12:59 PM, May 22, 2018 — Wage growth has been the mostly missing piece of the labor-market improvement thus far, and though some industries are seeing labor costs rise faster than others, the correlation between unemployment and pay isn’t as strong as it’s historically been, Wells Fargo said in a report.
“An improving labor market historically has resulted in rising wages as the pool of available workers shrinks and employers must compensate employees with higher wages to help attract new workers,” analysts from the bank said. “Yet, since the Great Recession of 2008, wage growth has been much lower than was anticipated. This may be related to many factors, including fundamental changes in the US labor market and/or whether the historical relationship between low unemployment and higher wages still exists.”
The unemployment rate last month reached an 18-year low of 3.9% amid strong economic growth. Wages have increased since 2012, but not at the pace investors expect given the historically low unemployment rate and other signs of improvement in the labor market.
The current rate of wage growth is 2.6%, but if prior trends had held, the current level of wage growth would be 3.5% to 4.5%, the bank said. While economic growth has accelerated, labor productivity growth and inflation both remain low, making it difficult for wages to improve.
“Higher productivity increases corporate profits and also allows workers to command higher wages,” Wells Fargo said. “When inflation rises, wages tend to increase as labor contracts are negotiated or companies offer higher wages to attract applicants. The current slow pace of US inflation growth has contributed to slow domestic wage growth.”
Structural changes are also affecting improvements in pay. The oldest Baby Boomers reached retirement age in 2011, and the implications of the generation leaving the workforce will be “widely felt” as many older, experienced workers earning higher wages will be replaced by younger workers at lower wages, the bank said. As this trend continues, the exit of Baby Boomers will put downward pressure on wage growth.
The participation rate continues to decline due to the exit of Baby Boomers, but the ratio of prime age employees — those between 25 and 54 — versus the overall US population has recovered to near-prerecession levels, and that supports a healthy labor market, Wells Fargo said.
The largest gains in job growth have been in lower-wage sectors including education, health services, hospitality and leisure, also putting downward pressure on pay increases. A decline in the union base that traditionally negotiated higher wages is weighing.
Still, pay in the US should continue to improve at a “moderate” pace as factors holding down wage growth are resolved, Wells Fargo said.
“The low productivity rate currently seen in the US likely will rise as the labor market continues to tighten and new tax incentives for investing in equipment stimulate business investment,” the bank’s analysts said. “Looking ahead, the structural changes in the labor market are likely to take longer to resolve. Yet, Baby Boomers retiring from the workforce eventually will be replaced by subsequent generations.”