Despite low unemployment and high inflation, fears that tight labour markets will drive inflation higher are misplaced.
The US Federal Reserve holds a dual mandate of maintaining full employment and price stability. It should thus be little surprise that the present moment of tight labour markets and significant inflation are of great concern to some economists, who worry labour market-induced price increases are on the way.
First, labour markets do indeed appear to be tight. Continuing claims — a measure of the aggregate number of people on unemployment benefits — fell by just under 1.5m in the first two weeks of March and unemployment currently sits at 3.8%. Some of this is a consequence of roughly half a million people leaving the labour force during the pandemic and not returning. Yet many employers are nonetheless struggling to fill vacancies.
This has made some economists, such as Sung Won Sohn, a professor at Loyola Marymount University, argue that the US has surpassed full employment and that ‘many firms reported raising wages and passing the higher labour costs through to final prices.’
These fears appear misplaced. There are five reasons to believe that the low US unemployment rate will not spur the real wage growth and inflation we might expect under Phillips curve dynamics.
- Monopsony and a lack of labour market competition: A recent report by the United States Treasury focused on labour market competition. It found that, starting in the 1970s, there was a distinct transfer of power from workers to corporations. One of the chief reasons for this, cited in the report, is the presence of monopsony employer power, as mergers between companies and the offshoring or automation of middle-wage work harmed labour market competition. This meant that a growing share of workers were living in regions or cities with a smaller number of good employers. There has also been considerable domestic ‘outsourcing’, where traditionally solid middle-class jobs are contracted out. For example, companies may no longer hire janitorial services and instead contract individuals that tend to receive less pay due to weaker bargaining power as well as fewer benefits. Economists Arindrajit Dube and Ethan Kaplan, cited in the Treasury Report, estimate that outsourcing among janitors and security guards reduced wages by 4%–24%.
- Anti-worker employer practices: The Treasury’s report also highlighted how employers have developed new devices to suppress worker power, wages and flexibility. This includes, for instance, imposing restrictions on where an individual can work after employment, which limits their ability to seek higher-paying jobs in their field. In the case of no-poach agreements, employees are not represented as part of the pacts between competing companies. A recent paper by Daron Acemoglu, Alex He and Daniel le Maire found that managers with a business degree reduce their employee wages within five years by an average of 6% and the labour share declined by 5%. These business managers did not have a greater ability to increase sales or profits and are less likely to share corporate income with workers.
- Low levels of unionisation: Union membership has been in precipitous decline since the 1970s. From 1973 to 2007, union membership declined from 34% to 8% for men and from 16% to 6% for women. Such a decline was the consequence of a concerted policy effort — exacerbated by conservative ideological movements and globalisation — to undermine and weaken labour unions. This has been a substantial contributor to inequality in hourly wages and it has reduced worker bargaining power. As recently discussed in a panel OMFIF hosted, there are some auspicious signs that point to greater levels of collective bargaining, such as during the 2018-19 teachers’ strike and the more recent Starbucks strikes in Buffalo and Denver. Yet, the tendency continues to overwhelmingly be one oriented around stifling workers’ ability to collectively organise, suppressing wages.
- Significant socio-economic vulnerability: These anti-worker policies and practices combine with the significant levels of private leverage and socio-economic vulnerability many workers experience. Roughly 40% of Americans have trouble paying for food, medical care, housing and other utilities. Nearly half of Americans have no retirement savings. 63% of Americans could not afford an unexpected $500 emergency expense. And 70% of college graduates have $15,000 or more in outstanding student loans. The consequence is elevated risks associated with leaving ones’ job, rocking the boat to ask for higher wages or abstaining from work to get employment on better terms.
- Employment polarisation due to digitalisation and globalisation: Perhaps the most significant contributor to reducing worker power has been the emergence of skills-biased technological change and the offshoring of labour. As scholars such as David Autor and David Dorn have demonstrated, both outsourcing and digitally enabled automation of labour tend to erode middle-wage and middle-skill occupations the most. The resulting bifurcation of wages in the economy and shrinking of the middle class have led to a glut of low-wage workers in the US and a growing share of Americans out of the labour force. These dynamics serve to make the experience of the labour market for millions of Americans one that is far looser than Department of Labor data might otherwise imply.
These five elements have been vital to the reduction of worker power since the 1970s and are responsible for the considerable productivity-pay gap in the US. Real wages for most workers are not growing fast enough to offset inflation. Consequently, the most significant challenge current labour market-inflation dynamics pose has little to do with the prospect of higher real wages for workers. On the contrary, the great danger of this current bout of inflation is that worker pay will not increase fast enough, while panic about rising wages will lead to an overly reactive policy response and more cautious hiring.
Julian Jacobs is an Economist at OMFIF.