Dems Need To Understand Link Between Low Unemployment And Higher Wages Is Mythical

One of Paul Krugman's pet peeves is the continued survival of what he calls "zombie" ideas, namely bad ideas, continually disproven, but that continue to live on in our political discourse. The ultimate example of this is the idea embodied by the Laffer Curve that reducing tax revenue will bring in more government revenue. Many studies have shown that the Laffer Curve only applies when tax rates are extremely high, over and above 70%. Such rates have not existed in this country in over the last half century. A corollary is the entire idea of trickle-down economics. For the past forty years, these two zombie ideas have driven the Republican party, culminating in the tax bill passed just a few months ago.

While both the Laffer Curve and the idea of trickle-down economics have been thoroughly rejected by most of the Democratic party, there is another zombie idea, directly related to trickle down theory, that was also used to sell the latest GOP tax plan and is still embraced by too many on the left. That idea is that low unemployment will automatically lead to higher wages.

The current unemployment rate stands at 4.1%, a rate not seen since the very end of the dot-com boom in 2000 and the late 1960s. The average hourly wage rose 8 cents in March and was up 2.7% overall for the past year. That may not sound too bad but, when you factor in inflation, that translates to real wage gains of only 0.9% for the past year, a year with similarly, near-historic unemployment lows. In fact, as the table below illustrates, the pace of real wage gains has been declining since 2015 despite these the extremely low unemployment rate and low inflation environment over that period.

In fact, real wages for the majority of Americans have not budged since the 1970s and are actually below the levels seen in the earlier part of that decade.

A similar and related break with the postwar period occurred in the 1970s between wages and productivity. For all of the past-war period, wage and productivity gains tracked extremely closely. But, again, starting in the late 1970s, they became disconnected and have remained so ever since.

The reasons for the disconnection of wages to other traditional economic indicators and the resulting rising inequality are myriad and the subject of volumes of analysis. They include globalization, automation and technological advances, the reduction in bargaining power for workers, undue concentration and consolidation within industries, tax policies, reduced labor mobility, unwarranted fears of runaway inflation by the Federal Reserve, and general government underinvestment.

Whatever the weight of each of those reasons, there is no doubt that real wage gains have suffered. And the evidence is that will not change anytime in the near or distant future. Goldman Sachs economist David Mericle recently put out a note anticipating that we are already at or near full employment. In addition, his projections for the next two years indicate record unemployment lows. Mericle expects "robust labor demand to drive the unemployment rate to 3.6% by end-2018 and 3.3% by end-2019, the lowest rate since the Korean War." Yet he warns "that wage growth expectations need to be recalibrated to the meager rate of productivity growth seen this cycle, implying a full employment rate of wage growth of roughly 3%. ... our wage tracker, now running at 2.5%, looks only moderately disappointing." This implies that real wage growth, even with unemployment rates well under 4%, will still be under 1% adjusted for inflation.

Yes, the press will be filled anecdotal stories about localized labor shortages creating wage gains and other benefits. But understanding that wage gains are no longer really tied to low unemployment will be important for Democrats as they craft plans to both increase employment and raise wages in order rebuild the middle class. Obviously, employment is better than unemployment. But a federal job guarantee will not necessarily raise wages unless the government actually offers competitive or even premium wages for the workers involved. In addition, this fact also has implications for guaranteed incomes or income subsidies for workers as the necessity for strong subsidies may not decrease as much as expected even in a high employment environment. More generally, this realization points to the need for a greater focus on the redistributing the benefits of this static wage environment of the last forty years, which largely accrued to the top 5%, and less focus on using existing free market solutions to rebuild the American middle class and support low-wage workers.