If wage inflation is good for you

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Happy 2023 and welcome back to Free Lunch. I hope all readers had a relaxing break.

In my last column before the break, I warned central banks against inevitably viewing rapid wage growth as an inflationary threat, which requires tighter monetary policy to curb jobs and income growth. It might instead reflect a more competitive labor market – that is, more competitive for workers. If more workers than before are moving from lower-paying to higher-paying jobs, then wage acceleration is a welcome indicator of an equally welcome redistribution of labor towards more productive occupations. (After all, the employers that workers are transferring to could only pay those higher wages if productivity warranted it.)

I was only able to refer to this in passing in the column, so I want to give more credit to the excellent recent research that suggests this is what is happening, at least in the US. Last month, MIT’s David Autor presented the results he, along with Arindrajit Dube and Annie McGrew, obtained from US Census data – you can watch his presentation for yourself here. I want to highlight four of the most telling graphs from the slide deck.

First, wage growth for the low paid has been much stronger since the pandemic began, significantly reversing decades of widening wage inequality:

This recent wage compression has been broad-based: it has occurred between occupations, between young and old, between the less and more educated, and in favor of minorities.

Second, despite high inflation, low earners have still seen real wage growth:

(This is true even for the shorter period of just the last 12 months.)

Third, people are switching between jobs much faster than before the pandemic:

And job mobility has increased, particularly among young workers with little formal education; ie, those who used to be most likely to get stuck in bad, low-paying jobs.

Fourth, by far the fastest acceleration in wage growth is among those who change jobs, rather than those who remain in office:

Note that the chart shows two different things: that wage growth is always higher for job movers, and that this advantage over job stayers has roughly doubled in the current strong labor market.

This should make us reconsider the standard story we’re being told by a dangerously “tight” job market. For one, common indicators of overheating may not be telling what we think. In particular, high vacancy rates may not be a sign that excessive demand is pushing up prices, but rather reflect disengaged workers (particularly low-wage workers). Because the more employees move, the more likely it is that employers will be looking for new staff. So we should expect a higher vacancy rate at any given level of aggregate demand. (Actually, alternative measures of job vacancies suggest the US labor market is less “squeezed” than traditional metrics suggest.)

Basically, if greater job mobility leads to higher productivity—as Autor and his colleagues argue—then current labor market dynamics should expand the productive capacity of the economy. That would be a force for lowernot higher prices – and thus a reason for the central banks to loosen rather than tighten monetary policy.

However, this speculation boils down to the fact that a productivity surge has been difficult to see in the numbers so far (unlike at the start of the pandemic). Like a recent New York Times Story shows, many companies find that higher employee turnover temporarily lowers productivity because more time is invested in training.

But the key word here is “temporary”. Check out the US output per hour worked in the chart below: It declined in the first two quarters of 2022. But that drop came after a spike in the early pandemic that lasted more than a year. (Productivity picked up slightly across the private sector as a whole in the third quarter of 2022, but continued to decline among non-financial corporations.)

Line chart of US production per hour worked, 2012 = 100, showing American productivity holding up well during the pandemic

So examine how productivity has evolved over the entire period of the pandemic, including shutdown and recovery. Looking at the available data for the last three years, from the third quarter of 2019 to the third quarter of 2022, non-agricultural corporate output per hour worked increased by 1.6 percent annually (1.3 percent for the non-financial corporate sector). That was about the same rate of productivity growth as in the previous three years and faster than the average rate over the previous 12 years (a period that included the previous major crisis). So productivity remains at or above pre-pandemic trend. Given all the disruptions over the past three years, that’s a strong record.

I met with Dube, one of the researchers, to find out more. (Free Lunch has previously presented his work on minimum wages and supplemental unemployment benefits in the US pandemic era.) He said their interpretation of the data was indeed that workers were moving from lower-productivity jobs to higher-productivity jobs, but he wondered if we that should expect it to show up in aggregate productivity data amid “all the background noise” of closures and reopenings. He suggested there could also be “growing pains” related to hiring and training: “Meanwhile, new hires might not be as productive in the short term.”

So we should watch how the productivity data develops. But there is at least reason for optimism. And – in my view at least – adequate room for caution in central bank tightening. Dube pointed out that the “usual story of how a wage-price spiral can take hold is that inflation expectations change and workers negotiate higher wages.” But job stayers, he says, “haven’t [had] unusually high wage growth. It’s all driven by job-changers.” That, Dube says, “limits the scope of inflationary pressures” from actually observed wage increases.

To reiterate, these results apply only to the US economy. While most of Europe also has historically high job vacancy rates, I have not been able to find any timely data on job turnover to see if this rate has also increased (Free Lunch readers, please send me any leads). While this benevolent view of wage growth is correct for the US, it is not so clear for Europe. Dube points out that stricter minimum wage laws mean Europe has fewer of the low-paying jobs that are driving his team’s results in the US. And another “reason why it may have happened more often in the US is that we were pursuing what ironically appeared to be a worse way of helping at the time” — which was making people lose their jobs and pay unemployment benefits, rather than having vacation-paying jobs to protect.

Other legibility

  • During the Christmas break, I noticed a few surprising pieces that, in different ways, reflect the biggest economic and political issues of the year just ended. Start with the wonderfully whimsical way Cinderella reflects protectionist industrial policies: Charles Perrault, who wrote the fairy tale of the girl with the glass slippers, was also responsible for furnishing the Palace of Versailles – including its Hall of Mirrors – and for establishing a national glassworks to ensure this in times of economic patriotism (today we would say ” Reshoring”) The Sun King’s most spectacular ballroom was furnished with local products.

  • Meanwhile, global automakers are quietly cutting ties with China.

  • My colleague Jemima Kelly, who always saw the crypto bubble for what it was, writes about what the year in crypto has taught us.

  • Stories from the coal mine, or rather the factory floor: How European manufacturers are coping with high energy prices and how a Chocolatier uses robots cope with labor shortages.

  • China’s about-face in Covid-19 policy may have an unexpected source: how the zero-Covid approach exacerbated inequality.

  • History-loving Vladimir Putin somehow never mentions Nicholas I, the dead Tsar he resembles the most.

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  • The IMF has warned that a third of the world economy will enter recession this year.

  • The ‘idiot premium’ that sent Britain’s borrowing costs soaring after September’s ‘mini’ budget has largely disappeared from gilt yields – but not from mortgage rates, says Chris Giles.

  • Inflation in Germany, France and Spain is slowing more than expected. Who would have thought?

Line chart of fixed rate mortgage rates (all LTV) and OIS rates (%) showing that mortgage costs have decoupled from underlying money market rates

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Adam Bradshaw

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