Once again on rigid wages

from David Ruccio

source*

Mainstream economists continued to be mystified by the fact that, even as the official unemployment rate has decreased, workers continue to get the same wages as before. That is, nominal wages for many workers in the United States simply aren’t increasing—that is, they are “upwardly rigid.” 

The question is, why? The best mainstream economists (like Mary C. Daly and Bart Hobijn) can come up with is “pent-up wage cuts.”

Downward rigidities prevent businesses from reducing wages as much as they would like following a negative shock to the economy. This keeps wages from falling, but it also further reduces the demand for workers, contributing to the rise in unemployment. Accordingly, the higher wages come with more unemployment than would occur if wages were flexible and could be fully reduced.

As the economy recovers, the situation reverses and the pressure to cut wages dissipates. However, the accumulated stockpile of pent-up wage cuts remains and must be worked off to put the labor market back in balance. In response, businesses hold back wage increases and wait for inflation and productivity growth to bring wages closer to their desired level. Since it takes some time to fully exhaust the pool of wage cuts, wage growth remains low even as the economy expands and the unemployment rate declines.

Ah, if only the labor market were like the market for oranges!

The fact is, during the downturn, employers respond to slack demand not by lowering nominal wages (hence the “downward rigidities” mainstream economists so deplore), but by firing workers, replacing full-time workers with part-time workers, and increasing productivity (which mainstream economists can only celebrate). The result is a growth in the Industrial Reserve Army (as we can in the dramatic growth in the so-called U6 unemployment rate).**

That pool of unemployed and underemployed workers (plus the availability of workers abroad, in China and elsewhere, together with the low level of unionization and the introduction of new, labor-displacing technologies) serves to regulate the level of wages: keeping nominal wages from rising even as economic growth picks up. In other words, employers don’t need to increase wages, either to keep their existing workers or to hire new ones. There are so many members of the Reserve Army of Unemployed and Underemployed workers willing to take whatever jobs are available that employers simply don’t need to increase wages.

That’s where the blame should be placed—not on”pent-up wage cuts,” but on employers who are unwilling to increase wages, even as their profits reach new record highs.

 

*This is a histogram of reported wage changes over the past year for U.S. workers who have not changed jobs throughout the year. This histogram (calculated by the Federal Reserve Board of San Francisco) is overlaid with a normal distribution centered at the median reported wage change.

**The U6 unemployment rate counts not only people without work seeking full-time employment (the more familiar U3 rate), but also counts “marginally attached workers and those working part-time for economic reasons