000 of its employees as a direct response to the tax cuts. Sounds great, right? It sounds great, that is, until you realize that the aggregate amount of the bonuses announced comes to $200 million, which is just 0.4% of the $48.5 billion in cash on AT&T’s balance sheet, just 1.5% of the nearly $13 billion that AT&T earned in 2016, and just 3% of AT&T’s income tax expense in 2016. What’s more, the bonuses are one-time in nature. But we’ve also received news that companies in other sectors are following suit, right? BB&T, PNC and Bank of America all announced bonuses, increases in minimum wage, philanthropic contributions, or some combination thereof. There is no doubt this is good news for those individuals and the economy at large. However, is there a reason that we are seeing so many banks making these announcements? Could it be that the regulatory authorities are currently in the process of rewriting banking regulations to make them less onerous?
From where I sit, the tax relief bill, which will add an estimated $1.4-$1.5 trillion to our deficits over the next 10 years (according to the Congressional Budget Office and the Joint Committee on Taxation), might have been better spent on investments in education and training for the jobs of tomorrow in industries like biotechnology, artificial intelligence and clean energy. We also need to make sizable investments in the things that will improve productivity over the long-term, like education & training, infrastructure, technology, and combating climate change and chronic health problems like the opioid crisis. Give a man a fish, he eats today. Teach a man to fish, and he eats for a lifetime. Corporate America, for its part, has shown a very limited willingness to make capital investments and boost wages over the past several years. Is it reasonable to expect them to do so now without meaningful improvements in demand for their products and services?
For now, the economic data continue to show improvement, and corporate earnings are rising. If recent corporate behavior is prologue, we expect to see additional share buybacks that could further elevate prices and valuations. Let’s count our blessings for now, but additional heavy lifting is required to increase economic growth to sustainably higher levels.