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Why We Should Give Wages Room to Grow

October 17, 2014 at 1:30 PM

My latest post for U.S. News’ Economic Intelligence blog shows that American workers have been shortchanged in the recovery from the Great Recession and explains why the projected quickening of wage growth over the next few years won’t trigger an upward spiral of wages and prices.  It says in part:

How can wage increases go from 2 percent per year to 3.5 percent [as the Congressional Budget Office projects will occur over the next three years] without igniting unacceptable inflation?  The answer lies in the arithmetic of prices, productivity and labor costs. In round numbers, since the start of the recession in late 2007, hourly labor compensation (wages plus fringe benefits) has grown at about 2 percent a year on average.  Productivity growth (increases in output per hour worked) offset about 1.5 percentage points of that increase.  The difference, a mere 0.5 percent a year, is the growth rate of labor costs per unit of output produced. Prices were rising three times as fast as that over this period — 1.5 percent per year — so businesses had three times the revenue per unit of output they needed to cover the increase in unit labor costs.  It’s not surprising that profits grew substantially while workers got the short end of the stick. Businesses could have raised hourly compensation by 3 percent a year over this period (half paid for by higher prices, half by greater productivity) without threatening their bottom line. CBO projects that inflation will rise gradually toward the Fed’s stated longer-term goal of 2 percent per year. That means hourly compensation can rise at 3.5 percent a year without putting any additional upward pressure on prices: Price increases would cover 2 percentage points of that increase, and greater productivity would cover the rest.

Click here for the full post.