Specter of Years of Stagnating Wages Haunts the Globe

Nearly three years after the start of the economic crisis, a new spectre is haunting the world’s most advanced economies: the prospect that the majority of their citizens will face years of stagnant wages.

Empty Wallet
Empty Wallet

In the postwar years, there was a belief in developed economies that each generation could expect to have materially better living standards than their parents. Yet the outlook for income growth has rarely looked worse than it does today.

For some middle-income groups, the idea of stationary or declining incomes is not new. Fork-lift truck drivers in Britain could expect to earn 19,068 pounds in 2010, about 5 percent lower than in 1978, after adjusting for inflation. Median male real US earnings have not risen since 1975. Average real Japanese household incomes after taxation fell in the decade to mid-2000s. And those in Germany have been falling in the past 10 years.

Some of this pressure on the middle income households was masked – at least temporarily – by the credit boom, which allowed families to spend more than they earned. Now, three years after the end of the cheap money era – and with developed countries struggling to get their economies growing again – middle classes around the globe are feeling the squeeze.

It is hardly the backdrop politicians would want as they are being forced to contemplate raising taxes and cutting public spending to repair public finances. And that consolidation is required before countries begin the even more difficult process of adjusting for rising longevity and ageing populations.

Two questions are raised by the trends in household wages and incomes. What exactly is happening to incomes across advanced economies? And why?

Only recently have the answers begun to be clear. Starting in 1975, male US median pay has stagnated in real terms, while gross domestic product continued to rise rapidly. At first, other countries resisted this trend, leading to concerns in the US that a peculiarly American disease was afflicting its culture and labor market.

Growth in per capita national income must go somewhere. In the US, the money flowed almost exclusively to the very richest. The earnings of US individuals with pre-tax income in the top 1 per cent accounted for 8 percent of total in 1974, but rocketed to 18 percent by 2008, according to the world top incomes database, a resource compiled from tax return data. Even larger proportionate rises in the share of income went to the top 1 percent of those with incomes within the 1 top percent.

But rising inequality in recent years is far from a US phenomenon. The Organisation for Economic Co-operation and Development found increasing income inequality between the mid 1980s and late 2000s in 17 out of 22 advanced economies for which it had sufficient data. “There are signs that levels [of inequality] may be converging at a common and higher average,” the OECD said in a recent report and “countries such as Denmark, Germany and Sweden, which have traditionally had low inequality, are no longer spared from the rising inequality trend”.

Rising inequality in almost all countries is being driven by trends in the labour market. Although most OECD governments have tried to fight the rise in wage inequality by increasing in-work state benefits and trimming payroll taxes for those on lower incomes, the growth in wage inequality has exceeded the willingness to impose ever more progressive tax and benefit systems.

Exacerbating the rising income inequality has been a squeeze in the need for jobs demanding mid-range skills. Across advanced economies, the labor market is becoming polarised into “lovely jobs and lousy jobs”, says Alan Manning, a professor at the Centre for Economic Performance at the London School of Economics. Between 1993 and 2006, the proportion of jobs with middling pay fell, while high- and low-paid employment rose. This finding was common across almost all advanced economies, regardless of their economic characteristics and political culture.

The similarity of the trends suggests that forces bigger than domestic politics or labor market characteristics are at work.

While there are competing theories about what is causing the trends in inequality and labour demand, a few trends emerge.

At the top of the income distribution, the revolution in communications has allowed many star performers to expand sales and revenues from a local to a global audience. Others, particularly in the financial sector, found ways to make fortunes by gambling with other people’s money.

For many university graduates, computers and the internet complement their flexible skills, allowing them greater opportunities. Publishers can distribute content globally, accountants or architects can serve clients far from their offices and professors have a global audience for their ideas in daily blogs rather than lecturing only to those in their institution. Demand for high-skilled jobs has outweighed the growth of graduates for more than a generation, leading to rising incomes.

At the bottom of the earnings distribution, technology is still irrelevant, being little use for tasks such as cleaning and caring for the elderly. But it has severely dented the demand for routine but skilled tasks – once the backbone of employment in advanced economies – from factory workers to bank clerks or to fork-lift truck drivers.

It is no fun to be a fork-lift truck driver in a world of automated distribution warehouses. That shows in middling jobs and wages. And since the middle decides elections, it will also weigh on the minds of politicians.