Wages growth is weak due to widespread underemployment, study finds

Federal
Reserve Board Chair Jerome Powell arrives to testify before the
Senate Committee on Banking, Housing, and Urban Affairs on ‘The
Semiannual Monetary Policy Report to the Congress’, at Capitol
Hill in Washington on Tuesday, July 17, 2018.
AP/Jose Luis Magana

• Federal Reserve officials have long been baffled by the
  absence of wage growth for median US workers despite a
  long-standing economic recovery that has sharply lowered
  unemployment to 3.9%.
• A new paper offers a convincing hypothesis for the
  Fed’s conundrum: underemployment and weak bargaining power for
  workers is more rampant than the official data
  suggest. 
• “There’s more labor slack then you think and therefore
  it’s an error for the Fed to raise rates,” David Blanchflower,
  a former Bank of England member and the paper’s co-author, told
  Business Insider.

Federal Reserve Chairman Jerome Powell has often expressed
surprised at the lack of wage growth for US workers despite a
historically low jobless rate below 4%.

“I certainly would have expected wages to react more to the
very significant reduction in unemployment that we’ve had,”
Powell told reporters
during his last press conference, held after the Federal Open
Market Committee raised interest rates again in June.  “So
it’s a bit of a puzzle.”

The Fed chairman should take a look at a new paper from David
Bell of Stirling University in Scotland and David Blanchflower,
former Bank of England member and Dartmouth College professor.
There, Powell will find a simple and convincing answer to his
puzzle: the job market is really not as hot as the headline
unemployment figure makes it look, leaving workers without the
requisite bargaining power to ask for raises.

“The explanation the others have is that it’s coming — but
it hasn’t. We have an explanation: There’s more labor slack then
you think and therefore it’s an error for the Fed to raise
rates,” Blanchflower told Business Insider.

“In the post-recession period underemployment has replaced
unemployment as the main indicator of labor market slack,” Bell
and Blanchflower write. “Underemployment has not returned to its
pre-recession level in many countries, whereas unemployment
has.”

And the phenomenon extends well beyond the United States to
other rich nations in Europe.

“Large numbers of part-time workers around the world, both
those who choose to be part-time and those who are there
involuntarily and would prefer a full-time job, report they want
more hours,” write Bell and Blanchflower. 

Most workers and job seekers are all too familiar with this
pattern. In a post-Great Recession world, not only was there wage
disinflation there was also requirement inflation — employers
were able to get a lot more qualified workers for a lot less
money. And those effects have lingered, in addition to worrisome
trends like involuntary part-time work,
contract and temp jobs, and job creation centered in
low-wage industries. 

The official US jobless rate has fallen sharply from a
crisis peak of 10% to just 3.9% last month. Underemployment as
measured by including “discouraged” workers who are no longer
seen as actively looking and those who are “part-time for
economic reasons,” (as in, not by choice, and measured by U-6)
has also fallen steeply.

However, Bell and Blanchflower argue even these measures
are inadequate because they fail to capture not only job quality
but also workers who might be content with working less than full
time but would like more hours than they are currently working.
They use US census figures to close that gap and gauge how much
more demand for more hours might have gone
unreported. 

Their findings help explain why annual wage growth
remained notably soft at 2.7% in July,
the same pace as the prior two months and well below the 4%-or so
clip economists would normally associate with a jobless rate this
low.

The already-modest wage gains are also starting to be
eroded by a gradually rising inflation rate, which remained
stubbornly below the Fed’s 2% target for
much of the recovery in another sign of underlying economic
weakness.

“Underemployment is pushing down on wages while the
unemployment rate contains little or no information on wage
pressure at such low levels,” the paper says. “Even though the
unemployment rate is at historic lows in many countries this
still does not suggest that these country’s labor markets are
anywhere close to full-employment.”

Unlike Fed officials, who believe the US economy is

at or beyond “full employment,” Blanchflower estimates the
jobless rate could drop to as low as 2.5% before any substantive
wage gains materialize.

The problem is “amplified
by weak unions, that have seen their membership decline
around the world, which reduces workers’ bargaining power.
Underemployment may be partly caused by the weakness of worker
bargaining power.”

The Fed has raised interest rates several times starting in
December 2015 to a range of 1.75% to 2%, and is expected to
continue lifting borrowing costs over the coming months and
potentially next year. But Blanchflower thinks this is a policy
error that could prematurely crimp the recovery.