Labor Market Enigma: As 'Full Employment' Nears, Wages Remain Stagnant

Kristian Rouz – Most of the Group of Seven (G7) nations, including the US, Canada, Germany, Japan, and the UK, are nearing a "full employment" situation in their respective labor markets, meaning the jobless rate is around or below 5pc. However, worker compensation in these countries has barely advanced even though the lack of capable workforce is supposed to have driven the employer willingness to increase their spending on labor in order to remain competitive by attracting top talent.

For a number of reasons, however, this is not happening, in an unprecedented contradiction to one of the fundamental rules of market economy: scarce resources typically go up in price. Not in the case with workforce, at this time, at least, as labor productivity hinders the output capacity of enterprises from Tokyo to London to Toronto to San Francisco.

In most advanced and high-income economies, including those mentioned above, lower unemployment has long been translating into higher salaries, more robust business investment, quicker inflation and, ultimately, stronger economic growth. Yet, positive labor market dynamics do not seem to help GDP growth, in the US and the UK, most prominently, even though the economic authorities have been reporting labor shortages and "full employment" for roughly a year already.

"It is a mystery," Torsten Slok of Deutsche Bank AG said. "We're barely seeing any wage growth."

In the US, jobless rate stood at 4.7pc as of early 2017, the UK reported unemployment of 4.8pc at the very end of the last year. Wage inflation, meanwhile, was 4.47pc year-on-year in January 2017 in the US, whilst the UK's average weekly earnings growth was 2.6pc in December 2016.

Even though nominal growth in worker compensation is outpacing the inflation – 2.5pc in the US in January 2017, and 1.8pc in Great Britain, a tighter labor market would suggest even greater gains in salaries and wages, which are at this point, only dragging along the price indices in both economies.

"I hate to say it but we may be in a new normal for wage growth," Omair Sharif of the New York branch of Societe Generale said. "Until you get productivity moving higher, it may be hard to get nominal wage growth above 3pc."

Low labor productivity is the main factor behind the lagging wage growth in the advanced economies. Even in a situation where workforce is scarce, employers are reluctant to pay more in worker compensation knowing their workforce is not doing an exceptionally good job and could be replaced with the latest achievements in automatisation or freelance outsourcing. The disposability of contemporary workforce is thus the main challenge to wage growth.

In the US, labor productivity rose just 1pc in 2016 compared to 2.6 in 2010, according to OECD data, which means dismal low gains in output per hour worked.

Part of the productivity puzzle that formed in the years of the post-Great Recession recovery is that the US has lost many manufacturing jobs, having instead created multiple non-competitive low-paying jobs in services and the governmental sector, where output is hard to impossible to estimate. The UK is chugging along, albeit the financial power of the Canary Wharf business hub makes labor productivity look brighter.

Another reason the wages are faltering is that many employers are struggling to make ends meet on their corporate books due to unfavourable macroeconomic conditions and international trade headwinds. The US experienced a massive contraction in corporate earnings in the period of mid-2015 to late 2016, the UK is mired in the Brexit anxiety, and in both nations, only select sectors of their respective economies are feeling relatively comfortable.

With employers hardly able to afford greater compensation for their workers, the labor market is facing a choice between bad and worse: stagnant wages or sweeping layoffs. The latter scenario would push jobless rate higher, making the case with contemporary labor market clearer, but most employers opt to keep their bloated payrolls, knowing that a smaller workforce would still not be productive enough.

There might be another explanation to the mystery of stagnant wages in the supposedly buoyant economies. According to ShadowStats, the US unemployment rate stood at 22.5pc in early 2017, compared to the official figures of roughly 5pc, or just below 10pc of both unemployed and underemployed. Meanwhile, ShadowStats' alternate inflation estimate puts annual prices growth at 6pc compared to the official estimate of just below 2pc, rendering the wage inflation actually weaker than prices growth.

"Inflation expectations have become exceedingly well-anchored, and, related to that, wage demands have been very tempered," Nathan Sheets of the Washington-based Peterson Institute for International Economics said. "It is a legacy of the low-inflation, disinflationary, and even deflationary environment we have had for the past couple of years."

Overall, while real gains in salaries and wages are shrinking against the backdrop of the accelerating inflation both in the US and the UK, other nations that face similar issues, such and Japan and Germany, might improve the situation due to their foreign trade surpluses that generally contribute to higher worker compensation. Both the US and the UK have yet to overcome their balance sheet deficits, while trying to overhaul their respective labor markets in order to boost productivity by finding the new sources of growth, such as the revitalization of infrastructure and manufacturing sectors.