What Causes Wages to Grow?

by Michael Doughty

February 5, 2020

Everyone agrees getting a raise is a good thing. When we consider inflation, raises are more than just a nice bonus; they are also necessary to maintain our standard of living. What makes wages rise? Individuals might answer it’s about having a good work ethic. From an economic point of view, the engine of real wage growth gets most of its fuel from three main sources: competition, productivity, and technology.

What are real wages? Simply put, real wages take into account changes in the prices of goods, otherwise known as inflation. Say you spend all your salary on apples. If the price of apples increases you cannot buy as many apples. Your real wage has decreased even though your income has not. As can be seen in the graph below, real wages in the Mid-Valley have generally grown since 2013.
Competition

How does competition impact real wages? As would be expected, competition for jobs puts downward pressure on wages. When there are more job seekers than actual job openings, businesses have less incentive to increase salaries. Conversely, when there are more job openings than there are job seekers, businesses tend to raise salaries to both attract and retain employees.

During the past several years, unemployment rates have remained near record lows. Competition between businesses for labor has given workers a strong hand when negotiating for salaries. In the graph above, the growth in real wages during 2018 was largely due to increased economic activity creating competition between businesses to attract and retain workers.

Productivity

When people think of productivity, they usually think of working hard. This is true, but when economists talk of productivity, they typically are speaking of the value of what is produced over a given time period. Here is a simplified example: if worker one digs a 100-foot ditch in a single day, while worker 2 builds a car in the same time, the value per day of worker 2 (assuming the car is more valuable than a 100-foot ditch) is more productive, regardless of the effort (or hard work) each task requires.

From the point of view of employers, if workers are more productive, the workers generate more income for the business. Workers have more leverage to negotiate salaries and the business has more income to pay the workers. Over the long run, increased productivity leads to increased wages.

As can be seen in the graph below, productivity for the United States has been trending lower for several decades. The relatively low rate of productivity growth has often been cited as a factor in the slower than expected wage growth seen since the last recession.
What impacts productivity growth? Any combination of factors including new technologies, improvements to processes, and the movement of workers from less-productive to more-productive employment (for example, the movement from agricultural work to industrial work in the mid-19th century).

Technology

Technology can impact wages indirectly through productivity and competition. Technology can increase worker productivity. Consider the ditch-digger from our previous example. If instead of a shovel worker one is given a backhoe, worker one will be more productive. The impact of technology has an outsized role in developed economies. Once the majority of a workforce has moved into the most productive employment in their economy, productivity gains are limited to those derived from technological improvements. This may account for the general downward trend in productivity growth seen in the chart above.

Workers also compete with technology. Several studies have indicated that competition between labor and new technology can reduce wages. For example, a study by the National Bureau of Economic Research found that wages in one area dropped between 0.25 and 0.5 percent for each robot added per 1,000 workers.

As with many situations in life, the impacts of competition, productivity and technology can be a double-edged sword. As a worker, it makes sense to take advantage of opportunities presented by labor markets and to prepare for changes that may arise from competition and technology. As productivity, competition, and technology have shifted over the last 10 years, Oregon’s workers have seen an increase in their real average wages, and overall purchasing power, amidst the changing landscape of Oregon’s economy.


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