Why real wages are falling

Real wages are falling at a near-record rate. Yesterday's figures show that they were 6% lower in April than they were in April 2008. This is the biggest five-year drop in real wages since 1921-26, and the second-largest fall since records began in 1855.

This cannot be blamed simply on the recession. As the IFS has pointed out (pdf), real wages rose during the recessions of the early 80s and 90s. Something, then, has changed since then. But what?

Here's a theory. Back in the 70s and 80s, bosses could often not efficiently monitor their workers. To keep pilfering and skiving within tolerable limits they therefore had to pay better than market-clearing wages, to buy goodwill. The upshot was that wages rose even during downturns, because bosses feared that real wage cuts would create discontent and thus increase thieving, insubordination and malingering.

This led to a huge literature in economics on efficiency wages, gift exchange (pdf) and insider-outsiders (pdf), which tried to explain high and sticky real wages.

However, as Frederick Guy and Peter Skott have shown, socio-technical change since the 80s such as CCTV, containerization and computerized stock control has made it easier for bosses to monitor workers. Direct oversight means they don't need to worry about buying workers' goodwill. They are instead using the Charles Colson strategy: "When you've got 'em by the balls, their hearts and minds will follow."

Years ago, firms wanted smaller but motivated workforces. Now they can control workers directly, they don't need to worry so much about motivation* and so are content with larger but grumpy workers.

All this has three implications:

1. Talk of "wage rage" misses an important point. At the point of production - to use a quaint Marxian phrase - there is little meaningful rage, because workers can do little to fight falling real wages. (This poses the danger that such rage will find perhaps misdirected political expression, such as in antipathy towards immigrants.)

2. Issues of industrial organization - how firms are organized - have important macroeconomic effects. Macroeconomics cannot be easily studied separately from ind. org. Economists need to look inside the "black box" of industrial structure.

3. You cannot understand economics without understanding power. The fact is that bosses' power has risen and (many) workers' power has declined. In this sense, the rising incomes of the 1% and the fall in real wages for the average worker are two manifestations of the same process.

* except, of course for top-level managers who cannot be directly monitored - hence their rising incomes.

Comments

[Chromatistes]

Interesting stuff, Chris; you don't need to be left-of-centre to be concerned about potential political implications.

[Yet another Chris]

Do your data for wages include the self employed? If so, it's possible that the big rise in self-employed, often working for less than minimum wage, might be the reason. Indeed, I've often wondered if self employment is being used on a grand scale to get round the minimum wage. I've only got limited evidence for this among the white van man community, but some I know were employed and are now self-employed working for the same employer. Except they now own their vans and work for peanuts.

[chris]

@ YAC - my data only measure the employed. Many self-employed have v. low earnings and hours.

[aragon]

Why not accept the consequences of more than two million immigrants on the employment market along with a stagnant economy.

http://www.telegraph.co.uk/news/uknews/immigration/10117717/Migrant-men-more-likely-to-be-in-work-than-indigenous-British-males.html

"It found that between 2001 the proportion of foreign born men in work increased from 72.3 per cent to 76.9 per cent.

In comparison, the share of British-born men in work fell from 78.14 per cent to 74.73 per cent over the same period."

Of course immigration is good for all, is a matter of faith for economists.

[Joe]

Hasn't some IMF research shown that strong bargaining power is the best way to reduce income inequality...

[Tom Chance]

I had the same thought as Joe. What does this look like in other countries with the same technological changes, but with much higher levels of collective bargaining?

Also, what happens if you control for the change in GDP? The dips in the late 1970s and early 1990s might not quite go negative, but those recessions weren't anywhere near as deep as our current stagnation.

[Rick]

Yet another Chris -

There is some data in the IFS paper to suggest the experience of your white van men might not be untypical. 40% of self-employed 'businesses' do not make the full-time minimum wage income.

http://flipchartfairytales.wordpress.com/2013/06/13/from-non-jobs-to-non-businesses/

[Luis Enrique]

do these explanations apply equally across all industries? If not, the hypothesis could be tested by seeing if wages have fallen further in industries where supervision and control over workers has increased more than in others.

Or maybe that wouldn't work because wages are equalized within labour markets that contain a mix of these different types of firms.

I'm not sure how much I buy all of this in any case. If bosses cannot observe if I am pilfering or skiving, why would I pilfer or skive less if I'm paid more? I think I'd just be a better paid skiver. And what's the elasticity here? Say I work in Gap and could steal clothes, is a 10% rise in my wage really going to make much difference to my inclination to do so? Enough to justify the cost?

[Metatone]

@Luis Enrique - I think there's two parts to this. The first is that some firms would pay more (or indeed, did pay more) as this gave them more choice in the labour market, thus helping them find those less likely to skive/pilfer. Ability to do this seems to have been related to scale. (Also of course management philosophy - Apple Stores are known to pay more that other retail, which they claim lets them find better workers.)

Of course, the second part is that this only works if some firms (or sectors, e.g. SMEs) don't take this approach. If everyone does it, the prevailing wage is just higher and you're back to square one. That's why I mention ability...

[paulc156]

Michael Roberts on his blog answers the 'real wages' issue in large part as a consequence of changes in welfare and pensions:
"Lone parents and older workers – in part associated with increasing pension age for women and the fall in the value of pensions and annuities for those approaching retirement – have been forced to look for work. So the ‘reserve army of labour’ has risen and competition for jobs has been intense. As a result, employers have been able to cut wages, especially in non-union sectors. As a result, the majority are taking the pain through lower real incomes rather than job losses, as price inflation outstrips pay rises."
It's smaller firms [less than 250 employees] who are reducing wages the most rather than sack staff and its these firms who tend to have little or no union representation. Whilst those firms with 250 plus employees are tending to lay off staff and and maintain wages.

[Luis Enrique]

metatone

so competition for higher ability workers between firms used to drive wages up, but now tasks are standardized and firms don't care so much about worker ability, this doesn't drive wages up any more?

that's a somewhat different argument, but I guess it works.

thing is, to my mind mechanisms like that are going to be dominated by cruder considerations like how large is the pool of unemployed workers you are recruiting from and how flexible are wages (union power, legislation). Things like competition from China (see here http://economics.mit.edu/files/6613 ) look like more powerful explanations. Although I've pulled that claim out of my rear end.

[Metatone]

I think I was unclear, it wasn't not competition for "higher ability" workers, it was competition for "higher character" workers.

And advances, as Chris outlines, have reduced the need for "higher character" workers...

But of course, I actually agree with you, all the cruder considerations, labour pool, foreign labour pool, automation, unions, look far more important in determining wage level.

[Luis Enrique]

ah, I see. But still, not sure I buy it. For example, seems to me that in service industries, where the "customer experience" matters, having higher character workers is likely to be more important to bosses than it was in metal bashing. And our economy has become dominated by services.

[Metatone]

@Luis Enrique - on "customer experience" - you might think so, but you clearly haven't visited an 02 store (to name one) recently...

The British Service Economy is an odd beast, built as it is on a culture of non-service...

[Ken Cameron]

The competitive labour market created by the EU is holding down labour rates in Europe. Employers have a larger choice of quality workers because those workers are permitted to cross borders. This has to be contrasted with the Soviet style uncompetitive state controlled economies of the EU which reward the rich by rewarding failure and so perpetuate economic inefficiency. This is achieved by printing money i.e. by using “have another drink to cure a hangover” economics i.e. Free labour market but distorted/retricted financial market. Small to medium sized enterprises (SMEs) are also disadvantaged by this system, as cheap zero interest money bypasses them and is used to bail out multinational organisations especially banks which are also allowed to minimise their taxation by exporting their profits to low taxation countries i.e. Free labour market but uncompetitive economics. The national SMEs are therefore at a disadvantage when competing with multinationals so their reduced profits result in lower wages for their employees which displaces local labour in favour of migrant labour.

[Seth]

"You cannot understand economics without understanding power."

YES.

The more complicated version of my response in Econ-jargon is: Arrow-Debreu is about equilibrium resulting from given exogenous boundary conditions. It is politically safe for economists to tediously marvel at the miracle of equilibrium while studiously ignoring the boundary conditions which generate those equilibria.

Equilibrium is the result of market action. The exogenous variables -- also known as externalities in some contexts -- are frequently tied directly to old fashioned power relations.

Economists are professionally at risk when they venture into the power dimension of their subject. This is why departments of Political Economy no longer exist. The economics profession are now a Dr. Panglossian priesthood chanting endlessly: all is for the best in this the best of all possible worlds. The more math they use to camouflage this, the better their career prospects.

[ronalvme]

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