Why Wages Are Growing Rapidly—Both Now And In The Future
Wages in 2021 have grown at the fastest rate in 35 years. This sudden and surprising burst will reduce corporate profits and add to already-soaring inflation.
What does this mean going forward? We can look at wage growth over three distinct time-horizons: spring and summer of 2021, late 2021 and 2022, and beyond 2022. The wage growth outlook is strong in the first and last of these periods, especially in blue-collar and manual services jobs. Here’s what to expect:
Current Labor Market Conditions
Wages are going to rise to new peaks this summer. Despite high unemployment rates, the US is now experiencing severe labor shortages and historically-high wage growth.
Typically, slow wage growth accompanies high unemployment. But that did not happen during the pandemic-recession. Wages are growing much faster than at any other time in recent decades. According to the June Bureau of Labor Statistics jobs report, average hourly earnings over April-June rose by an annual rate of 6 percent. This is two to three times the typical growth rate in recent decades. And according to a June survey by the National Federation of Independent Business (NFIB), an historically high share of employers raised worker pay over the past three months.
Why? Because the US labor market is much tighter – workers are harder to find – than anyone expected. A surge in demand for workers combined with stagnant labor supply created historic recruiting difficulties in the past three months.
Usually, businesses form and expand gradually during periods of economic growth, creating a steady demand for workers. But as the in-person economy re-opens all at once, demand for workers is surging. Several industries, especially in the entertainment sector, need to double their workforce in a matter of months, an event without historical precedent.
On the supply side, many working-age adults are only slowly re-entering the workforce because of lingering factors driven by the pandemic (high federal unemployment benefits, fear of infection, the need to take care of young children during school closures/remote learning, elder care).
Employers have been deeply impacted: Qualified workers are once again hard to find. According to the May NFIB survey, almost half of all employers, 48 percent, have job openings they are unable to fill – the highest rate ever. In addition, according to the Job Openings and Labor Turnover Survey, the share of workers voluntary quitting their jobs, usually for another job, is historically high.
Recruiting and retention difficulties are more pronounced in blue-collar and manual services jobs, which often involve low wages and a higher risk of infection. In addition, the elevated unemployment benefits are an especially attractive option for workers with relatively low wages.
When it is harder to recruit and retain workers, employers react by raising salaries. This helps explain the stunning jump in wages in the leisure and hospitality sector, (a 15 percent annual rate, in February to June) which drove the overall salary surge in the spring.
New hires’ faster wage growth could lead to significant salary compression – when the wage premium for experience shrinks or even turns negative – so that more-experienced workers feel that their pay advantage is no longer significant. Such pay compression could lead to higher labor turnover as more-experienced workers, who can easily find new jobs in this tight labor market, decide to switch.
The acceleration in wages during the spring and summer could have a significant impact on future inflation. In recent months, inflation has been growing at the fastest rate in decades, probably mostly due to non-wage factors, such as a rapid rise in commodity, computer chip and auto prices. Significantly-growing labor costs in 2021 will have a noticeable impact on consumer prices and corporate profits – and labor costs are much stickier than commodity prices and are less likely to reverse.
Late 2021 and 2022
Wage pressures may cool later this year and early next. The labor shortage is likely to ease in the fourth quarter, as some of the pandemic-related supply-constraints moderate. The labor market will be looser throughout most of 2022. Only towards 2023 will it again be tight enough to generate significant new wage pressures.
Another trend that will impact compensation trends in the coming one to two years is the shift to remote work. Employers operating in expensive labor markets may be able to lower overall costs by employing more workers in cheaper US labor markets or abroad. Moreover, many companies are likely to adopt flexible wage structures allowing differentiation in compensation across regions.
2023 and Beyond
Demographics may drive wages up again mid-decade. Historically-strong job growth in the next year and the rapid decline in the number of working-age people without a college degree are likely to tighten the labor market for blue-collar and manual service workers until the next recession.
It typically takes about four to seven years for unemployment to return to its natural rate after a recession. Because of the strong recovery in employment, this time it will probably happen during 2022, about two years after the beginning of the recession. By 2023, the unemployment rate is likely to be below 4 percent, and the US labor market will again be very tight. How rapidly employment grows, and the unemployment rate drops, partly depends on the rate of automation. Ultimately, more automation will reduce the demand for labor and slow the drop in the unemployment rate.
Once the unemployment rate starts declining, it usually keeps doing so until several months before the next recession. The unemployment rate is likely to sharply decline in the next year, and after reaching its natural rate of about 4.5 percent, decline more moderately for the next five to 10 years.
That downward pressure is going to be stronger than usual because, for the first time in US history, the working-age population is shrinking. The large Baby Boom generation continues to reach retirement age, setting up a steady drain on the labor market.
Education trends will also make the tightening labor market, and faster wage growth, more noticeable in blue-collar and manual services jobs. New labor market entrants are much more likely to be college graduates than the workers they’re replacing: The share of the workforce with a bachelor’s degree is increasing by about 2 percent annually. Conversely, the number without a bachelor’s degree – who are also the ones willing to work in blue collar and manual services jobs – is shrinking. On top of that, the labor force participation of young men without a college degree, who comprise a large share of blue-collar industries like construction and transportation, is significantly declining over time.
In sum, as a tight labor market will be the norm until the next recession, expect ongoing wage pressures in the coming years, especially in blue-collar and manual services jobs. The tight labor market is likely to generate more automation and calls for increased immigration, which could partly offset the demographic squeeze.