United States: Will the Real Wage Measure Please Stand Up?
[Any thoughts on this? - Mish]
Richard Berner (New York)
Despite firming labor markets, wage gains have yet to quicken, giving comfort to policymakers and market participants that inflation will remain in check. But two wage metrics are telling sharply divergent stories: Growth in wages and salaries measured by the Employment Cost Index (ECI) — generally considered to be the most accurate measure of labor costs — shows no sign of turning up. Private industry wages have decelerated to just 2.2% in the year ended in September; that’s the smallest increase in the 25-year history of the data. In contrast, average hourly earnings (AHE) are accelerating smartly; that monthly gauge rose by 3.2% in the year ended in November, a two-year high, and at a 3.7% annual rate in the past six months. Which measure is sending the right signal, and what are the implications?
The truth about pay gains may lie in between these two gauges. They differ in coverage, frequency, and sampling, and their recent divergence reflects some of those differences. More fundamentally, in my view, rapid increases in benefits have held down gains in take-home pay in recent years, but that is starting to change. As I see it, investors should not look to pay gains as leading inflation indicators; they tend to lag inflation and inflation expectations. But rising unit labor costs likely will reinforce the incipient inflation increase, and firmer labor markets and elevated inflation expectations are likely to push both wage measures up at a faster rate in coming months.
Sadly, neither wage metric is ideal. The ECI, according to the Bureau of Labor Statistics, is a quarterly, fixed-weighted measure of labor costs, so it is free from the influence of employment shifts among occupations and industries. Wages in the ECI, which is designed to cover all workers, are defined as the hourly straight-time wage rate or a close proxy, and exclude overtime pay and nonproduction bonuses such as lump-sum payments provided in lieu of wage increases.
The ECI thus theoretically is superior, but it has shortcomings: For private industry workers, BLS statisticians derive the ECI from a relatively small sample of about 9500 establishments. While they rotate the sample completely every five years to capture changes in the economy, that procedure may nonetheless miss new industries. What’s more, they derive the ECI’s fixed weights from the BLS’s comprehensive but dated 1990 Occupational Employment Statistics survey. Many of today’s fastest-growing occupations did not exist in 1990. In March, the BLS will unveil an overhauled ECI that may fix some of these inadequacies, but the transition to the new NAICS industrial classification system likely will invalidate historical comparisons. The upshot, in my view, is that the ECI wage metric could recently understate pay gains because it may miss changes in the economy.
In contrast, Average Hourly Earnings (AHE) is a monthly gauge reflecting the actual earnings of workers, including premium pay. It is simply the quotient of gross payrolls and total hours, so compositional shifts in employment often affect it. It is thus not a true measure of wage rates, and it covers only production and nonsupervisory workers, although that subset amounts to 81% of private payrolls. While the AHE is thereby clearly deficient, it has three offsetting advantages. First, it is derived from the large and thus relatively reliable CES sample that covers one-third of all nonfarm workers at 400,000 establishments. Second, it is timely, appearing with the monthly employment canvass. Third, the lack of fixed weights that obscures true wage changes may ironically help it capture changes in the economy.
Compositional shifts in employment in the wake of Hurricanes Katrina and Rita probably contributed to the recent acceleration in AHE. The devastation of the Gulf Coast tourist industry cost 53,000 jobs in leisure and hospitality between August and November, and those jobs pay about half the norm, implying a shift to higher-paying jobs that boosted growth in the AHE. But this distortion doesn’t change the basic message of acceleration. As proof, and to control for such compositional shifts, we calculated a fixed-weight alternative, using 2002 employment shares. The fixed-weight variant rose by 3% over the year ended in November, or 0.2% less than the published version, and 3.4% annualized over the past 6 months, or 0.3% less than the published data. The upshot: While the published data may exaggerate the magnitude, the acceleration in pay measured by the AHE clearly sends a very different signal than the one in the ECI.
Many analysts attribute today’s tepid pay gains to globalization that has forced Corporate America to be stingy with raises. I agree that globalization has been a secular disinflationary force, and that low inflation has held down nominal compensation growth, but I see today’s lukewarm pay through a different, domestic lens. In my view, recent rapid increases in benefits, especially for healthcare, have been a more important factor holding down gains in take-home pay in recent years; employees view that tradeoff as acceptable, given that benefits are tax-free income. While unpublished ECI data show that healthcare costs per hour have decelerated to 6.7% in the past year from double-digit gains in 2002 and 2003, some of that deceleration reflects the pickup in hours. Increased flexibility in pay arrangements has also helped to hold down take-home pay gains, with more employees getting bonuses tied to company performance.
These developments are starting to change. As I see it, pay gains tend to lag inflation, and firmer labor markets and elevated inflation expectations are likely to push both wage measures up at a faster rate in coming months. There’s no magic threshold for the unemployment rate below which pay gains accelerate. But with the jobless rate hovering around 5%, any improvement in job growth will likely tighten the screw. Longer-term inflation expectations at 3.1% in late December have stayed slightly but firmly above their average of the past seven years. And according to Morgan Stanley analyst Christine Arnold, employer-paid healthcare costs for large groups should decelerate to 6.9% in 2006 from 10.3% in 2005, making room for bigger gains in take-home pay. Anecdotal and survey evidence also suggests that pay gains are improving or will pick up. For example, the Fed’s Beige Book in November reported “modest overall upward pressures on wages with Minneapolis, Kansas City, and San Francisco Districts reporting moderate increases in wage pressures, …[and]..Boston, Richmond, Atlanta, and San Francisco [indicating] more substantial upward pressure on wages in one or more particular industries.”
Now that monetary policy is no longer accommodative, inflation and wage developments will be critical issues for policy and market direction. Fed officials in the minutes from their December 13 meeting “indicated that their concerns about near-term inflation pressures had eased somewhat over the intermeeting period.” Accordingly, market participants increasingly believe that inflation will stay benign, and that the Fed may stop tightening after the January FOMC meeting. In contrast, our call for higher yields hinges on our outlook for somewhat higher inflation and above-trend growth. A pickup in pay gains will support both, simultaneously boosting unit labor costs and consumer wherewithal. As always, risks to this call abound. Wage gains could continue to be subdued for a while longer as benefit cost growth remains high and companies strive to maintain profitability. But there are also risks that pay gains will now pick up faster than I reckon, having lagged inflation for an extended period. |
