What's Causing the Wage Stagnation?

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I recently wrote about sluggish and stagnant wages, which are said to weaken the economy's recovery. I argued that workers' fear of losing their jobs is an important - perhaps decisive - explanation. In a nutshell: Frightened of being fired and being unable to find a new job, workers are less inclined to quit and search for something better. Therefore, employers don't have to raise wages, or can raise them less, to retain their best workers. Wage gains have been running at about 2 percent annually, a bit above the rate of inflation.

There are many competing theories. The most obvious: For labor, it's still a buyer's market. There remain millions of unemployed Americans eager to fill openings; this includes both those officially counted as unemployed and those so discouraged that they have stopped looking for work. Businesses keep wage gains down because there's a surplus of applicants.

But one theory I should have mentioned involves what economists call "downward nominal wage rigidity." In plain language, workers don't like to see their wages cut, even in hard times. The prejudice against wage cuts is so strong that many firms voluntarily abstain from doing so. The reason is not altruism, but fear of adverse consequences. Workers would be demoralized; productivity would suffer; companies would be stigmatized as bad places to work.

In a paper, three economists at the Federal Reserve Bank of San Francisco argued that the norm against wage cuts helps explain wage patterns in the Great Recession and the subsequent recovery. "As the economy falls into a recession," they wrote, "businesses would like to reduce wages" - but don't because that would violate the norm. Instead, the economists contended, companies compensate by holding down wage increases during the recovery.

The economists found that the share of workers receiving no annual wage increase reached a record 16 percent in 2011 and that wage gains for other workers were lower than in the pre-recession year of 2006. Companies satisfied the recession's "pent-up" demand for wage cuts by skimping on pay gains during the recovery. The same pattern prevailed in the recessions of 1990-91 and 2001, but the magnitude was much greater this time, the economists said.

There may be something to this. Businesses are always looking for ways to reduce labor costs, but the pressure against outright pay cuts is powerful. This is a pragmatic way of bridging the contradiction.

On the other hand, it seems a little too theoretical for my taste. In the real world, I suspect, most companies - though respecting the norm against wage cuts - simply pay what they figure they must. For me, the reluctance of many workers to leave their present jobs and the fact that potential job-seekers still exceed available jobs are more plausible explanations of meager pay gains.


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