Despite a tight labor market, wage and productivity growth remain low in the U.S. Wage growth stood at just 2.5% in July 2017, on par with post-Recession performance. Labor productivity growth averaged only 1.1% between 2007 and 2016. Between 1995 and 2007, by contrast, the average growth rate was 2.5%. Although cyclical factors may be partially to blame, there are several key structural features of the U.S. economy contributing to diminished growth. Wage and productivity growth are being held back by persistently low inflation expectations, workforce demographics, and the shift in the payrolls distribution in the economy in favor of lower-wage sectors.
The Federal Open Markets Committee’s (FOMC) minutes of the July 25-26 meeting underscored its concern with wage and productivity data. The committee noted there was “tightness in the labor market, but. . . little evidence of wage pressures.” Some FOMC participants speculated if the “hiring of less experienced workers at lower wages” was a contributing factor. Others pointed out that low wage growth is in line with what productivity growth and the inflation rate (both sluggish, of late) would suggest. Indeed, the Federal Reserve’s concern about wage and productivity growth is likely to be a major factor in the debate over the timing and termination point of future rate rises – arguing for fewer and further apart hikes, and perhaps a termination point around the range of 1.50% to 1.75% for federal funds.
The FOMC’s unease with wage and productivity growth is hardly unique. Analysts and academics alike have advanced a spate of theories to explain the low numbers. Favorite suspects include lingering weakness in the labor market not captured in the headline unemployment number; downward nominal wage rigidity; output mismeasurement, particularly in services and tech-related sectors; a drought of productivity-boosting, technological advancements; a slowdown in capital growth; and the deteriorating quality of public education.
Although many of these factors may play a role in limiting wage and productivity growth, the U.S. economy has also undergone several structural changes: 1) persistently low inflation expectations, 2) shifts in workforce demographics, as Baby Boomers exit and Millennials enter the workforce, and 3) the changing distribution of payrolls by industry favoring lower-pay sectors. Our view is that structural changes are largely responsible for the modest growth in wages and productivity in the economic expansion after the Great Recession of 2008-2009. By implication, there is nothing the Federal Reserve can do with monetary policy to address structural changes related to demographics and shifts in the distribution of jobs among sectors.