Global: From Jobless to Wageless
Stephen Roach (New York)
Fully 39 months since the last recession ended in November 2001 and the American job machine finally seems to be back in gear. Hiring gains are still not spectacular when judged against earlier cycles, but as underscored by the 262,000 gain in nonfarm business payrolls in February, they have certainly been on the upswing over the past year. Unfortunately, the quality of hiring remains decidedly subpar -- dominated by those toiling at the low end of the pay spectrum. Moreover, an even bigger hole remains in the US labor market: Despite generally sharp increases in productivity since 1995, there has been no discernible pick-up in real wages. The character of America’s recovery has shifted from jobless to wageless -- with profound implications for both the economy and financial markets.
In the 12 months ending February 2005, US businesses added nearly 2.2 million workers to private nonfarm payrolls -- an average of 181,000 per month. Such vigor on the hiring front was last seen in the year of the Great Bubble -- specifically, back in September 2000, when the 12-month gain in private nonfarm payrolls was running at a 2.3 million clip. While recent job gains have been impressive, they have not exactly been concentrated in the cream of the occupational hierarchy. Industries leading the pack on the hiring front over the past year include (in descending order): administrative (temp-dominated) and waste services (385,000), health care and social assistance (332,000), construction and real estate (321,000), and restaurants (257,000). Collectively, these four industry groupings, which employed 36% of all US workers on private nonfarm payrolls a year ago, accounted for fully 60% of the total growth in private hiring over the most recent 12-month period. Apart from the obvious impact of the housing bubble on relatively high-wage employment in real-estate-related activity, the industry mix of the hiring dynamic remains skewed toward the lower end of the US pay structure.
That takes us to the missing link in the long and arduous healing of the US labor market -- the lack of any meaningful growth in real wages. Despite all the fanfare over jobs, the February labor market survey underscored an extraordinary development on the real wage front -- average hourly earnings were unchanged in current dollars for the month and up a mere 2.5% over the past 12 months. The annual increase in nominal wages falls short of the rise in the headline CPI (3.0%) and only fractionally exceeds the core inflation rate (2.3%). On an inflation-adjusted basis, average hourly earnings are no higher today than levels prevailing at the trough of the last recession in November 2001.
To be sure, the average hourly earnings sample is not the most accurate of the wage statistics in the US. The prize, in this case, has long gone to the more broadly based Employment Cost Index (ECI) tabulated by the Bureau of Labor Statistics. But the ECI is a quarterly series and is only available with a lag; the monthly labor market statistics are timelier and often provide a good hint of what to expect from the ECI. And it turns out that both measures are basically telling the same story today. For workers in private industry, ECI-based wages and salaries were up only 2.4% in the 12 months ending December 2004 -- virtually identical to gains in average hourly earnings and 0.6% below the headline inflation rate. Moreover, the ECI points to a striking deceleration of wage inflation over the past year, with the current pace of 2.4% representing a marked slowing from the 3.0% pace in the prior 12-month period ending December 2003. Consequently, no matter how you cut it -- the ECI or more the more timely monthly data -- real wage stagnation is an undeniable feature of this economic recovery.
This development stands in sharp contrast with real wage patterns in earlier periods. This can best be seen by looking at cyclical patterns in average hourly earnings, a series that has a longer history than the ECI. In contrast with the real wage stagnation 39 months into the current recovery, real wages have normally risen 1-2% by this point in the past four business cycles. While that doesn’t sound like a huge bonanza for the American worker, it underscores one of the time-honored axioms of economics: Over the broad sweep of time, real wages are closely aligned with underlying productivity growth. Ironically, there was a tighter linkage in past cycles, when US productivity growth was running at only a 1.6% average pace over the 1970-95 period, than there has been in the current cycle, when productivity trends have accelerated to a more robust 3.1% annual pace in the post-1995 period. Obviously, something very unusual has gone on in the current cycle -- first a jobless recovery of record proportions and now an unprecedented degree of real wage stagnation.
The most likely explanation, in my view, is a new strain of globalization. The global labor arbitrage has a rich and long history, but for some time I have argued that it has entered an entirely different realm in the Internet age (see my 5 October 2003 essay, “The Global Labor Arbitrage”). Courtesy of e-based connectivity, both tradable goods and an increasingly broad array of once non-tradable services can now be sourced anywhere around the world. That has turned low-labor-cost platforms in places such as China (goods) and India (services) into both wage- and price-setters at the margin. During the early stages of the current recovery, I argued these offshore employment options played an important role in crimping domestic hiring. Now, I suspect these same forces are having an important impact on the US real wage cycle. Put yourself in the position of an American corporate decision maker: Why pay up for a software programmer at home when you can get the same functionality at a fraction of the cost from Bangalore?
Interestingly enough, a detailed breakdown of recent wage trends, as seen through the lens of the ECI, suggests that the recent intensification of downward real wage pressures has been concentrated in the white-collar services segment of the US workforce. Over the 12 months ending December 2004, wage increases for white-collar workers slowed to just 2.5% -- down sharply from the 3.4% increase in the 12 months ending December 2003. Similarly, wage gains in the services sector slowed to 2.4% by year-end 2004 versus a 3.3% gain in the prior 12-month period. By contrast, wage inflation in goods-producing industries and amongst blue-collar occupations has held relatively steady at around 2.4% over the past two years.
I don’t think it’s a coincidence that wage pressures have now intensified in precisely that segment of the US economy where an e-based labor arbitrage is coming into play for the first time ever. Long shielded from global competition, it’s an entirely new game for once sacrosanct services companies. Put that together with ever-expanding trade in manufactured products, and a case can be made for a fundamental shock to operating conditions of US businesses: A lingering lack of pricing leverage in most products and services keeps cost-cutting uppermost in the minds of corporate decision makers. A new globalization of the US wage-setting mechanism could well become an integral part of such cost-cutting strategies -- suggesting that real wage stagnation could endure for the foreseeable future.
If that’s the case, there are profound implications for the macro climate. For starters, real wage stagnation keeps American consumers under considerable pressure. Over the first 38 months of this recovery, the wage and salary component of personal income has risen just 5% in real terms -- far below the 14% average gain over comparable periods of the previous five cycles. This dramatic shortfall of real labor income is an outgrowth of both subpar hiring and real wage stagnation. The recent pick-up in hiring is only of limited consequences if real wages don’t rise. It’s largely for that reason labor income has remained under pressure. Such an outcome leaves hard-pressed consumers with little choice other than to keep relying on asset-based spending strategies and going further into debt to fund such tactics. As a result, real wage stagnation is a recipe for persistently low income-based personal saving.
For financial markets, the impacts of real wage stagnation are equally profound. The good news is that real wage stagnation limits labor cost and inflationary pressures -- helping to boost profit margins and constrain any back-up in long-term US interest rates. The bad news is that the resulting shortfall of labor income keeps pressure on the US current account deficit as the principal means to compensate for a shortfall in domestic saving. That ups the ante of America’s imbalances -- putting downward pressure on the dollar and upward pressure on US real interest rates. Persistent real wage stagnation also puts pressure on the political arena, as hard-pressed workers are likely to demand increasingly protectionist “remedies” from their elected representatives; such an outcome would also put the dollar and real interest rates under pressure. My best guess is that prospective trends in long-term interest rates ultimately will be more influenced by the bearish considerations of the current account adjustment and trade frictions rather than by the bullish implications of well-contained inflation. From, time to time, however -- especially during periodic growth scares -- market sentiment could temporarily push bond yields to the downside.
For America, this recovery has been unlike anything ever experienced in the annals of the modern-day, post-World War II era. Record twin deficits and surging debt underscore the heightened vulnerabilities of a saving-short US economy. The need to normalize real interest rates raises warning flags for the immediate future. A new and exceedingly powerful strain of e-based globalization rewrites the sourcing equation as never before. Despite these extraordinary pressures, the hope all along has been that the sustenance of growth would shift away from the artificial support of policy stimulus and asset appreciation back to the organic support of labor income generation. But as the character of America’s recovery now morphs from jobless to wageless, the likelihood of such a “handover” looks exceedingly dubious. That raises serious questions about the hopes and dreams in financial markets of a benign rebalancing of the US and the US-centric global economy.
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