2005 March 24 Thursday
Most Workers Not Keeping Up With Inflation

Wages are not keeping up with inflation in spite of a strong economic recovery.

After adjusting for inflation, average weekly wages for production and non-managerial workers fell o.4 percent last month, and dropped 0.8 percent over the 12 months that ended in February, the department said. Those employees account for about 80 percent of the labor force.


In addition to energy prices, another reason for rising inflation pressures is that the economy has been growing rapidly so far this year, at about a 4.5 percent annual rate, according to some estimates, fueled by strong consumer spending and business investment.

The economy is growing rapidly and yet wages are not keeping up with inflation. Why? Rising oil prices are one reason for this. But Morgan Stanley chief economist Stephen Roach says this recovery is different because foreign workers are competing more directly with American white colllar workers and keeping down white collar wages.

This development stands in sharp contrast with real wage patterns in earlier periods. This can best be seen by looking at cyclical patterns in average hourly earnings, a series that has a longer history than the ECI. In contrast with the real wage stagnation 39 months into the current recovery, real wages have normally risen 1-2% by this point in the past four business cycles. While that doesn’t sound like a huge bonanza for the American worker, it underscores one of the time-honored axioms of economics: Over the broad sweep of time, real wages are closely aligned with underlying productivity growth. Ironically, there was a tighter linkage in past cycles, when US productivity growth was running at only a 1.6% average pace over the 1970-95 period, than there has been in the current cycle, when productivity trends have accelerated to a more robust 3.1% annual pace in the post-1995 period. Obviously, something very unusual has gone on in the current cycle -- first a jobless recovery of record proportions and now an unprecedented degree of real wage stagnation.

The most likely explanation, in my view, is a new strain of globalization. The global labor arbitrage has a rich and long history, but for some time I have argued that it has entered an entirely different realm in the Internet age (see my 5 October 2003 essay, “The Global Labor Arbitrage”). Courtesy of e-based connectivity, both tradable goods and an increasingly broad array of once non-tradable services can now be sourced anywhere around the world. That has turned low-labor-cost platforms in places such as China (goods) and India (services) into both wage- and price-setters at the margin. During the early stages of the current recovery, I argued these offshore employment options played an important role in crimping domestic hiring. Now, I suspect these same forces are having an important impact on the US real wage cycle. Put yourself in the position of an American corporate decision maker: Why pay up for a software programmer at home when you can get the same functionality at a fraction of the cost from Bangalore?

The acceleration of inflation is pressuring the US Federal Reserve to raise interest rates.

The reading on the Consumer Price index, the government's main inflation gauge, came in higher than most economists had forecast. The Labor Department said CPI rose 0.4 percent in February after a 0.1 percent increase in January. It was the biggest increase since October.

The "core" CPI, which excludes often volatile food and energy prices, rose 0.3 percent after a 0.2 percent January increase, the department said.

The Fed is continuing to slowly tighten the money supply.

The Fed nudged up short-term interest rates for the seventh time in the last year, raising the federal funds rate on overnight loans between banks to 2.75 percent from 2.5 percent. It restated its intention to keep raising them at a "measured" pace in the months ahead.

While high oil prices and foreign competition are keeping down real wages America is running a huge and unsustainable trade deficit. We could hit a point where the dollar starts declining against East Asian currencies causing inflation in imported goods prices while interest rates rise as East Asian central banks stop heavy buying of US Treasuries. The US could be pushed into a recession by all these pressures.

Share |      By Randall Parker at 2005 March 24 01:32 AM  Economics Political

GUYK said at March 24, 2005 3:52 AM:

Energy costs are no doubt a big part of inflation. And there is no doubt that wages are not keeping up with inflation. I am semi-retired. I have a USAF pension,VA disability and Social Security as well as private saving and income from a small business. I had planned a comfortable retirement for my wife and I and thus far we are not destitute. However, we are feeling the pinch, especially the energy prices which affect everything from the electric bill to freight prices. An example is a distributor that I deal with who just raised the minimum order by $500 to receive free shipping. I will either have to make bigger orders and live with excess inventory-which cost money-or pay freight which cuts into the profit margin. The other option is to raise prices in an already highly competitive retail business.

I have no real big problems with the Fed raising interest rates provided they do not get out of hand as the rates were in the late 1970's. Return on savings should at least be a point or two over inflation rates. But, as you know, interest rates in themselves can cause inflation rather than help to slow it. Business operates on credit. When prime goes up so does the cost of doing business and there are just so many notches in a belt to tighten up to. Eventually the increased costs have to passed on to the consummer.

Invisible Scientist said at March 24, 2005 4:35 AM:

Solution Package:

1) Modify the existing immigration policy so that all children with IQ over 140,
under the age of 14 would be given automatic US citizenship, with government sponsored
education. Additionally modify the Annual Immigration Lotter system that gives 50,000 green
cards to have a minimum IQ requirement of 125.

2) Immediately start a national Bronx project for robotics, spending $50 billion per year (0.5 % of the GDP)
which would form the seed capital for robotizing the USA. Japan is involved in robotics projects
for the purpose of avoiding hiring foreign workers in the future. In the case of the USA, this
robotics movement of national scale, will mitigate the dangers of outsourcing too many jobs
to foreign countries. This outsourcing issue is becoming a national problem.

3) Guaranteed national scholarships for science and engineering education for smart kids.
This is NOT a pork barrel project, it is money well spent, and it would pay off many times.

Jason said at March 24, 2005 10:15 AM:

"The "core" CPI, which excludes often volatile food and energy prices, rose 0.3 percent after a 0.2 percent January increase, the department said. "

The Treasury Inflation Protected Securities (TIPS) use the core CPI for setting the interest payments and principal repayment. These bonds were first issued when energy prices were low. The bull market in energy started in 1999. Energy price increases are a big part of inflation today, but the CPI doesn't measure it. What the Treasury has done is issue bonds whose real value declines as energy prices increase. The Treasury has issued bonds which have a negative real return. Brilliant. Take a bow Larry Summers and Bob Rubin.

Because commodity production is capital and time intensive, energy prices follow long term trends. When the price of energy is low, there is insufficient return on capital to create supplies of commodities. For example, if the cost to drill for oil is $20 a barrel and the price is $15, no investment will be made. Then the world is left with no new capacity coming online. Eventually demand will grow more than supply and the price will go up. Since it isn't profitable to build new production, there is no new supply. But demand grows and the price keeps going up. At a point, it becomes profitable to create new production. Investors will rush to create new oil production. However, since it takes years to build new production, the demand will continue to surge and the price will go up. The price of oil started climbing is 1999. Noone knows when it will stop. It could be two years from now or ten years from now. Bull markets tend to go on for longer than anyone would imagine, though. Eventually, enough new investment will be put into oil production that supply will be greater than demand. The price will decline. But because the money has already been spent, there is no way to take production offline and recoup the investment. For example, if billions are spent building a pipeline at the oil price peak, it is a sunk cost. The pipeline will run even if price of oil isn't high enough to make the whole project profitable. The price will decline for years.

Because bull markets in energy run for long periods of time, it is my opinion that the US will experience serious inflation within the next ten years. Knowing this, a person can make prudent choices going forward. However, I imagine most people will be highly surprised by inflation. I can only hope and pray that politicians don't propose something as a Nixon's price freeze, accuse companies of profiteering from price increases, or otherwise interfere in the economy to 'protect the consumer'. A side note: I imagine the high rate of incumbent reelection on these past twenty some years was simply due to low inflation. In a high inflation era, the incumbent reelection rate would come down. But heaven forbid, if the politicians actually DO something.

Brent Anderson said at March 25, 2005 6:12 AM:

The floodgate of immigration must be a reason for stagnanting wages; supply and demand is at work.

Additionally, all the jobs we've exported overseas hasn't helped, either.

On top of that, productive people pay too much in taxes--the main economic rationale for the second spouse to be working while raising a family. The taxes have to be paid.

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