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Pay Raises Trail Growth in Economy

By David Wessel
From The Wall Street Journal Online

The recession in the U.S. has been over for more than three years. The economy has been growing at better than a 4% annual clip for the past two. Profits, at least until recently, have been up. Growth in worker productivity has remained strong. Unemployment has fallen to 5.2%, the lowest since September 2001.

Yet wages for the typical worker aren't even keeping up with inflation. Wages are growing unusually slowly for this point in the economic cycle, especially given persistently strong growth in productivity, the goods and services produced for each hour of work.

The U.S. Labor Department says that hourly wages for private-sector workers who aren't bosses rose 2.6% to nearly $16 an hour between March 2004 and March 2005, which is short of the 3.1% increase in consumer prices over that period. Weekly paychecks are up a bit more, but only because workers are putting in more hours. The department's broader Employment Cost Index, which covers more workers, says wages and salaries rose just 2.4% last year, well shy of last year's 3.3% increase in prices.

Employers don't give raises because they feel generous. They give raises because they can afford to -- that is where productivity comes in -- and because they have to do so to attract or keep workers. Profits and productivity, up 4% last year, suggest employers have the money, but don't feel pressure to give raises.

To those who argue that wages aren't rising because "today's businessmen are greedy...or Wal-Mart is cunning," Bradford DeLong, an economist -- and prolific blogger -- at the University of California at Berkeley replies that's nonsense. Something else is going on. "The link between wages and productivity depends on the fact that businessmen are greedy and cunning," he says. "You don't raise wages out of altruism; instead you expand your work force out of greed, and the expanding work force pushes wages up."

Not everyone's wages are sinking. Demand for workers with the most skills and education remains strong, and their wages are climbing because they are still in short supply. Demand also appears strong for low-paid workers -- those who bathe the sick or wait on tables and whose jobs can't go offshore or be automated -- but there are so many willing low-skill workers that their wages don't rise. Globalization and technology, meanwhile, seem to be eroding demand and wages for many workers in the middle. But despite the headlines, that has been happening for some time, even during the glorious 1990s, so it is hard to believe that explains the whole recent mystery of wages.

Health-care costs are one piece of the puzzle. Workers are getting more of their pay in health benefits instead of cash. The cost of employee benefits rose 6.9% last year, according to the Employment Cost Index; the combined cost of wages and benefits rose 3.7% before adjusting for inflation. But rising health costs can't explain the whole conundrum: 40% of American workers don't get health insurance on the job.

Looking at wages, inflation, health costs and productivity, Harvard University economist Lawrence Katz estimates that wages have been growing about two percentage points shy of the increase in productivity during the past four years.

That suggests the American labor market is weaker than the falling unemployment rate makes it appear. Other numbers confirm that. Employers still aren't hiring readily. More than one in five unemployed Americans has been out of work for six months or more. Lots of workers remain on the sidelines: About a third of all adults are neither working nor looking for work, more than usual. "Apparently, the demand for workers has been strong enough to allow many of those actively looking for jobs to find them but not strong enough to pull people back into the labor force who may have dropped out -- perhaps for early retirement or additional schooling," U.S. Federal Reserve governor Donald Kohn suggested in a recent speech.

The question then, as Mr. Katz frames it, is: "Why are firms so reluctant to hire given the strong growth in productivity and, until very recently, the surge in profits?" He suspects that employers are so uneasy about so many things -- energy prices, interest rates, the effect of the budget deficit, the dollar -- that they remain unusually hesitant to add workers permanently, though there has been an upturn in hiring of temps. Some business executives add that regulatory, auditor and press scrutiny after recent scandals continues to discourage business.

Whatever the cause, the effect is to damp demand for workers and, thus, the need for employers to raise wages for most workers. The risk to workers now is that the Federal Reserve, anxious about indications that inflation is returning, will raise interest rates to slow the economy before the labor market gets strong enough to push wages up to match rising productivity.