LOSE-LOSE? WAGE INFLATION & LABOR'S BAD BANK

SUMMARY

MINIMUM WAGE PROPOSAL ANALYSIS:

  • Its largely a lose-lose proposition for employers as a cost pass-through ultimately drags on aggregate demand while a statutory increase in wage expenses serves as a de-facto income transfer from owners of capital to labor
  • Ironically, rising demand for higher-skilled workers driven by legislated increases in the minimum wage may perpetuate a recurrent, self-defeating cycle for policy makers
  • On net, a legislated federal minimum wage increase would benefit low income families, primarily via an income shift from business owners and higher income families and would work to support consumption in the short-term while reducing per-capita GDP over the longer-term.       

WAGES & LABOR’s BAD BANK: 

  • There’s a credible case to be made for a Good Bank/Bad Bank view of the current domestic labor market and a lower level of labor slack than appears superficially.  
  • The current employment base and new workers with relevant skills (collectively “the good bank”) are in relatively good shape as initial claims base near frictional resistance and the economic stabilization matures while the long-term unemployed (“the bad bank”) remain unattached and in a terminal run-off of sorts.
  • Initial Jobless Claims continue to move along near their historical, frictional lower bound at ~300K, the NFIB “Job Openings Hard to fill” Index continues to advance,  Business Hiring Plans continue to make higher highs as does the Job Openings and Quits rate data in the JOLTS survey.
  • There’s compelling evidence that the cyclical impacts of the recession on the LFPR have largely faded, and the secular drivers of the decline in labor force participation - which began in 2000 – are again reemergent.
  • Short-term unemployed likely have a significantly greater impact on the direction of wage inflation than the long-term unemployed.
  • The broader TREND in wage growth remains positive.
  • Passivity doesn’t sell advertising and generally doesn’t drive AUM, but a little more patience and a little less manic punditry is probably the right prescription

Earlier this week the CBO released its analysis of the employment and growth impacts likely to occur should the federal minimum wage – as has been proposed by lawmakers - be raised over the course of the next three years.

Below we review the prevailing, conventional view of wage controls on labor economics, summarize the CBO’s main conclusions, and offer some additional commentary on the current state of the labor market and prospects for the slope of wage inflation.  

THE IMPACT OF WAGE CONTROLS:  THE TEXTBOOK

The scope of effects stemming from legislated wage controls are ranging but conventional economic analysis suggests a few primary, and non-mutually exclusive, impacts on employment and aggregate demand.  

  • THE SITUATION:  Facing a direct drag on profitability from higher wage costs, employers are faced with a selection of tradeoffs and a few operational options. Broadly, and in the shorter-term, they can eat the full impact of higher human capital expenses, pass on all or some of the cost increase to consumers, or attempt to mitigate margin contraction via implementation of some combination of the two.   Alternatively, if they judge they have excess capacity, employers can simply fire workers to help buttress profitability. 
  • THE IMPACT:  A pass through of costs raises the price of goods /services for consumers and, all else equal, results in lower demand.  In reflexive fashion, lower end-demand leads to lower production and, subsequently, lower demand for labor.  This negative scale effect is somewhat constrained given the percentage of the total labor force impacted by the wage controls but, in effect, represents the canonical self-reinforcing cycle that characterizes larger contractionary cycles.  
  • Note that its largely a lose-lose proposition for employers as a cost pass-through ultimately drags on aggregate demand while a statutory increase in wage expenses serves as a de-facto income transfer from owners of capital to labor.  
  • SUBSTITUTION & SKILL SHIFT:  Beyond the more immediate term, the rise in labor costs relative to other inputs of production (ie. technology) incentivize a shift towards increased use of technology at the expense of low-wage human capital.  Further, employment of higher-wage workers may increase given generally higher productivity rates and the need for higher skill/specialization to operate/manage that new technology.   

Ironically, rising demand for higher-skilled workers may perpetuate a recurrent, self-defeating cycle for policy makers as decreased/increased demand for low/high wage workers can serve to drive further wage disparity, ensuring a re-emergence of the same wage disparity dynamics lawmakers were targeting in the first place.  

CBO’s CONCLUSION:  On net, real income would increase by ~$2B. 

  • Employment:  CBO estimates that an increase in the minimum wage to $10.10/hr by July 2016 would result in ~500K fewer jobs than would otherwise be created.
  • Real Incomes:   CBO estimates that aggregate real income would increase by $5B for low-income families and lift ~900K people above the poverty line.  Further, real income for families between 3X and 6X the poverty line would increase by $2B on net and real income for families above 6X the poverty line would decrease by $17B on net.

GROWTH:  Positive in the shorter-term, negative longer-term

The marginal propensity to consume is generally higher for low-income individuals.  Thus, a legislated rise in income for low-wage employees is likely to flow through to consumption rather immediately.

However, over the longer-term, in which aggregate output is determined by the size of the labor force, the capital stock, and factor productivity, the CBO estimates a smaller workforce would lead to lower national output than would otherwise be the case.   

So, on net, a legislated federal minimum wage increase would benefit low income families, primarily via an income shift from business owners and higher income families and would work to support consumption in the short-term while reducing per-capita GDP over the longer-term.       

Source:  CBO - HERE

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - CBO Income Transfer

LABOR’s BAD BANK:  IS THE LABOR MARKET TIGHTER THAN IT APPEARS?

 

There’s a credible case to be made for a Good Bank/Bad Bank view of the current domestic labor market.  

The current employment base and new workers with relevant skills (collectively “the good bank”) are in relatively good shape as initial claims base near frictional resistance and the economic stabilization matures while the long-term unemployed (“the bad bank”) remain unattached and in a terminal run-off of sorts.

 

SUPPORTING EVIDENCE:  Initial Jobless Claims continue to move along near their historical, frictional lower bound at ~300K, the NFIB “Job Openings Hard to fill” Index continues to advance,  Business Hiring Plans continue to make higher highs as does the Job Openings and Quits rate data in the JOLTS survey (Job Opening & Labor Turnover Report).   

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - Claims LT Average

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - NFIB Hiring Plans

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - NFIB Positions Hard to Fill

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - JOLTS    Quits and Openings

Further, recent research out of the Philadelphia Fed (HERE), which analyses worker flow and non-participation data from the BLS’s Current Population Survey (CPS), offers compelling evidence that nearly 80% of the decline in the labor force participation rate (LFPR) since the beginning of 2012 is accounted for by the increase in non-participation due to retirement (which, in turn, is driven by domestic age demographic trends). 

This analysis, which sits in general agreement with our prior analysis (see: EARLY LOOK: PARTICIPATE),  suggests the cyclical impacts of the recession on the LFPR have largely faded,  and the secular drivers of the decline in labor force participation - which began in 2000 – are again reemergent.

Source:  Shigeru Fujita, Federal Reserve Bank of Philadelphia (study link above)

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - Retirement NonParticipation Trends

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - LFPR HE

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - LFPR by age

So, there exists a fairly steady drumbeat of improvement across a range of labor market metrics. 

 

 

DOES A TIGHTER (than it appears) LABOR MARKET AUGUR RISING WAGE INFLATION?

Recent research from the NY Fed  (Here) examining the impact of unemployment duration on compensation growth suggests that long-duration unemployed exert less of an influence on wages than short-duration unemployed. 

In the context of a good bank/bad bank labor market model, evidence that short-duration unemployment exerts a disproportionate influence on compensation growth argues that labor market slack may be less than total unemployment figures suggest and inflationary wage pressures greater.

CHICKEN OR EGG?  Inflation, however, is generally a lagging indicator and wage inflation vs. broad price inflation presents as a chicken or egg problem.  Specifically, can you get wage inflation without rising prices or accelerating demand? 

On balance, evidence supporting wage pull inflation – rising wages sparking broader price inflation via a wage-price spiral - isn’t particularly convincing.  Most arguments for higher wages causing higher prices pre-suppose higher demand or fail to address the initial reason wages increased to begin with. 

Indeed, wage and unit labor cost growth moves largely in tandem with broader measures of price inflation and discerning the direction of causality isn’t clear. 

Overall, it’s hard to argue for any material/sustainable wage inflation in the absence of a broader rise in prices or without rising demand or an acceleration in credit expansion and/or corporate investment.    

Source: Linder, Peach, and Rich (study link above)

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - Wage Unemployed Duration 

SURVEYING WAGE TRENDS  

Despite near universal lamentation about the lack of wage inflation, the Trend in salary and hourly earnings growth has been positive.  Below we profile a number of the primary measures of wage growth.  Generally, on both a 1Y and 2Y basis the slope of improvement remains positive across each of the metrics.    

Pulling the charts back, however, reveals the chief source of economist discontent.  While we’ve experienced consistent, ongoing (albeit slow) improvement in wage growth, we remain well below historical averages. For example, nominal earnings growth for production and nonsupervisory employees currently sits just above 2% vs. a long-term historical average of ~3.1%.   

  • Real Wage Growth for Non-Supervisory Employees:  The plight of middle and low income earners has been well advertised and the chart below has been well circulated.  As can be seen, while the trend in growth has been positive over the NTM, real wages for production and nonsupervisory workers haven’t advanced in over four decades.
  • Private Sector Wages:  On both a 1Y and 2Y basis, real hourly earnings of private sector workers continues to improve.  
  • Aggregate Private Sector Salary & Wage Income:  The combination of employment gains and wage growth continues to support growth in aggregate private sector salaries and wages with growth currently running +5% on a 2Y basis.   Notably, State & local gov’t employment growth  has been positive for 5 straight months now and December’s budget deal which modified sequestration was spending friendly on the margin – so there’s some positive momentum for wage & salary income.

 LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - Nominal Hourly Earnings Produciton and Non Supervisory Employees

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - Hourly Earnings Produciton and Non Supervisory Employees

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - Hourly Earnings Private

LOSE-LOSE?  WAGE INFLATION & LABOR'S BAD BANK - Private Sector Salaries   Wages

PATIENCE OR PROTRACTED PENURY?

 

The frustration and impatience on the pace of the recovery that pervades media reports and pundit commentary offers an interesting juxtaposition against the almost universal acknowledgement that balance sheet crises and the back end of long-term credit cycles invariably augur protracted periods of sub-trend growth.  

We’ve purposefully offered a one-sided take highlighting the evidence that the labor market may be tighter than it appears superficially and there are certainly credible arguments supporting the case for secular stagnation.  There’s little argument that the pace of the recovery remains stubbornly slow, but broader labor market trends remain positive. 

Passivity doesn’t sell advertising and generally doesn’t drive AUM, but a little more patience and little less manic punditry is probably the right prescription 

Christian B. Drake

@HedgeyeUSA