Wednesday, September 9, 2015

Real Wage Growth and Tight Labor Markets

The Atlanta Fed publishes a lot of great stuff on their blog.  This is a recent post about Quits and wage growth.  What they find is that while wage growth does correlate strongly with Quit rates, wage growth rises most strongly, and more in line with quits, among job quitters.

From the Atlanta Fed post
This is why the relationship between real wage growth and inflation is not strong.  In the aggregate, employers and workers aren't locked into some ongoing negotiating drama.  It seems like they are, and this fits with our us vs. them narratives about fighting over income shares.  But, in the aggregate, there just isn't that much to fight over.

Profits, as a proportion of national income fluctuate by around 1% to 3% through business cycles.  Most of this is due to shocks that move profits out of equilibrium and labor out of full employment.  It seems that less than 1% of national income at any given time is available due to some sort of cyclical negotiating power.


The reason wages grow during expansions, when unemployment is low, is because of the quits.  The growth doesn't come from capturing more production from existing employers.  The growth comes from finding a job where you can be more productive.  The reduced frictions and risks of shopping your skills mean that you can match your skills better.  Laborers are becoming more productive, not simply because of the application of capital, but because capital is complementing their labor more efficiently, because small disloyalties can be committed by employees and employers without undue damage.  There are many more separations during expansions than there are during contractions.  It's just hard to remember that because the separations that happen during contractions are so painful.

It seems like this can't be the case.  In every workplace, there are individuals who provide value to the firm with sharp variance to their compensation.  And, between firms, there can be tremendous differences of returns to invested capital.  But, these represent inefficiencies that must play out within the realm of either labor or capital compensation.  There are too many interdependent variables and actors to remotely comprehend, but that mass of unpredictable, untrackable activity creates an aggregate result that contains very little systematically tradable income.

I believe some of the reduction in profit as a share of national income which we do see late in some of the longer expansions may be the result of lower risk premiums and more forward looking corporate capital allocation.  The effects of this tend to be overwhelmed by real shocks to the economy that happen subsequently, so it doesn't seem to carry on into long term growth rates.  For instance, growth rates are low now even though the late 1990s were a period of transformative corporate investment.  Maybe the effects just aren't measured well. Both the late 1990s and the late 1960s were at the tail end of especially stable periods where profits declined relative to compensation during healthy recoveries and both periods are known for creating a new wave of frontier firms.

In any case, it seems as though the overwhelming factor for positive outcomes is stability.  That seems to be associated with inflation rates in the 2% to 4% range.  Stability will be related to low unemployment and low risk premiums.  The risk to our economy of wage growth, if there is any risk at all, seems greatly overshadowed by the risk of business cycle instability.  If we are managing the economy as if low risk premiums and tight labor markets are problems to be avoided, then we are  doing it wrong.

PS.  Evan Soltas has an interesting post on this issue.  I'm still wrapping my head around all the ramifications, but he finds that while some sectors have increased their productivity over this period than other sectors, compensation within each sector has basically grown in line with productivity.  At the least, it suggests that average compensation tracks productivity at the sector level.  Evan argues that the standard intuition that compensation tends to track productivity seems to be a better explanation of changing distribution of compensation than changes in labor market institutions.

At least the Bivens and Mishel report from EPI seems to be moving toward defining the issue as about distribution of income within labor rather than about the split between capital and labor.  Their headline graph lends itself to unhelpful labor narratives, but almost all of the differences between median compensation and average productivity, as presented in the graph, are happening within compensation and the cost of housing.  Maybe the conversation can move to productive grounds.  Confiscatory or obstructive policies toward capital income would be deeply unhelpful.  Evan's post, I think, is actually a good argument for pro-growth, pro-capital policies.  There would be great benefits to creating more opportunities for workers to move into the more productive sectors.  That could be accomplished through domestic capital formation and through more aggressive international trade.


  1. In any case, it seems as though the overwhelming factor for positive outcomes is stability.  That seems to be associated with inflation rates in the 2% to 4% range. ---Erdmann.
    Holy Toledo!
    I have suspected this, never could think of a wsy to show it.

    For the sake of looking pretty on a nominal index, we are suffocating the economy?

    1. Yeah. It's why it seems to me an ngdp target closer to 7% would be more robust. That is, after all, more or less the long term average, and I don't see any signs of poor real outcomes below 4% inflation. 5% is probably fine, because minimizing the problems caused by inflation targeting probably allows avg inflation to be lower, and the target is as much a political thing as an empirical thing.

  2. Well there might be a few pro-business, print money guys in America. Maybe even dozens.