Looking into underlying fundamentals behind the sluggish US economic recovery, we find that slow wage growth is central.
Modest income gain largely explains why real consumer spending struggled to regain its pre-recession luster almost five years after the end of the crisis. Indeed, with real personal disposable income growing at an average annual pace of 1.9 percent since 2010, it is no surprise that real household outlays have not breached the 3 percent mark on a consistent basis.
The shortfall in income has meant that increases in household outlays have had to be financed through credit, savings, and wealth. On the credit front, conditions appear to have turned more favorable, and US households are gradually rekindling with their credit cards. But credit standards remain tighter than pre-recession.
On the savings front, we have seen a gradual yet steady decline in the savings rate as US consumers have had to dip into their savings to finance their outlays. This situation however is not sustainable in the long run. Similarly, wealth-financed spending is also unsustainable and only favors the wealthiest. As such, there appears to be no alternative to income growth if we are to see consistent gains in consumer outlays in the coming quarters.
Employment is indeed picking up. Payroll gains have averaged 200,000 jobs a month in the twelve months leading up to April, with more than 250,000 jobs per month from February to April. But wage growth remained sluggish and this appears to be the weak link that is preventing the US economy from fully expanding its wings.
The US ranks poorly in terms of low-paying wages amongst OECD countries, and there appears to be a secular trend towards more lower-paying services jobs. According to a recent research paper by the Center for Economic Policy and Research, the US currently holds the highest share of low-paying jobs in the OECD with close to 25 percent of workers earning less than two-third of the national median hourly wage. Unfortunately, we don’t foresee the number of low paying jobs in the US falling in the near future as the economy continues its ongoing transition towards a service economy.
But there are recent indications that incomes for low-income earners are rising. Several other ongoing developments may also help reduce the slack in labor markets and lead to a gradual rise in compensation.
A good measure of under-employment, U-6 – which includes those working part time but desiring a full time job and discouraged workers – remains elevated by historical standard at 12.4 percent in April 2014. Oxford Economics’ expects that as the US economy continues to its advancement towards a full recovery, the under-employment rate will converge toward its long-term average around 9 percent. As labor market progress continues, and slack diminishes, we expect wage growth to pick up.
Long-term unemployment remains at an elevated 35 percent of total unemployed. We view long-term unemployment as more cyclical than structural, and we expect that the participation rate will rebound in the coming months.
The labor force participation rate has declined as a result of baby boomers retiring, a large number of workers moving onto disability, more post-secondary school enrolments, earlier retirements, and an increased number of discouraged workers. While some part of this decline is certainly structural, it appears that a large share is cyclical.
Oxford Economics expects an improving economy will attract more potential school enrollees and formerly discouraged workers into the labor market. Similarly, while retirees may not re-enter the work force, early-retirements will mean less retirements in the coming years.
There are already indications that wage growth is percolating. Indeed, the National Federation of Independent Businesses’ (NFIB) reading on the percentage of small businesses that expect to raise wages has been trending up consistently over the past few months. Since it generally leads the ECI’s private compensation indicator by 6 to 9 months, we foresee gradually rising wages through the end of the year.
The writer is Lead US Economist at Oxford Economics.
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