The Economy's Persistent Impasse

 | Feb 29, 2012 | 5:00 PM EST  | Comments
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As many readers know, I have been concerned that workers' wages have not been growing. Real weekly wages have fallen by 0.9% since their nearby peak in October 2010. Consumer spending is important; it accounts about two-thirds of our economy. But the only way consumer spending can grow is if workers see bigger paychecks.

While consumers can, of course, take on more debt or save less, the savings rate is a low 4%, and increasing credit-fueled consumption would only lower the savings rate further. By comparison, for many decades the savings rate had been in the 8% to 10% range, up until about the early 1990s, and workers need to replenish retirement accounts.

Although the stock market has rallied since its low, that doesn't mean that 401(k) accounts have increased in tandem. According to the Employee Benefit Research Institute, the average 401(k) account balance in 2010 (the latest figures available) was $60,329, compared with the high of $65,454 in 2007. This reflects new contributions, withdrawals and investment performance. And according to the Federal Reserve flow of funds, total financial assets held by households and nonprofits are still 7% below the peak in 2006. This does not even reflect housing wealth, which dropped by 29%, according to these data. Overall, household net worth (assets minus liabilities) is 12% below its 2006 peak.

As more of the population nears retirement, we would expect the savings rate to increase, not decrease, as workers fund a looming retirement. As such, I would expect consumer spending to be constrained over time, as households both earn less in real terms and spend a smaller portion of those earnings. How does the consumer increase savings and increase spending when real (after inflation) wages are falling?

One may hope this trend of falling real wages is a temporary, but there is reason for concern. The Cleveland Fed did some research into this, from the perspective of the share of income going to labor compared with the share that's going to capital (i.e., business owners).

The researchers note that the share of income going to labor has been trending down. In the nonfarm business sector, which accounts for roughly 74% of the output produced in the U.S. economy, the share has decreased from values of around 65% before 1980 to the current level of 57.6%. This decline has accelerated during the last decade. Excluding the financial sector, the labor income share was more stable up to the year 2000, but it has been trending down ever since.

Basically, wages are growing slower than profits, in nominal terms. Businesses are enjoying record profits, as output has regained its pre-recession peak, but aggregate compensation is still 5% less than its peak, factoring in that there are 5 million fewer people working now than before the recession. The primary mechanism for profit growth that has far exceeded wage growth is that the benefits of higher productivity have accrued to business owners, rather than to labor.

The reasons for this, the researchers note, are threefold. One is that labor has less bargaining power, because of lower unionization rates. A high rate of unemployment means that workers and job hunters are price-takers, not price-setters, and are likely to accept the wages that are offered, given a dearth of other opportunities.

Another is that labor-intensive jobs, including skilled labor, are migrating to lower-cost nations as companies offshore some of their facilities. These can range from manufacturing plants to call centers.

A third reason is that technological change has enabled companies to increase productivity -- output per unit of labor -- by offering online banking and airline reservations, to name two simple examples. A company simply doesn't need as many employees to generate the same amount of revenue, and the result is that profits expand while total compensation does not.

Here's where we get into a bit of game theory and depart from the Cleveland Fed's research. Companies wishing to expand domestic revenue would hope that consumers' incomes would increase to drive more sales. But for them to pay their own employees more when their competitors do not means that their profits relative to their peers would then suffer. So employers want other companies to give pay raises to their workers before they give their own employees more money. It seems almost like a game of chicken, for lack of a better analogy.

How do we break from this impasse? That is probably the biggest challenge. For workers to have more bargaining power, there needs to be more of a demand for labor and less of a supply. In other words, unemployment must come down. Meanwhile, companies cite a lack of demand as a primary reason for not hiring, but demand is lacking because workers' real incomes are not growing.

Talk about a Catch-22 that I really don't think anyone knows how to solve. In the meantime, given all of the factors above, I don't see how consumers can meaningfully increase their spending at the same time they play catch-up to their retirement savings needs. This is a longer-term theme extending well beyond just the current quarter or two.

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