The Job Market Is Improving, But Wages Should Be Growing Faster

Last Friday's employment report showed that the U.S. economy added an impressive 255,000 jobs while the unemployment remained at 4.9 percent. The underemployment rate -- which accounts for workers who have given up looking for work because they feel no job exists for them (discouraged workers) and those working part-time who want to be working full time (involuntary part-time employment) -- rose slightly to 9.7 percent. The labor market is in substantially better health today than it has been in almost a decade.

Despite this improvement, there are signs that the labor market might not be as strong as many think. The length of time of the average unemployment spell increased from 27.7 to 28.1 weeks, almost double its historical average. And wages grew at an annual rate of 2.6 percent, well above the rate of inflation. While the increase in wage growth is long-overdue and improving over time, it is still far below where it should be to generate economic growth.

Why is a strong labor market failing to produce significant wage growth? When the unemployment rate falls and firms ramp up hiring, workers have more bargaining power to demand higher wages because of the shrinking pool of available labor to replace them if they were to be fired. It also increases their bargaining power because employers know that they must outbid their competitors for labor and raise wages to keep the most productive workers. Normally when the unemployment drops to such low levels over an extended period of time, as it did in the late 1990s, wage growth accelerates.

But things are different today. Using the historical relationship between the unemployment rate and wage growth -- what economists call the Phillips curve -- wage growth would be about 50 percent higher at 3.9 percent. This potential growth is in line with what Federal Reserve Chairwoman Janet Yellen considers to be the rate consistent with stable inflation. So why isn't this happening?

There are two related reasons for subdued wage growth. The cost of job loss -- the expected weekly income loss associated with unemployment -- is near historic levels. Workers who become unemployed can expect to lose about 50 percent of their previous income, once income-assistance programs (like unemployment insurance) and re-employment earnings are accounted for. This means that employed workers are fearful of the possible punishing financial blow of unemployment, causing them to moderate their wage demands.

Similarly, the rising share of long-term unemployment -- the percentage of all unemployed workers who have been jobless for more than 26 weeks -- is near a historic high of 26.6 percent. This also causes fear among employed workers: if they were to be fired, there is a good chance of remaining unemployed for an extended period, leading to a high cost of job loss. As a result, workers become increasingly unable to ask for higher wages for fear of being laid off.

Workers who lost their job since the start of the recession have been dealt a punishing economic blow. But the effects have now seeped into the minds and behavior of the employed. Although low unemployment rates are welcome, the rising tide of employment insecurity is not because it keeps a lid on wage growth. Since consumption is approximately 70 percent of all economic activity, low wage growth will depress overall economic growth and living standards.

There are significant economic and social costs to low wage growth. The first is a prolonged period of slow growth and rising inequality, which depresses consumption, business investment, and productivity growth. Lower growth reduces the willingness of firms to hire and invest, leading to lower potential growth in the future. It also creates the conditions that allow fascist political extremism to flourish. The rise of Donald Trump from a fringe candidate to Republican presidential nominee suggests this shift can happen rapidly and dramatically.

If policymakers fail to address the issues that cause a rising cost of job loss and long-term unemployment, it is likely that the U.S. economy will remain depressed and be increasingly vulnerable to dangerous economic and social policies. Expanding the social safety net to not only include income-assistance, but also subsidized child care and re-training, is a good first step. But in the longer term, providing funding for large-scale infrastructure investment -- which is currently an incredibly cheap investment since the government can borrow money from willing investors at the lowest interest rate in history -- is a profitable opportunity with numerous economic benefits.

But why stop there? Since the labor market has become increasingly weak during subsequent recoveries for the past 40 years, the government should become an employer of last resort, offering quality jobs providing key social and economic goods and services. We could remake New Deal programs, such as the Civilian Conservation Corps and the Works Progress Administration, for the modern era. Unemployed workers could receive income assistance for a short period of time -- say 4-8 weeks -- to help them adjust. But after they expire, workers would be forced to either find employment in the private sector or accept a job in the public sector. Since the private economy is unable to generate job growth as it did in the past, the availability of public employment is critical to maintain a strong economy with a skilled workforce. These jobs could create new infrastructure projects, child and elder care services, and investments in ecologically sustainable resources.

We are at a political and economic crossroads. Failure to address pressing economic needs such as low wage growth will lead to stagnation and reactionary political extremism. Instead of thinking about how to grow the economy and living standards, policy will become more protectionist and isolationist not just internationally but also domestically. Workers will increasingly find "others" -- minorities and women -- appealing targets for their justified anger. But this shift will only lead to less growth and more fear, exacerbating the cycle we are so dangerously close to entering, if we haven't already.