How wage growth could continue as the economy slows

(Bloomberg Opinion) – The perks and costs of strong economic growth don’t fall equally on all Americans.

Friday’s jobs report showed that the GDP growth of recent quarters continues to benefit workers, with the highest wage growth reported during this cycle. What’s becoming increasingly clear is that this tightening of the labor market is disproportionately benefiting workers in industries that are more likely to employ less educated workers.

Where that leads is an open question — potentially bringing more workers into the labor force, or leading businesses to deploy technology to eliminate costly positions. It could also test the conventional wisdom that if economic growth slows, wage growth and inflation will slow with it.

In 2018, wage growth for non-managerial workers increased from 2.4% to 3.3%. Gains were even faster for workers in the wholesale trade, construction and retail industries. Wage growth in wholesale trade — an intermediate step in the distribution of goods, employing over six million people — grew from 1.6% to 4.1%. Construction wage growth grew from 3.1% to 4.2%. Retail trade wage growth grew from 1.6% to 4.6%. Wage growth in the leisure and hospitality sector was steady at 4.3%. It was the first month in 18 years in which all four industries saw their wage growth increase by at least 4% on a year-over-year basis. And it’s been accelerating in recent months, with three-month annualized wage growth in all four industries exceeding 5%.

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What’s interesting is that wage growth for the professional and business services industry, which tends to be higher-paid, educated, white-collar jobs, is only at 3.1%, less than wage growth overall. Wage growth for these workers outpaced overall wage growth at the end of the past two cycles, suggesting something has changed in the labor market dynamic between more and less educated workers.

That change might be explained by the relative growth of the two groups in the labor force. Since the end of 2007, the labor force has added 14 million workers over age 25 with a bachelor’s degree, while it’s lost around 4.5 million workers with a high school education or less.

This change makes sense — the older workers who have been retiring over the last decade tend to be less educated than the younger workers who are replacing them, and as immigration shifts from Latin America to Asia that has resulted in the U.S. bringing in a more educated workforce from abroad as well.

There are a couple ways of thinking about this. On the one hand, a more educated workforce tends to be more productive and higher paid, increasing prosperity for all. On the other, by the law of supply and demand, adding millions of educated workers should depress wage growth for that group, while the shrinking of the pool of less educated workers should drive up wages for them. This dynamic could lead to a smaller wage gap between more and less educated workers.

All of this raises some interesting questions about the economy in 2019. When economists talk about real potential GDP growth in the 1.5 to 2% range, there’s an underlying assumption that growth in that range should put neither upward nor downward pressure on the unemployment rate, wage growth and inflation. But if the pool of educated workers continues to increase rapidly, while the pool of less educated workers is flat or shrinking, it’s possible that trend GDP growth will put downward pressure on wage growth for educated workers while it continues to put upward pressure on wage growth for less educated workers.

To the extent that inflation is a bottom-up phenomenon driven by price pressures in low-cost, commoditized activity first, and broadening out from there, it’s possible that trend or even slightly below trend economic growth could still put upward pressure on some prices.

There are other possibilities too: Perhaps 5% wage growth for less educated workers is enough to draw more workers into the labor market or lead to labor-saving investments by businesses. But while market participants and economists focus on negative financial market and political headlines over the past few months, persistent tightness in the market for less educated workers may keep a floor on wage growth and inflation in 2019, even if economic growth slows somewhat.