AMERICA’S unemployment rate is 5.5%. By historical standards, that is low. It is also falling rapidly: unemployment is down more than a percentage point from a year ago. Economic theory suggests that in such circumstances, workers should begin to enjoy healthier pay rises. Low unemployment means that employers have to try harder to find new workers, while existing workers can threaten to move elsewhere. As a result, workers should be able to demand higher wages. Yet firms in America seem not to have got the message. Inflation-adjusted wages for typical workers are stagnant. In fact, they have barely grown in the past five years; average hourly earnings rose 2% year-on-year in February of 2015: about the same as in February of 2010. Why hasn't America's falling unemployment translated into faster wage growth?
To understand current patterns one first has to remember how American firms behaved during the 2007-09 recession. At that time, they were desperate to cut costs. They would like to have foisted pay cuts on their staff. But cutting pay is harder than it sounds (just imagine what would happen to workplace morale if your boss tried to cut everyone’s pay by 10% overnight). Instead, employers reacted to the deep downturn by firing as many workers as they dared, beginning with the least productive. Better workers, meanwhile, were squeezed in order to boost their productivity, so as to manage too-high wage rates without having to lay off the cream of the payroll. As conditions improved after the recession ended, firms' prior response left them with a wage hangover. Rather than continue to pump workers for extra productivity, firms preferred to return to more normal management conditions, and to let too-high wages adjust over time: “pent-up” wage cuts have been achieved simply by not granting raises. Wages, in other words, are not rising by more because in many cases they are already too high.
