Fair Wages for Hard Work? Not in America

An analysis by Josh Bivens at the Center on Budget and Policy Priorities looks at the connection between wages and inflation.  The strong link between interest rates and price inflation is through the mechanism of wage increases which are spurred by tightness in the labor market.  By increasing short-term interest rates, the pace of economic activity is lowered, reducing the pace of declines in unemployment which reduces the ability of workers' to bargain for higher wages which, in turn, reduces the pressure on inflation.  Mr. Bivens observes that, since wage inflation and not slackness in the labor market is the most significant intermediate link between interest rate increases and lower price inflation, the brilliant minds at the Federal Reserve should focus on wage inflation as an indicator of where interest rates should head.  With the Federal Reserve contemplating a move toward tightening after their prolonged experiment with zero interest rates because of improvements in the headline unemployment rate, perhaps they need to take a closer look at what has happened to nominal wages to determine their future policies.

As has become apparent, the traditional measures of economic health, particularly the headline U-3 unemployment rate have become particularly useless indicator of economic health since the labor force participation rate, at 62.5 percent, is depressed to levels not seen since the late 1970s as shown on this graph:

Other economic measures like estimates of the natural rate of unemployment which is the rate below which inflationary pressures will increase are subject to large margins of error and are not suitable for determining monetary policies.

As we've noted, since late 2010, the unemployment rate has fallen steadily yet, inflation has remained tame as shown on this graph:

This is telling us that even though unemployment dropped from 10 percent in 2010 to approximately 5.5. percent in mid-2015, inflation has not reared its ugly, frightening (to central bankers) head.  Conventional wisdom would tell us that inflation should be much higher than it is given that unemployment has nearly halved and that there should be significant upward pressure on wages.  Unfortunately for those of us who work for a living, this graph that shows what has happened to nominal wages and unemployment since 2006 is particularly sobering:

Economists like to use the Phillips curve which plots the percentage change in inflation (or nominal wages since the two are closely connected to each other) against the level of unemployment which looks like this for the 1960s:

As you can see, at high levels of unemployment, inflation/wage increases are low.  In the 1960s, as the economy moved from 6.5 percent unemployment to 5.5 percent unemployment, inflation/wages rose by a less than one-half percent.  When the economy moved from 4 percent unemployment to 3.5 percent unemployment, inflation/wages rose by more than a percent.  As unemployment decreases, inflation/wage increases begin to rise at a faster rate.  This is not the case now; as the graph above shows, at 5.5 percent unemployment, the inflation rate/rate of nominal average wage increases is far, far lower than most economists would predict using the Phillips curve.

Now, let's switch gears and look at another measure of economic health, productivity, a measure that will help us set a wage target.  First, here's a rule of thumb from the paper:

"...as long as nominal wages are growing at or beneath the rate of productivity growth, then labor costs are putting no upward pressure on prices at all. This concept is embodied in unit labor costs, i.e., the unit of compensation per unit of productivity. If real wages and productivity accelerate by equal amounts (in percentage terms), there is no increase in unit labor costs and no pressure on prices from wage growth, as more efficient production (faster productivity growth) has “absorbed” the wage increase such that it does not need to be passed through to prices.

For small magnitudes, the change in unit labor costs can be approximated as the percentage change in hourly pay minus the percentage change in productivity. And this change is what the Fed is hoping to keep running below its target rate of overall price inflation. So long as unit labor costs are rising at less than 2 percent, they are not putting upward pressure on the price inflation target."

Obviously, changes in worker compensation are closely connected to the growth rate of productivity.  Here is a graph showing the total growth in net economy-wide average annual changes in productivity over 12, 24 and 60 month-long cycles between 1995 and 2014:

Productivity growth over the cycle between 2001 and 2007 averaged 2.1 percent and over the four cycles between 1973 and 2007, it averaged 1.5 percent.  The author feels that range of 1.5 to 2.0 percent is reasonable.  Therefore, if we sum changes in productivity at 1.5 percent to 2.0 percent and  accompany it with inflation at 2.0 percent (the Federal Reserve's target rate), then hourly compensation growth of between 3.5 and 4.0 percent should not cause a problem.  That said, as shown on this graph, the year-over-year change in nominal average hourly earnings of American workers since 2007 has been well below the minimum wage-growth target (shaded grey):

As you can see, hourly wage growth has been between 1.5 and 2.5 percent since 2009, well below the wage-growth target.  This extremely low level of wage growth makes us wonder why inflation hasn't been even lower than it is.  Here's the fly in the ointment:

All of the growth in prices since the second quarter of 2009 can be accounted for by rising profits (light blue bars) due to increases in markups over costs.  Unit labor costs have been flat and all other costs have actually declined but unit profits on a pre-tax basis have increased by 7.6 percent annually.  This growth in unit profits are responsible for 64 percent of the rise in prices since the last business cycle peak in the last quarter of 2007.

This is why the labor share of corporate sector income has done this since the early 1980s:

With nominal wage growth of 4 percent, it would take until 2029 to attain the pre-Great Recession labor share of corporate sector income of 79.4 percent in Q4 2007.  Using the same 2 percent inflation numbers and 1.5 percent trend productivity growth as before, with nominal wage growth of 4.5 percent, it will take until 2022 and with 5 percent nominal wage growth, it will take until 2019 to attain the pre-Great Recession labor share of profits as shown on this graphic:

Despite the fact that we are now seven years past the trough of the Great Recession, we are still seeing very little improvement in the wages of American workers.  Wages are still growing at levels that are well below the non-inflationary wage-growth target levels of between 3.5 and 4.0 percent.  Rather than sharing the benefits gleaned from increasing worker productivity since the Great Recession, Corporate America is choosing to pad its bottom line, explaining why inflationary pressures have been far lower than we would normally expect.

Corporate America and its Growing Pile of Offshore Cash

A recent report by Citizens for Tax Justice (CTJ) shows how offshore cash holdings by American companies is becoming an even bigger issue than it was just one year ago.

Ten major American corporations, primarily in the technology and pharmaceutical sectors, have increased their offshore profit holdings by $5 billion or more in the last year alone as shown on this list:

In total, these ten corporations have added $106.6 billion to their offshore holdings.  Most of these profits were earned in the United States but have been shifted to offshore tax havens to keep their American corporate tax burden to a minimum.

Not only have these ten companies added over $100 billion to their offshore holdings, an additional 92 of the Fortune 500 companies have increased their offshore profit holdings by at least $500 million each for an additional total of $229 billion.  Over the past four years, 48 American corporations have added at least $3 billion to each of their offshore cash piles for a grand total of $518 billion.

Current laws prevent the U.S. government from taxing these so-called foreign profits and it is estimated that this "oversight" will cost the federal government an estimated $600 billion over the next decade as shown in this Joint Committee Report from the Staff of the Joint Committee on Taxation.

From CTJ, here is a listing of the unrepatriated foreign profits from 20 of the top Fortune 500 corporations between 2009 and 2011:

That's pretty much a "who's who" of the American corporate world, isn't it?

Note that the top 20 companies hold a total of $793.6 billion in offshore profits and the remaining 300 of the Fortune 500 companies that disclose holding at least some profits overseas hold an additional total of $794.3 billion for a grand total of $1.588 trillion.  What's interesting to see is that General Electric heads the list; its CEO, Jeffery R. Immelt, just happens to be the head of Barack Obama's President's Council on Jobs and Competitiveness whose responsibilities included the following:

1. Solicit ideas from across the country about how to bolster the economy and the prosperity of the American people that can inform the decision making of the President; 

2. Report directly to the President on the design, implementation, and evaluation of policies to promote the growth of the American economy, enhance the skills and education of Americans, maintain a stable and sound financial and banking system, create stable jobs for American workers, and improve the long term prosperity and competitiveness of the American people; and

3. Provide analysis and information with respect to the operation, regulation, and healthy functioning of the economy and other factors that may contribute to the sustainable growth and competitiveness of American industry and the American labor force. 

So, how's that working out for Main Street America?  

In an odd twist of fate, in mid-February 2013, GE announced "furloughs" for roughly 500 factory workers at its much ballyhooed Appliance Park facility in Louisville, citing sluggish appliance sales.

America's Profitable Banks - The Rich Get Richer

The Federal Deposit Insurance Corporation (FDIC) recently released their second quarter 2012 Quarterly Banking Profile for U.S.-based commercial banks and savings institutions insured under the FDIC umbrella.

In the second quarter of 2012, these federally insured institutions reported aggregate net income of $34.5 billion, up $5.9 billion or 17 percent from the same period a year earlier.  The share of institutions reporting improved year-over-year net income reached 62.7 percent with only 10.9 percent showing a loss, down from 15.7 percent one year earlier.  This is the twelfth quarter in a row that the banking industry has registered a year-over-year increase in net income.  Here is a bar graph showing the quarterly net income for the banking sector over the past four years:

Since the first quarter of 2010, it's been good to be a banker!  Aggregate profits are just off their peak of $35.2 billion in the third quarter of 2011 but well up from their losses of nearly $37.8 billion in the fourth quarter of 2008 alone, the year that American taxpayers stepped up to the plate to bailout the banking system.

Of the 7246 banks and savings institutions currently covered by the FDIC, only 732 are considered to be "problematic", down from 772 in the previous quarter and down from the eight year peak of 884 at the end of 2010.  This is the lowest number of problem banks since the end of 2009.  Here is a bar graph showing the dropping number of "problem" institutions:

While the number of "problem" institutions is dropping, albeit slowly, you will note that even at current levels, the number of "problem" banks is up over 1100 percent from its average annual level of 65 between 2004 and 2007 and has only dropped 17 percent from its peak value.  This suggests that if part 2 of the Great Recession becomes entrenched in the economy, the banking sector could see new record levels of failure.  

Fifteen insured institutions failed during the second quarter with another nine failing thus far in the third quarter, bringing the annual total for 2012 to forty thus far.  This is the lowest number of problem banks since the end of 2009.  At this point last year, there had been 68 failures.  Here is a graph showing the number of failures since 2009 in red:

Here is a bar graph showing the rapid growth in the size of the assets of "problem" institutions since the beginning of the Great Recession:

Again, while the assets of "problem" institutions have dropped by 30 percent from the peak of $402.8 billion at the end of 2009, the number is still up 1700 percent from its 2004 to 2007 average level of $16.4 billion.

There is no doubt that, when measured in terms of net income, the banking sector as a whole looks very healthy.  What is of some concern is the dramatically elevated levels of both "problem" institutions and the assets of these institutions.  We are now three full years into the post-Great Recession recovery and yet significant parts of the banking sector are still under stress.  This could prove to be a big problem for American taxpayers when the banking sector comes hat-in-hand looking for another bailout if the Eurozone influenza crosses the Atlantic.