MainStreet Macro: Wages, Three Ways

I really like watching cooking competitions. One technique master chefs often use to demonstrate their expertise is to take a single ingredient and use it in three completely different recipes.

Think of today’s blog as a one-person cooking competition, where the main ingredient is wage growth.

Wages have been on a tear lately. In August, they grew 4.3% from a year earlier. To put that number in perspective, in the decade leading up to the pandemic, wages never grew more than 3.5% from the previous year.

There are three possible reasons wages are accelerating, each with a different implication for the broader economic recovery. Here are wages three ways.

1. Wage growth due to productivity increases

The first contender in our wage growth competition is the U.S. economy’s increase in productivity. New technologies, investments, and other improvements mean workers can produce more than they used to in the same amount of time.

This is the fan favorite of the competition.

More output per hour worked leads to higher wages for employees and greater profits for business. That boost in income raises living standards for everyone.

Productivity is measured by output per hour. In the first quarter of 2021, productivity jumped 4.1% from a year earlier. This was an 11-year high (congrats, everybody). 

But this productivity boost wasn’t sustainable. By the second quarter, output per hour had dropped to just 1.8% from the previous year. 

In the 10 years prior to the pandemic, productivity gains in the U.S. have been lackluster, averaging just 1% growth per year. It might be the case that after this year’s initial burst, the economy is returning to the sluggish productivity growth that characterized the previous decade.

2. Wage growth due to composition of jobs

The pandemic hit low-paying jobs in high-contact service areas the hardest. When these jobs disappeared, it made overall wage growth look much stronger.

That certainly was the case in August, which reported zero growth in leisure and hospitality jobs. This sector had been leading job gains all year, but likely took a hit from the summer wave of rising COVID cases. Another low-wage sector, retail, actually lost jobs last month.

At the same time, the economy saw strong gains in high-paying jobs such as architecture, engineering, and scientific research and development (basically all the fields I hope my teenager majors in one day, now that he’s decided that economics is out of the running).

Wages in low-paying service-sector jobs have been growing fastest during the recovery. However, the fact that there are fewer of them than there were before the pandemic makes overall wage growth look much higher than it actually is.  

3. Wage growth due to competition

Another reason wages are increasing could be that employers are having to pay more to attract and retain workers. Businesses posted a record 10.9 million job openings in August.

One reason the hunt for talent has picked up is that workers who remained employed during the pandemic are doing a lot of job-switching.

The quits rate – a measure of people who voluntarily leave their jobs –  is now above pre-pandemic levels. And it’s highest in precisely those sectors that were hit hardest by job loss due to the pandemic – retail stores, restaurants, and hotels.

These traditionally are high-turnover sectors, but their quits rate is higher now than a year ago. Employers might be forced to raise wages not only to hire more people, but to retain current employees.

This means that businesses might be paying more to get the same level of output from each worker than they did a year ago. The upshot: lower profits.

Business owners sometimes absorb such costs, but more often they’re passed along to consumers, raising the cost of goods or services.

Price increases eventually could lead to higher inflation. If prices get too high, living standards fall because more income is needed for the same level of consumption.

My Take

Wage growth matters, but the “why” of wage growth is important, too.

Wages will be a key factor for Federal Reserve policymakers when they meet next week to decide whether to normalize monetary policy — in other words, turn down the spigot of financial support that’s been flowing to the economy since the pandemic began.

If wages are growing because productivity is growing, the economy’s recovery is sure-footed and monetary support can be withdrawn — slowly — without disrupting the economy’s growth path. That’s surely a recipe for success.

However, persistent skills shortages and ongoing public health challenges have produced a head-scratching trend of record job openings even as more than 7 million people are sidelined by the pandemic.

Wage gains tied to those labor market bottlenecks could have the unappetizing effect of slowing economic growth and increasing inflation. If the Fed policymakers judging this competition decide that this recipe best reflects reality, we can count on them to stay the course on monetary support.