Usually, when the rate of unemployment is low, pay is supposed to be rising. The logic behind this economic theory is that at times of low unemployment, companies have to pay more to attract new talent and retain their existing employees. However, over the past year, only a 2.5% increment has been recorded in the hourly wages of private non-farm workers in the US despite the nation’s unemployment rate hitting a decade low. The last time unemployment rate was this low, wages increased by more than 4%.
A lot of concerned parties — including policymakers at the Federal Reserve — are wondering why the economy is behaving this way. With a jobless rate this low, officials at the Federal Reserve should be raising interest rates to prevent the escalation of wage-price inflation. What happened to the relationship between unemployment and wages? Here are eight possible explanations as to why the relationship between unemployment and wages isn’t behaving as it should.
The Phillips Curve Is Dead
Economists have always used Phillips Curve to explain the relationship between unemployment rate and wage growth. In the graphical representation of the Phillips Curve, unemployment is on the horizontal axis, and wage growth is on the vertical axis.
The curve slopes downwards from left to right as unemployment increases and wage growth decreases, but the correlation is not always perfect. Some experts say that that the Phillips Curve isn’t effective anymore and can’t be used to explain the relationship between unemployment rate and wage growth citing its recent inconsistencies.
Wage Growth Will Start To Appear Soon
According to Jeremy Nalewaik (Federal Reserve Board Principal Economist), wage increments will start to appear soon. In a paper titled Non-Linear Phillips Curves With Inflation Regime-Switching that he released last year, Nalewaik pointed out that the curve does not remain flat at all levels of unemployment rates. According to his theory, there is a sharp bend where wage growth is unaffected by a broad range of unemployment rates but rise rapidly below a certain threshold.
Wage Growth Is Being Under-Measured
A section of economists is of the opinion that pay increment is being under-measured. According to this group, some hourly wage measurements from the BLS may not be accurate hence don’t give an accurate picture of what’s actually happening in the labour market.
A Slacking Labour Market
While attempting to explain the incongruity in the Phillips Curve, some economists argue that there is slack in the labour market. This means that employees’ leverage is lesser than what is indicated by the current unemployment rate of 4.4%.
Workers Are Not Worth the Pay Hikes
Data from the BLS shows that output per hour has been shrinking in four out of the last six quarters. Companies are all about protecting their bottom line. For this reason, they may be resisting to give in to their workers’ wage demands due to low productivity.
Companies Are Making It Work with the Workers They Have
Another explanation for the Phillips Curve anomaly is that employers are making do with the workers they have. Instead of paying top dollar for new recruits, companies are putting their current employees through training programs and only raise pay for positions they need to fill with new talent.
Employees Are Content with Their Pay
The rate of inflation has remained low since the economic recession of 2009. As long as inflation rates are low, workers are always willing to settle for smaller pay increments. This has been the case since the recession, and this is a possible explanation of the anomalies in on the Phillips Curve. Wage growth rate will remain low despite low unemployment rate if workers don’t demand pay hikes.
Reduced Workers’ Bargaining Power
In 1983, 20 percent of wage and salary employees were union members. According to the Bureau of Labour and Statistics, this number has dropped to less than 11 percent in 2017. Declining rate of union membership is attributable to the weakening of the workers’ bargaining power. Globalization, to some extent, has also contributed to the low bargaining power employees. Due to globalization, companies can easily shift production to low cheaper wage areas.