Janet Alvarez: Economic discussions during election years tend to focus on issues affecting the American worker, and this year is no different. The spotlight is on wage growth, and in this installment we’ll explore wage growth since the Great Recession and its impact on markets, business and investors.
You’re listening to the Insights & Ideas podcast brought to you by Charles Schwab. I’m Janet Alvarez. Slow wage growth is a consequence of most recessions, but during the current economic recovery, there has been concern that growth has been unusually slow.
Schwab’s chief investment strategist, Liz Ann Sonders, will help us make sense of the wage growth issue. She says the numbers may not be as bad as you think, and explains the surprising reasons why.
Hello, Liz Ann, and thank you for joining us today.
Liz Ann Sonders:
Thanks for having me.
As you know, investors have been overwhelmed with stories on slow wage growth since the recession. And it’s become an especially contentious topic during this election year. When you look at the wage growth numbers, what are you seeing? How much do today’s wage growth numbers actually differ from previous recessions?
They do differ for one primary reason. I think the reason why it has been so contentious is that the slide in wages that came toward the end of the recession and into the very early stages of the recovery was not terribly abnormal. But the pace of improvement since then has been what’s abnormal. So if you look at past recoveries in the economy and recoveries in wages, they tended to have sort of a V-shape to them. You tended to get to the bottom, and then the move back up in terms of growth was pretty swift.
And that has been decidedly not the case this time, where wages bottomed in 2010 and for several years really flatlined before only recently starting to pick back up.
So are today’s wage growth statistics accurate, or are we perhaps not seeing the complete picture?
Yeah, I think that that is absolutely part of the story.
And in March of 2016 the Federal Reserve Board of San Francisco put out a pretty interesting economic letter. This is a regular series of papers that they put out. And what was found in that research was that changes in the composition of the workforce actually propped up wages during the Great Recession. Again, if you look at average hourly earnings, you’ll see for the bulk of it, wages were actually going up. And that is obviously despite a significant increase in what we call labor market slack.
And the reason why earnings actually went up was because of a disproportionate firing of lower-wage workers. So employers basically got rid of, in most cases, the more marginal workers who, by their nature, were probably at the lower end of the wage spectrum. And the mix of workers that kept their jobs during the recession were those folks who generally had a higher level of skill, which in turn probably meant a higher level of wages.
So that moderated the overall decline in wages. And that impact was even more distorted because hiring slowed so dramatically. So when you don’t have hiring, new entrants into the workforce tend to earn lower wages; you keep the higher-wage workers in the workforce. That actually had the effect of increasing wages. So it was sort of an odd thing that happened. And now we have the opposite occurring.
Job growth has been improving. Contribution from wage growth from those who are continuously full-time employed, that has actually increased. But now we’ve got workers coming back into the workforce. And in some cases, you’ve got part-timers moving back to full-time jobs. Those workers tend to earn less than the typical full-time employee. So that actually has the effect of bringing down average wages. So you had a distortion during the recession that oddly caused wages to go up.
And I think you’ve had the opposite distortion so far through this recovery, which has kept wage growth in traditional measures down.
What other sort of cyclical factors are impacting today’s wage growth figures? I’ve heard talk of the retirement of the boomers, and millennials now entering the workforce, sort of skewing the statistics again. Can you speak a little bit about those factors?
The portion of workforce exits coming from the boomers, which tend to be above median wages, as that goes higher, it reflects the higher earnings of older workers. So you’ve got older workers who, by their nature, have been working a lot longer—call it, I don’t know, 40 years—they’re exiting the workforce. Now the millennials are entering the workforce.
And a lot of people don’t realize that the millennials are sometimes called the “echo boom” generation, the children of the baby boomers. They’re increasingly coming into the workforce. By nature of their age, they’re coming into the workforce at a lower wage level. So you’ve got higher-wage earners leaving the workforce. You’ve got lower-wage earners coming into the workforce. So again, the aggregate numbers are then suppressed by virtue of how the math works. So there’s definitely a demographic angle to this unique nature of wage data in this cycle.
Understanding wage growth and markets, by the numbers. One of the underestimated reasons for changes in wage growth is the rate at which companies are hiring new, younger workers. That difference can be quite pronounced.
Workers under the age of 25 with a college degree made $34,736 a year on average in 2014. But workers 25 and older with a college degree made $62,036 a year, almost double that, according to the Bureau of Labor Statistics.
It sounds like an increase in wage growth may impact investors in two ways: There’s an impact on the broader economy through potentially higher interest rates and possible inflation. And there’s a potential impact on equities through potentially thinner profit margins. Is that an accurate description of the scenario we’re facing?
It is accurate. I will say, though, that if you look at the long history of peaks and profit margins, they’re not necessarily big negative periods for the stock market.
It really depends on if profit margins peak, and they just slowly revert toward some long-term mean; that environment is actually not bad for the equity market. Typically, stocks have continued to do somewhat well in that environment. The opposite of that would be if profit margins are peaking and you’re heading into a recession, or profit margins are really going into a tailspin, that’s the most negative environment for the stock market. So just seeing a peak in profit margins isn’t necessarily a bad thing, unless it looks like an upside-down V and that peak is leading into something protracted and pretty steep on the downside.
And looking at the broader global macroeconomic picture, are there any comments that you can make regarding sort of the global macroeconomy and issues pertaining to trade and so forth that might impact the economy here, the American worker’s ability to demand higher wages?
Well, I think that we are in, call it midterm perpetuity in a slow growth environment, not just in the United States but globally. And there’s lots of discussion as to what the primary reason for that is. Are we in some sort of long-term secular stagnation? Or is this just the aftermath of what was a pretty significant debt bubble?
They may be one and the same in terms of implications longer term for the global economy. But I tend to think it’s best defined as this post-debt bubble environment, or sometimes called post-debt super cycle environment, where this was not just a U.S. problem leading into the financial crisis, but it was a global problem where debt levels across the board—public sector, private sector, corporate sector—had really just accelerated into the stratosphere.
And I think what we saw back in 2008 and 2009 was just the initial prick of that bubble. It had the effect of causing a global financial crisis. And since then, I would argue, we’ve been in a series of rolling crises. It’s certainly hit the U.S. hard and forced an era of deleveraging in terms of the U.S. private sector, U.S. households, even corporations, that was pretty significant and maybe closer to its finale than its beginning. But we haven’t even started the process of unwinding some of that debt in terms of the public sector.
I would argue it hit maybe second in Europe. And we are still in the midst of seeing the unwinding of the debt bubble there. And I think in emerging markets, too, even in places like China, they are going through their version of crises associated again with this debt bubble that really was about a 30-year build from the early 1980s. And the broad effect that that has had is crimping economic growth. High and rising burden of debt just crowds out the ability for an economy to grow.
And I think that’s not an environment we are exiting any time soon. And therefore, I think the expectation for overall global growth will continue to be subdued.
What sort of factors would we need to see, Liz Ann, in order for wage growth to reach that sort of normal trend level?
I think we just need an overall better pace of economic growth, which, again, I think is probably somewhat limited by virtue of these longer-term secular forces weighing down. So I think that an expectation of the kind of surge historically that we have seen is somewhat limited not only by overall growth but the fact that broadly in the United States, even in the global economy, we still have a very, very low level of inflation.
Disinflation still is a fairly significant macro trend. And in some countries—not the U.S.—deflation is still a force. And I think that limits the kind of wage growth that certainly would feel good for us. Wouldn’t necessarily be a good thing in terms of the inflationary implications, but I think getting to that point in this cycle is very limited.
Liz Ann, thank you very much for speaking with us today.
The year was 1972, the Vietnam War was drawing to a close, and the Watergate scandal was just about to rock the nation. The Godfather lit up the silver screen, the Dow peaked at 1,036, gasoline cost about 55 cents per gallon, and a new house averaged about $27,000.
But an equally important economic milestone was reached in 1972: The average real wage of American production and nonsupervisory workers—the vast majority of the workforce—reached its historical peak of $811 per week in inflation-adjusted dollars per week. That’s according to data from the Department of Labor.
And though the Dow would go on to rise 17-fold, the average real wage for most employees that year has yet to be exceeded, even today.
Liz Ann Sonders is the chief investment strategist at Charles Schwab. She’s on Twitter @Lizannsonders, L-I-Z-A-N-N-S-O-N-D-E-R-S. That’s it for this installment. The Insights & Ideas podcast is brought to you by Charles Schwab. You can find us on iTunes or insights.schwab.com. Thank you for listening.