According to the rich world’s politicians, economics has a new villain. The modish scoundrel of the past seven years—the immoral banker outwitting inept regulators—has been edged out by a returning blackguard: the tight-fisted boss crushing the hopes of honest workers with miserly pay. In America workers have been demonstrating for higher pay and stronger union rights in the profitable but poorly paying food industry. Hillary Clinton has blasted CEOs who earn 300 times what the average worker does, pledging that her run for the presidency will champion the “everyday Americans” who have the “deck stacked” against them. In Britain Ed Miliband, leader of the opposition Labour Party, has told the electorate that he plans to punish “predatory” capitalists that exploit the low-paid; his electoral rival David Cameron retorts that his Conservatives are the “party of working people”. In Japan Shinzo Abe has sworn to lift salaries, and cajoles and threatens Japanese bosses to deliver on his promise.
The facts give such rhetoric resonance. In most places the recession that followed the financial crisis had dire effects on wages. Despite five years of growth American real wages are still 1.2% below what they were at the beginning of 2009. In Britain, real wages fell every year between 2009 and 2014, the longest decline since the mid-1800s. In 2014 median pay was 10% below its 2008 high. Germany, a haven during the euro-zone crisis, has done better, but wages are still 2.4% below their 2008 level. While there are exceptions—median pay has risen since 2008 in Canada and France—these have generally been bad years for wages.
Sin of wages
Flat and falling pay does not just matter to the people afflicted and to those who worry generally about growing inequality (a linked problem, but not quite the same one). Workers are also shoppers. Across the G7 group of rich countries household consumption ranges from 55% (France) to 68% (America) of GDP. While it makes sense for an individual boss to hold down pay, low pay across the economy as a whole threatens to put a lid on the growth that one would otherwise expect after a recession. If it does not there’s a chance it will be because households are again borrowing to spend in an unsustainable way.
But if there is good reason to be worried about wages, the political heat also has a concerning side. To design sound policies it is vital to understand why wages have stopped rising, what the implications of a flat-wage world would be, and the likely impact of pay-propelling policies. But economics is still only just getting to grips with these questions.
Part of the problem is that, even before the recession, wages had not been improving as straightforward economics might suggest—which is to say, in line with productivity. The two moved in tandem following the second world war (between 1947 and 1960 both rose by 51% in America) but have been drifting apart since the 1960s: since 1960 productivity in America has risen by almost 220%, but real wages by less than 100%. Many other advanced economies have seen the same sort of trend. The result is that labour’s share of GDP has fallen. And of the share that goes to labour, more and more has been going to the people who earn the highest salaries, exacerbating the problem for the rest.
Scholars seeking to explain this decline in the labour share reckon a number of big forces are at work. One is that the income from capital—especially from housing—has been increasing more than the income from labour. Another is that, in many industries, capital goods have become a lot cheaper and/or better. Bosses can choose whether to spend money on machinery or people, and declines in the price of the kit required for a given amount of output—which can come about either because existing machines get cheaper or because new ones can do more—reduce demand for labour.
Globalisation can reduce the demand for rich-country labour, too. Michael Elsby of the University of Edinburgh and Bart Hobijn and Aysegul Sahin of the Federal Reserve have shown that in industries where imports became a more important part of the supply chain between 1993 and 2010 the labour share fell the most. And the decline of trade unions reduces labour’s bargaining power. The share of the American workforce unions represent has fallen in every decade since the 1960s, and similar declines have been seen across the G7.
The new part of the puzzle—the bit that makes the lack of wage growth after the recession perplexing—concerns the other factor that, in the past, economists have seen as crucial in the setting of wages: unemployment. The usual assumption is that once unemployment gets below a certain rate, idle labour becomes scarce and competition to hire already employed workers heats up. As firms outbid each other for talent, new workers get better starter salaries and valued staff secure juicy raises. Estimating the unemployment rate at which wage-driven inflation kicks in the NAIRU (non-accelerating inflation rate of unemployment)—is part of the core business of central banks.
Following a major recession, the NAIRU often goes up. Periods of unemployment have lingering effects on workers, from a loss of vim to clinical depression. Time out of work can mean skills dwindle or become mismatched to the needs of the market; the skills needed by industries that flourish in the recovery may differ from those central to the industries which laid people off in the slump. All this means some unemployed workers will find it harder to get back into the workforce—indeed, some may stay unemployed until they reach pensionable age—and their presence on the unemployment rolls thus does little to hold down wages. So after a big crisis the NAIRU rises; inflation should kick in sooner rather than later.
In the wake of the current recession, though, this rule of thumb has been broken in a number of countries (see chart 2). In 2013 the OECD, a rich-country think-tank, thought wage-driven inflation would kick in in Britain if unemployment got back below 6.9%. But joblessness was well below that throughout 2014 and average real wages still declined by 0.6%. In a 2013 paper Federal Reserve economists estimated a stable unemployment-wage rule for America: every percentage-point reduction in unemployment should lift inflation by 0.3% over the next year. But despite the fact that joblessness has fallen by more than two percentage points since then, median hourly wages were the same in the first quarter of 2015 as a year earlier. In Japan, unemployment averaged 3.6% in 2014, well below its pre-crisis average, but real pay fell by 2.5%.
Odd, but if temporary perhaps not too troubling. And there is evidence that real-terms wages might now be shaking off their sloth. In late February IG Metall, Germany’s largest union, brokered a 3.4% raise for its members, well above the current inflation rate, 0.3%. The latest British data show average salaries up by 1.7% in a year; with inflation close to zero this is a decent real-terms rise. In America, average real pay is up by 2.2% over the past year. If this continues as unemployment falls it would mean a return to pre-crash normality, with sustained wage inflation eventually triggering central-bank interest-rate hikes.
There is, though, another possibility; that the recent hints of a wages bump are largely an artefact of unexpectedly low inflation, and that the underlying wage stagnation continues. Average pay data in America and Britain may be hiding the continuing plight of the median worker behind the success of the most sought after. It may be that the damage this recession did to the labour market—the loss of skills and the mismatch between industries where workers have experience and those where there are vacancies—is being expressed not in the form of long-term unemployment but as lasting low pay. If that is true, and low pay locks in, sustained inflation might not return even with low rates of unemployment. That labour-market shift would chart a very different course for central banks, which would keep rates low. It would also mean the politics of low pay could be here to last.
What might account for a change of this sort? One likely factor is that, in many places, more flexible labour contracts make it easier to fill posts without raising wages. In Germany “mini jobs”—positions with pay under €400 ($440) per month—are rocketing. In Britain, “zero hours” contracts, in which neither employer nor employee commits to a fixed number of hours, have been becoming more common. By making it easier to fire workers these contracts aim to take the worry out of hiring. By making workers’ positions more fragile they cut bargaining power.
Not for the long haul
The ever larger “staffing industry” may be having a similar effect. It is important across a much wider swathe of the economy than is often realised; having started out in the 1960s supplying office temps, today temping companies like Kelly Services, Adecco and Randstad mainly supply light manufacturing and industrial workers. In 2013 Kelly Services was America’s second-largest private-sector employer, after Walmart, with 750,000 staff. America’s 2.9m temps account for 2% of its jobs.
Temping is flourishing across the G7. In Japan, once the land of the shûshin koyô, or job for life, transient employment is ever more common; in 2014 Recruit, the country’s largest temp agency, listed for $19 billion on the Tokyo stock exchange. In Britain everything from the Olympics on down comes with temporary security guards supplied by G4S and temporary caterers provided by Compass, the country’s largest and third-largest private employers, respectively.
The industry provides flexibility for both workers and firms, and its ability to match workers on its databases to jobs may be very helpful: the 2010 Nobel prize was awarded for work showing how better job search and matching could lower unemployment. But labour aggregators that compete for business on the basis of helping lower clients’ staff costs have an incentive to keep pay low. In 2014 a report by Rebecca Smith and Claire McKenna of the National Employment Law Project, an American lobby group, claims that staffing agencies cut temps’ bargaining power.
Across the G7 politicians are mulling three ways to overcome the problems low pay poses. The first and least appealing is re-regulating the labour market so as to limit flexibility. In Germany trade unions are critical of mini jobs, arguing that they cannibalise higher-paying ones. The evidence suggests that this is not the case; mini jobs are growing fastest in industries where full-time jobs are up strongly too, according to the IAB, a government research institute. In Britain, the Labour Party is promising voters it will outlaw zero-hours contracts.
Credit where it’s due
This push will not make workers better off. For one thing many workers like the two-way flexibility temping provides. Temping is popular with some Japanese workers, allowing women with young children and retired workers seeking a pension top-up to enter the workforce. And making the market less flexible raises the risk that an economic downturn will cause mass lay-offs. France has the G7’s least flexible labour market, and a 10% unemployment rate. Since 2010 the French economy has created around 140,000 new posts. Ultra-flexible Britain has created 1.6m. Although politicians are right to ensure that work pays, the hard truth is that in a wounded economy a low-paying job is better than none at all.
The second approach to low pay is tax cuts. Britain provides a good example of how they can help. In 2010 a worker in Britain earning the minimum wage—then £5.93 per hour—was liable for tax on £5,900 of the £12,300 he would have earned that year. Today the equivalent total is £13,520 ($20,870), but increases in the tax-free allowance mean only £2,920 is taxable.
The problem is that such tax cuts are untargeted, so the better- and indeed best-off gain too. This makes them popular, but expensive. To focus low tax on the poorest, instead, many countries use tax “credits”, like the Working Tax Credit in Britain or the Earned Income Tax Credit in America, which provide refunds to those on the lowest pay. In Britain, for example, someone earning £13,100 or less receives a top-up of £1,960. Since there is no cost to the employer any urge to hire remains robust.
But there are concerns here too. Some worry that stingy bosses are able to rely on tax credits rather than raise pay. Low-paid workers flipping burgers at McDonald’s, Burger King or Wendy’s, America’s largest fast-food chains, or those pulling pints at JD Wetherspoon, Britain’s biggest pub group, will be getting substantial tax credits. Yet critics point out that these outfits are profitable and returning cash to their shareholders. Other companies find higher pay affordable: Walmart plans to raise its minimum wage from $7.25 to $9, a step which should be easily manageable given profits of $27 billion and dividends of $6 billion in 2014. Indeed it may pay for itself through reduced churn and better motivation; studies of Britain’s economy find that higher pay helps firms retain workers.
And even though targeted tax credits are cheaper than across-the-board cuts their costs add up: the British exchequer spent £30 billion boosting low pay like this in 2013-14, more than twice what it paid a decade earlier. A recent report from the Centre for Labour Research and Education at the University of California, Berkeley, calculates that between 2009 and 2011 America spent $227 billion (around 6% of the annual federal budget) on top-ups for low-paid workers. Two major outlays—tax credits ($67 billion) and food stamps ($71 billion)—aim to pep up purchasing power directly. The other—Medicaid ($83 billion)—offsets the fact that companies provide less health insurance than they did, with coverage falling from 67% to 59% of workers between 2003 and 2013.
A third approach—higher minimum wages—would shift the burden back to firms. The legal floor to pay varies a lot across the G7: Italy has no minimum; France tops the pack at €9.61 (see chart 3). Many on the left would like to see higher rates. In America, Barack Obama wants the minimum wage boosted by nearly 40% to $10.10. In Britain, the Scottish National Party wants to hike the minimum to £8.70; the Living Wage Foundation, a think-tank, reckons workers outside London need £7.85 an hour and those in London £9.15—41% above the current minimum.
In general, setting floors and caps to prices is risky. Energy-price caps can stop firms investing in power stations, wage floors can stop them from hiring workers. France’s lofty minimum wage comes with high unemployment. Yet most studies suggest that at moderate levels they do little to worsen unemployment. A study focusing on employment and wages during Britain’s sharp recession of 2009, carried out in 2012 by Mark Bryan, Andrea Salvatori and Mark Taylor of the University of Essex, found no evidence that the minimum wage prevented firms hiring. Left-leaning think-tanks reckon politicians should go further: American cities, free to set their own pay floors, often demand wages well above the federal minimum, and a 2011 study of San Francisco, Santa Fe and Washington, DC, by John Schmitt and David Rosnick of the Centre for Economic and Policy Research found that this had no impact on employment.
Work must be a route out of poverty, not a way to stay stuck in it. To that extent new political interest in stagnant and falling pay is welcome if it really boosts what poorly paid workers take home while not deterring job creation. But although the new world of ultra-flexible labour markets has its flaws, those on the left looking for a restored rigidity are playing a dangerous game: the unemployment that could result would help neither those rendered jobless nor those scraping by.