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Monday, March 16, 2015 2:25 AM

Wage Growth vs. Economic Theory

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If economists were right, wage growth and inflation would be soaring. After all, the Phillips Curve states that decreased unemployment in an economy will correlate with higher rates of inflation [and higher wage growth].

Let's explore that thesis.

Average Hourly Earnings Percent Change From Year Ago

Civilian Unemployment Rate

Let's hone in on that theory, this time with three charts.

Average Hourly Earnings Percent Change From Year Ago - Detail

Civilian Unemployment Rate - Detail

CPI Detail

If Economists Were Right

The Phillips Curve theory is so preposterous, I wonder why anyone still believes it. Even those who disbelieve the theory (at long last), still wonder why the theory went wrong.

I will explain the reasons in a moment. First, please consider the Bloomberg article that brought the ridiculous Phillips Curve theory into the spotlight once again: If Economists Were Right, You Would Have a Raise by Now.

Six years into the U.S. expansion, the link between falling unemployment and rising wages -- once almost as basic to economic theory as supply and demand -- seems to be coming unhinged.

The disconnect is puzzling to people like Colorado Governor John Hickenlooper. With one of the best growth rates among the 50 states, a population that’s younger and better educated than the nation’s and a jobless level that’s fallen further and faster than the national average, Colorado seems to have everything going for it.

Yet the rise in the state’s median wage since the recession ended in mid-2009 has averaged just 1.1 percent a year, based on data from the federal government’s Current Population Survey. That’s no better than the lackluster 1-percent-to-2-percent national pace. What gives?

“The whole notion that wage growth has been lagging job growth -- that’s the crux of the problem here,” Hickenlooper said in an interview. “We’re working very hard to figure out why.”

Divergence Pronounced

The divergence is even more pronounced at the state level. Wages aren’t growing faster in states with lower, sometimes substantially lower, jobless rates than the nation’s. They’re also not rising nearly as fast as they did at similar points in the past. In fact, the link between state unemployment rates and wages, which weakened during the 1990s and 2000s expansions, is fraying still further this time around.

“If we think unemployment is going to continue to fall, we can’t assume, as we once could, that that’s going to bring wage growth with it,” said Matthew Notowidigdo, an economist at Northwestern University in Evanston, Illinois, who specializes in state labor markets.

The break in the bond “has got to make you wonder whether any of the traditional economic policy tools can work as well as they used to.”
What Went Wrong

  1. Inflation is understated
  2. Unemployment is understated
  3. Global wage arbitrage still matters
  4. Robots matter

1. Economists are 100% clueless as to how to measure inflation. Monetary inflation does not always manifest itself in the form of higher consumer prices. Therefore, the CPI is an absurd measure. The CPI ignores asset bubbles (stocks, bonds, land, housing, etc). Given that economists and central banks have a perfect track record of never spotting asset bubbles until after they pop, it's no wonder inflation looks benign. Bear in mind this discussion comes from a confirmed deflationist. Economists who cannot spot inflation now are simply brain dead. My off the cuff guess is that 90% of them are indeed brain dead.

2. Unemployment is what it is. By definition, I cannot argue with the number. But I can argue with the idiocy of a definition that discounts disability fraud, students continuing education because they cannot find a job, people so discouraged they drop out of the labor force, and those who retire not because they want to, but rather because unemployment benefits ran out and they need to collect Social Security to survive.

3. Wages in China are rising. But wages in other places aren't. So, price  pressures remain.

4. Robots take jobs left and right. And the higher the minimum wage and the lower the cost of capital, the more industries are likely to fire workers and replace them with hardware and software robots. For this point, blame legislatures for higher minimum wages and blame the Fed for suppressing borrowing rates.

Nearly Every Mainstream Economic Theory Wrong

I started to write nearly every mainstream economic theory is suspect. I changed the subtitle to wrong because there is not a single mainstream theory that takes into consideration asset bubbles instead of a fatally flawed CPI as a measure of inflation.

Add to that, misinterpretation of GDP and unemployment, and it's no wonder that many theories behave so badly in practice.

Economists cling to fatally flawed ideas. Garbage in - Garbage Out is the general rule of thumb.

Mike "Mish" Shedlock

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