Why you should be afraid: the next recession is likely to include wage deflation
by New Deal democrat
Why you should be afraid: the next recession is likely to include wage deflation
Beginning 3 years ago, I identified poor wage growth as the shortfall in the economy that worries me the most. And it still worries me, even though there has been some modest improvement.
Why? Because unless there is enough of a cushion, the next recession, whenever it comes, there is a significant danger of outright wage deflation. And as we know from the Great Depression, outright wage deflation means that payments on previously contracted debts become, in real terms, higher. This can lead to a vicious spiral of debt-deflation, whereby more and more people fall behind on debt, leading to a further economic contraction, more unemployment, and even more wage deflation, and so the cycle repeats.
So why am I particularly concerned now? Because a decline in wage growth is a feature of virtually all recessions. And we may start the next recession from such a low level of wage growth that the decline in wage growth turns into an absolute decline.
Here’s the data.
Below is a graph of the YoY% change in average hourly wages (a mean measure) for the last 50 years (blue), and also median usual weekly earnings, a quarterly measure, since the start of the series in 1979 (red):
We are 6 years into this economic expansion. Six years into the last 3 expansions, nominal wage growth already exceeded 3% YoY, and ultimately exceeded 4%. This time, both average and median wage growth is under 2%. Simply put, wage growth is likely to decline by more than that whenever the next recession hits.
More specifically, with only one exception (1974), growth in average hourly wages declined substantially during each recession. Similarly, with one exception (1991), growth in median weekly wages declined substantially during each recession as well. Below I have broken out this data in chart form, showing the pre-recession high and recession or post-recession low in both average and median wages, as well as the net change, for each recession since the start of each series:
*Series inception: actual previous high might have been higher
As of now, the highest growth of average hourly wages YoY since 2009 has been +2.5% in August 2014. In 3 of the 7 most recession recessions, growth in average hourly wages have declined by more than that.
Even worse, the highest growth of median weekly income since the end of the Great Recession was +2.9% in Q1 3014. In every recession except possibly one since the inception of the series, median wages have dropped by more than 2.9%. In other words, if the next recession has a similar footprint, median weekly income is going to go into absolute decline.
Hopefully this economic recovery continues for quite a while, and hopefully nominal wage growth improves substantially from here. But if it doesn’t, or it doesn’t improve enough, we are likely to cross from wage growth into wage declines in the next economic downturn, with the distinct possibility of triggering a debt-deflationary spiral.
We barely escaped such a spiral in 2009. Here is an article by Mike Shedlock: Wage Deflation is starting in, from March 27, 2009, listing 14 companies that had announced wage cuts.
Are you scared now?
cross posted with Bonddad blog
Scared? Who? Me?
My concern is that there are politico’s who see the wage decline, the shift in share of income and the fact that those effected by both to their detriment are living via debt but they don’t seem to understand just why this has to change. Instead we keep getting proposals based on some past fantasy of the rise of industry in this nation and the garage started business along with tax code give backs as the solution and some safety net stuff (if not destroyed first).
None are talking about the true needed solution which is a raise in the power of labor to extract more of the income thus balancing such against capital and the means by which government can make this happen.
None are talking to the people about why this has to happen in our economy in the broad sense of understanding how an economy works. That is knocking big chips out of this fantasy free market meme that all have bought into to some degree.
Eighty years ago a pretty smart guy told us to watch out :
“When the rate of interest has fallen to a very low figure and has remained there sufficiently long to show that there is no further capital construction worth doing even at that low rate, then I should agree that the facts point to the necessity of drastic social changes directed towards increasing consumption. ”
FDR accurately comprehended what was meant by ” drastic social changes ” – to the great benefit of the US and the rest of the world. Today , all involved appear to be totally clueless.
Not only would I not be afraid of it but I would welcome it. Nothing wrong with wage deflation if, in fact, your wages are artificially high relative to the market fundamentals that would allow you to compete effectively.
Years of perverse credit creation by central banks around the world, combined with the distorting effects of restrictive regulations and welfare (both corporate and individual) have so warped the labor markets here and elsewhere that wages are artificially high relative to what they really should be in the absence of such credit creation and governmental intervention.
As with the Great Depression, and efforts then to keep wages buoyed, the result was economic disaster. Wages (and asset values) need to reset, it is what market forces have been trying to do since the turn of the century.
Nothing wrong with a decline in real wages if labor is overvalued. Bring it! Let the malinvestment liquidation and labor wage corrections begin.
You state, ‘None are talking about the true needed solution which is a raise in the power of labor to extract more of the income thus balancing such against capital and the means by which government can make this happen.’
The return to capital is set by the global market since capital is highly fungible and mobile and competes globally. Why would anyone invest in America if they are going to get less than a fair market rate for their investment relative to labor? It would just go elsewhere where the ratio still holds.
Labor cannot, in the long run, extract more than it is worth and collective bargaining does not make it worth more.
The real problem with wages is that the government is trying to fight market forces that require that they be lower. Let them drop.
Or, if you really want a solution, attract more capital. Capital-intensive economies tend to provide the highest wages. More capital chasing fewer wage earners in the quest to make profit. Adopt policies that encourage more capital to flow into the US. Drop corporate taxes, drop capital gains, reduce market distorting regulations (not all of them) and sit back and watch labor benefit as all that capital chases labor to produce a return. The lower taxes and regulations will reduce the hurdle rate for companies to get a fair return and more businesses will prosper. It is the increased competition for labor that drives up real wages…not some government mandate that artificially empowers labor to seek more than a fair market rate.
Because direct labor cost is a very small ratio of the cost of manufacturing as compared to Overhead or Materials. Capital is a sunk cost which is depreciated rapidly dependent upon what schedule one uses. Attracting more capital will not automatically insure a higher proportion of Labor. What you are arguing is a return to the early 20th century and 19th century in a Labor environment.
You state, ‘Because direct labor cost is a very small ratio of the cost of manufacturing as compared to Overhead or Materials.’
Who cares about manufacturing? Not me. 11% of the US workers are in manufacturing, give or take. I am talking about labor in general and in the US; the highest paid labor is in the service industry, lawyers, doctors, engineers, professors, etc, not semi-skilled labor woking on a production line. All labor gets bid up in economies that are capital intensive…no matter the economy you look at: Switzerland, Hong Kong (almost no manufacturing), Singapore, USA, Germany, Sweden, etc. More money chasing same amount of labor = higher wages.
That being said, manufacturing labor benefits the most from capital investment because it is capital that makes their labor worth more. Capital is invested in mechanization and robotics which makes less labor more valuable in the production process. No capital investment in these labor-productivity-increasing machinery and robotics and your labor becomes simply brute force labor…that is no different from brute force labor in India…and hence worth Indian wages. The car industry is able to pay higher wages because of capital investment that makes it more productive, not because labor somehow miraculously started providing more value per hour worked devoid of this investment in capital improvements, right?
Want higher wages…attract more capital formation and investment. Problems solved.