From the blog azizonomics – Union Members and Inequality. Below is a very significant graphic
Union membership and minimum wages are usually thought to reduce inequality by helping the distribution of wages. However although stronger unions and an increase in the minimum wage has the potential to reduce inequality, the fact that wages go above the market-clearing level could mean unemployment increases leading to higher inequality.
Strong unions can persuade political parties to engage in more redistributive policies. By getting workers to vote for parties that promise these policies there is a greater chance of them being implemented.
C = Private Consumption
I = Business Investment
G = Government Demand
(X-M) = Net Exports
With government spending being very liberal and effective in creating growth there is a need for the other components of GDP to do their part – Private Consumption, Business Investment and Net Exports.
Exports in the US have been disappointing equaling 14% of GDP compared to the euro zone’s 26%.
Business investment has also been subdued as lower profits mean less investment.
Private consumption hasn’t been as strong as anticipated even with the windfall gain of the significant fall in oil price and the growth of outstanding consumer credit. The biggest barrier to increasing private consumption is the level of pay to employees. Across the US median inflation-adjusted wages are not higher today than they were pre GFC.
Why are wages so low?
The Economist identified three things that have been behind the slow growth of wages in the US.
1. America’s Unemployment-Insurance
With the US government cutting back on unemployment benefits the wage expectations of workers fell. Businesses took advantage of this cheaper pool of labour and in 2014 a significant proportion of the 31 million jobs created wherein poorly paid industries.
2. The Behaviour of Firms
When the GFC hit firms found it difficult to reduce the wages of their staff but fired their least productive workers keeping the most productive happy. To compensate for the higher wages paid to the most productive firms were willing to offer new recruits only low wages.
3. Persistent Labour Market Slack
As there are worker available to fill jobs that become available firms are able to offer paltry wages. The number of part-time workers who would rather be full timers – called part-time for economic reasons (PTER) – fell much more slowly than the official unemployment rate following the GFC. The same can be said for discouraged workers i.e. the number of those wanting a job but say there is no point in looking. Research has found that a 1% fall in the PTER rate is associated with 0.4% fall in real wage growth. When the PTER is high, workers may feel unable to ask for higher wages, since what they really want is more hours.
It seems that the US economy lives and dies by what happens to consumer spending.
The Economist in their Free Exchange column had an interesting piece on the size of firms and the growing disparity in wages. In America the best-paid 1% of workers earned 191% more in real (ie, inflation-adjusted) terms in 2011 than they did in 1980, whereas the wages of the middle fifth fell by 5%.
Economists have long recognised that economies of scale allow workers at bigger firms to be more productive than those at smaller ones. That, in turn, allows the bigger firms to pay higher wages. This should not, in theory, cause a rise in inequality. If the chief executive and cleaner at a larger firm are both paid 10% more than their counterparts at a small firm, the ratio between their wages—and thus the overall level of inequality—should remain the same.
However two reasons are given for why this has not happened:
1. Larger firms find it easier to to automate tasks than smaller ones and if there is resistance from unskilled workers over the wage rate then mechanisation is always another option.
2. Because of the potential promotional prospects in a big firm workers are more willing to accept lower wages.
But if governments wish to reverse the inequality big firms foment, reforms to the labour market are unlikely to do the trick. Instead, they will have to spur competition by reducing barriers to entry for smaller firms, most notably by improving their access to credit. That should reduce income inequality and boost economic growth at the same time.
Source: The Economist
Unemployment figures in the US, Japan and the UK have reached levels that are below pre-crisis lows. In the US economy recent figures show that since 2010 10 million American workers have found employment – unemployment has fallen by 40%. Similarly in Japan the number of unemployed has fallen from 3.6 million to 2.3 million and in the UK the unemployed figures have been cut by 50% with 800,000 unemployed. The question that needs to be answered here is why has wage growth been stagnant when the demand for labour has increased? See graph below for USA.
The rationale behind this is that these economies have experienced an increase in uncertain forms of employment:
* part-time work has risen
* there is an increase of the underemployed where more hours could be worked
* looser contracts have helped create flexible workforces
* in general workers bargaining power has dropped
As a result of little wage growth there has been some political backlash:
* Obama has urged congress to increase the minimum wage form $7.25 – $10.10
* Both the main parties in the UK plan to clarify when insecure ‘zero hours’ contracts are abusive
* In Japan Shinzo Abe (PM) recently announced that temporary workers should expect the same deals as their full-time permanent colleagues.
As these steps lift pay and firms’ costs, inflation should follow.
Source: Economist March 2015
Justin Wolfers wrote a very good article in the New York Times on the so called relationship between wage growth and the level of unemployment. Recent unemployment data from the USA has shown that it has fallen faster that what was anticipated – figures have fallen 1% in the past three years to 5.9%. However what is unusual about this is that the economics textbooks say that lower unemployment leads to faster wage growth and this has not been evident – see graph below. Wages tend to increase when:
1. Workers feel they have job security
2. When there is lower unemployment companies feel they need to pay better wages to attract the best workers
Ultimately when there is wage growth these extra cost pressures feed through into higher inflation something that has not been prevalent in the US economy. The key variable in this situation is how much spare capacity is in the labour market. When unemployment gets near to its natural rate this puts pressure on prices. Any central bank would be very cautious to further stimulate growth when unemployment is close to the natural rate of unemployment – NRU. The issue is that the Federal Reserve are not entirely convinced that they know what the NRU is – their current estimate is 5.5%. How can we explain that the lack of wage pressure is evident when the economy is about to run out of spare capacity? There are a couple of explanations:
1. The unemployment rate is giving us a false signal, and there are millions more workers waiting to return to the labour market than suggested by the official statistics. That is, the jobless will return when the jobs return.
2. The natural rate is really much lower than most economists estimate. After all, at the end of the Clinton administration, unemployment was below 4 percent, while inflation remained low and stable.
Business will only feel it necessary to increase prices if wage growth is greater than inflation and the rate of productivity growth. With the Fed Reserve targeting inflation of 2% and productivity growth at approximately 1-2% the economy is out of spare capacity when wage growth is between 3-4%. This suggest that there is currently spare capacity.
A telling graph below showing how the wages of different sectors have been affected by GFC. As you would expect the car industry and the manufacturing sector saw a decrease in wages but those in the financial sector have benefited from a rise in their pay.
In early August this year fast-food workers across the US staged a walkout in protest about their levels of pay – they were demanding an increase from $7.25 (Federal Minimum Wage) to $15 an hour. Under the current minimum wage a worker’s income is $15,000 per annum which is below poverty level pay. Although the minimum wage has increased it is still below its peak in 1968 when it was worth approximately $10.70 an hour in today’s dollars. As well as the low pay, workers in the fast food industry get few benefits and also prospects for full-time work are limited. Add to that a weak job market and ultimately bargaining position, the prospects for these workers look bleak. Although this low pay has been prevalent for many years why is it that is has become such a political issue?
Why are older workers in fast-food and retail jobs?
Historically these part-time jobs have been filled by students or parents looking for work to supplement the family income. However with the downturn in the US economy and increasing unemployment, many in the labour force have had no choice but to try and pick-up any available work. This includes major income earners for families and today low-wage workers provide up to 46% of their family’s income. This is in contrast to forty years ago where there was no expectation that fast-food or retail jobs would provide the living wage as they were not the jobs that the main breadwinner in the household was employed in. In the 1980s profitable companies like Ford, General Motors and other manufacturing industries were big employers in the US economy. Workers were well paid and also had the benefit of pension plans and medical cover. However globalisation and the drive for lower costs have seen a number of US firms looking to locate overseas in countries such as Mexico and China.
The above is a brief extract from an article published in this month’s econoMAX – click below to subscribe to econoMAX the online magazine of Tutor2u. Each month there are 8 articles of around 600 words on current economic issues.