19/12/16: U.S. Wages (Lack of) Growth: a Structural Crisis

One of the persistent features of today’s economy is the decline in wage growth and lower returns to human capital, relative to financial capital. Starting with 2010 - the onset of the so-called ‘recovery’ from the Great Recession - annual hourly earnings rose only 2 percent (data through 2015), which is about 1.5 percentage points lower than prior to the Global Financial Crisis (GFC).

This phenomena is not exactly new, but it is becoming increasingly alarming from the point of view of contagion from economic displacement risks to political risks. You don’t need to travel far to spot the issue: just consider the recent U.S. Presidential elections, dominated (apart from dirt flinging between the candidates) by the plight of the disappearing middle class.

A recent paper by Stephan Danninger (IMF), linked below, titled  “What's Up with U.S. Wage Growth and Job Mobility?” tries to determine the key reasons for this change in the structure of the U.S. economy.

Danger documents the problem in chart 1 below:

The above chart shows that the decline in wages growth has been pronounced in the face of other labour market dynamics, including the unemployment rate. Which suggests that structural change or structural factors should be more pronounced as the drivers of this trend. This contrasts with previous recessions, when cyclical factors dominate during the early stages of recovery. Per Danninger, evidence points to the fact that following “the deep recession and slow recovery” the U.S. have witnessed “skill erosion and reduced employability of marginal workers. Once labor demand picked up and employment reached workers less attached to the labor market, low entry wages, suppressed average wage growth.”

However, in addition to the above factors, “Davis and Haltiwanger (2014) and Haltiwanger (2015) have pointed to a secular decline in labor market fluidity and business dynamism as possible factors. With productive firms growing less rapidly and the speed of labor reallocation across sectors flagging, technological advances permeate slower through the economy. Labor productivity has been strikingly low in recent years averaging only 0.5 percent during 2013–15 and moves up the wage ladder have become rarer.”

Institutional factors also contribute to anaemic wage growth: “…declines in workers’ bargaining power as a result of less unionization and the emergence of alternative employment arrangements of the “gig” economy (Card and Krueger 2016; Mach and Holmes 2008) have further weighed on average income gains.”

To better disentangle role of cyclical and structural factors, Danninger poses three questions:
1) “Is labor market repair still weighing on recent wage growth?”
2) “Has the relationship between labor market slack and wage growth permanently changed, i.e. has the Wage-Growth Phillips curve flattened?” Note: Wage-Phillips curve implies inverse relationship between money wage changes and unemployment
3) “Focusing on job-to-job mobility, what is driving the decline in labor market churning?”

So key findings are: 

1) “…post-GFC larger declines in local unemployment rates are associated with smaller increases in average wages. …after controlling for the tightness of the local labor market, decreases (increases) in local (county-level) unemployment rates tend to reduce (raise) the average hourly wage rate in the same locality. The preferred interpretation of this effect is a moderating offset of average wage growth through the entry (exit) of low wage earners. This interpretation is consistent with recent findings that the reintegration of workers at the margins of the labor market is holding down median wage rates (Daly and Hobijn 2016).” In other words, when unemployment rises, layoffs predominantly impact those with lower wages (earlier in their careers, part-timers, contract employees, and those with lower productivity), and when unemployment starts to fall, re-hires tend to be of lower average quality than those who managed to stay in employment through the period of higher unemployment.

2) “…structural changes in the labor market are also affecting wage growth”. Which is the main kicker of the paper. Structural changes are those that extend beyond cyclical - recession-linked - factors and as such are long-term trends. Per Danninger, “the wage-growth-Phillips curve has flattened. Declines of unemployment rates …provide a smaller boost to wage growth after the GFC than in the past. …after 2008 wages of full-time full-year employed do not commove with local unemployment rates, while they did prior to the
GFC. …Labor market data up to 2014 no longer show evidence of a similar kink in the post GFC period.”


3) “Job-to-job change rates—associated with higher wage growth—have declined well before the GFC. …post 2000 demographic changes, in particular labor force aging or changes in education, cannot account for the sustained decline in job-to-job transition rates. Rather job-to-job turnover rates have fallen in all education and age groups, irrespective of the tightness of the regional labor market. This common feature is not easily explained by more positive interpretations, such as better job matching or higher return to job tenure (Molly et al 2016).” Traditionally, those who change jobs - job-to-job movers - earn higher wage premia in terms of moving to higher wage growth jobs from lower wage growth jobs. This no longer holds.

As Danninger notes, “these findings have important implications for future wage growth. In the near term, as continued job growth reduces the remaining employment gap — and with it headwinds from the re-employment of low-wage workers—average wage growth is expected to accelerate.”

“However, a return to sustained high wage growth rates is uncertain. The
flattening of the wage-Phillips curve post-GFC points to broader structural changes in the labor market.”

So in summary, including my take on this:

• Job-turnover rates have fallen and continue to decline. 
• “Job-to-job transitions — associated with higher wage growth — have slowed across all skill and age groups”
• The above means that the new - post-GFC - labour markets are no longer consistent with ‘normal’ recoveries and that we might be in a structural period of decline in wages growth.
• This, in turn, suggests that both secular stagnations (demand and supply theses) are cross-linked through the labour markets (lower wages growth triggers lower demand growth, leading to slower investment, resulting in slower productivity growth).

Full paper is available here: Danninger, Stephan, What's Up with U.S. Wage Growth and Job Mobility? (June 2016). IMF Working Paper No. 16/122. https://ssrn.com/abstract=2882557

17/4/16: Start Ups, Manufacturing Jobs and Structural Changes in the U.S. Economy

In the forthcoming issue of the Cayman Financial Review I am focusing on the topic of the declining labour productivity in the advanced economies - a worrying trend that has been established since just prior to the onset of the Global Financial Crisis. Another trend, not highlighted by me previously in any detail, but related to the productivity slowdown is the ongoing secular relocation of employment from manufacturing to services. However, the plight of this shift in the U.S. workforce has been centre stage in the U.S. Presidential debates recently (see http://fivethirtyeight.com/features/manufacturing-jobs-are-never-coming-back/).

An interesting recent paper on the topic, titled “The Role of Start-Ups in Structural Transformation” by Robert C. Dent, Fatih Karahan, Benjamin Pugsley, and Ayşegül Şahin (Federal Reserve Bank of New York Staff Reports, no. 762, January 2016) sheds some light on the ongoing employment shift.

Per authors, “The U.S. economy has been going through a striking structural transformation—the secular reallocation of employment across sectors—over the past several decades. Most notably, the employment share of manufacturing has declined substantially, matched by an increase in the share of services. Despite a large literature studying the causes and consequences of structural transformation, little is known about the dynamics of reallocation of labor from one sector to the other.”

“There are several margins through which a sector could grow and shrink relative to the rest of the economy”:

1. “…Differences in growth and survival rates of firms across sectors could cause sectoral reallocation of employment”
2. “…differences in sectors' firm age distribution could affect reallocation since firm age is an important determinant of growth or survival behavior” 
3. “…the allocation of employment at the entry stage which we refer to as the entry margin could contribute to the gradual shift of employment from one sector to the other.”
4. “…because the speed at which differences in entry patterns are reflected in employment shares depends on the aggregate entry rate, changes in the latter could affect the extent of structural transformation.”

Factors (1) and (2) above are referenced as “life cycle margins”.

The study “dynamically decomposed the joint evolution of employment across firm age and sector”, focusing on three sectors: manufacturing, retail trade, and services.

Based on data from the Longitudinal Business Database (LBD) and Business Dynamic Statistics (BDS), the authors found that “…at least 50 percent of employment reallocation since 1987 has occurred along the entry margin.” In other words, most of changes in manufacturing jobs ratio to total jobs ratio in the U.S. economy can be accounted for by new firms creation being concentrated outside manufacturing sectors.

Furthermore, “85 percent of the decline in manufacturing employment share is predictable from the average life cycle dynamics and the early 1980s distribution of startup employment across sectors. Further changes over time in the distribution of startup employment away from manufacturing, while having a relatively small effect on manufacturing where entry is less important, explain almost one-third of the increase in the services employment share.”

Again, changed nature of entrepreneurship, as well as in the survival rate of new firms created in the services sector, act as the main determinants of the jobs re-allocation across sectors.

Interestingly, the authors found “…little role for the year-to-year variation in incumbent behavior conditional on firm age in explaining long-term sectoral reallocation.” So legacy firms have little impact on decline in manufacturing sector jobs share, which is not consistent with the commonly advanced thesis that outsourcing of American jobs abroad is the main cause of losses of manufacturing sector jobs share in the economy.

Lastly, the study found that “…a 30-year decline in overall entry (which we refer to as the \startup deficit) has a small but growing effect of dampening sectoral reallocation through the entry margin.”

These are pretty striking results.

The idea that the U.S. manufacturing (in terms of the sector importance in the economy and employment) is either in a decline or on a rebound is not as straight forward as some political debates in the U.S. suggest.

Reality is: in order to reverse or at least arrest the decades-long decline of manufacturing jobs fortunes in America, the U.S. needs to boost dramatically capex in the sector, as well as shift the sector toward greater reliance on human capital-complementary technologies. It is a process that combines automation with more design- and specialist/on-specification manufacturing-centric trends, a process that is likely to see accelerated decline in lower skills manufacturing jobs before establishing (hopefully) a rising trend for highly skilled manufacturing jobs.