Posted by: Josh Lehner | June 16, 2021

Wages Level Up

The labor market is tighter than you think. That’s the title of the joint report our office released a couple months ago with the Employment Department. In that report we wrote, “[a]t some point, declining COVID-related frictions, competition to hire workers, and relatively low unemployment will push to a market clearing wage that pulls more people back into the labor force.” Well, we’re seeing this play out in real time as it is clear firms are not responding to the pandemic like the long-lasting, demand-driven recessions experienced in recent decades.

Let’s first take a look at our office’s wage forecast that underlies both our economic and revenue outlook. You can see that the average wage has increased significantly so far during the pandemic, rising nine percent above trend. Our office has also built in a higher wage outlook over the long run. Wages have leveled up. These gains are seen in our withholding tax revenue as well. Now, the initial increase in wages was due to compositional changes. With the pandemic and shutdowns, the economy lost a lot of low-wage jobs, meaning that the average wage for those who kept their jobs was higher, even if per worker wages held steady.

But we know per worker wages have not held steady. The Atlanta Fed’s wage tracker shows continuing wage gains, unlike the past couple of cycles where wages sagged in part due to the nature of the cycle and the high number of unemployed workers per job opening. We know this cycle is different. What’s interesting to find, if you dig into the data further, is that the impact from the compositional changes in the labor market is mostly gone now based on the latest U.S. data. Overall, weekly earnings have increased nearly 8% since the start of the pandemic (annualized 6.5%). However if we hold the industry mix steady at pre-pandemic shares, earnings have risen just over 6% (annualized 5.3%), or 82% as much as the topline data. These are strong, underlying gains. (See methodology note at the end for more details)

If we look at these changes relative to pre-pandemic trends, you can see the evolution more clearly. Initially the spike in earnings was entirely due to the compositional changes, or the mix of industry employment. However over the past year, those underlying earnings have really picked up (combination of number of hours worked, and the hourly wage). As of April, 69% of the above-trend earnings gains are due to that underlying growth, with just 31% due to the industry mix.

So what does this mean? A number of things.

First, strong gains are expected to continue. The competition for workers is expected to remain fierce even as some of the unique pandemic circumstances holding back labor supply fade in the months ahead. Firms will need to get used to these dynamics. This is especially true within the lower rungs of the wage distribution, where wages were rising fastest even before the pandemic.

Second, wages are sticky. This is good news for workers. Employers rarely cut wages outright so the recent increases in pay should hold in the years to come.

Third, we are already seeing these dynamics play out in Oregon based on the latest job vacancy survey data from our friends over at the Employment Department. Starting wages for both retail, and transportation and warehousing have risen about $2 per hour in the past year. However they have not (yet) for leisure and hospitality. This industry competition is an additional hurdle for bars and restaurants as they staff back up. The data show that starting wages in retail now outpace leisure by $3.50 per hour, and transportation and warehousing outpace leisure by $7 per hour. To the extent we do see labor reallocation (workers moving into different industries), these are key numbers to keep in mind.

Fourth, the good news for firms is strong consumer demand means they can better afford to pay higher wages and pass along necessary cost increases to maintain profit margins. Plus the additional investment in equipment, IT, software, and the like we are seeing will further raise productivity, creating a virtuous cycle.

Fifth, stronger wage gains, and firms ability to pass along cost increases does indicate inflation that may be stronger in the years ahead, even as the reopening-related inflationary pressures fade. We are not talking about hyperinflation, but rather underlying gains stronger than we saw last decade. To the extent we do not get the productivity gains, then inflationary pressures in a supply-constrained economy will likely be larger.

Sixth, the key question is just how far do wages level up? In our forecast (first chart) we have wages slowing in the year ahead as those compositional effects reverse (we will be adding a lot of low-wage jobs back into the calculation). However given the updated analysis above and the job vacancy survey data, the risks are likely even more to the upside than we anticipated. Note that our most recent forecast marked the first time we raised the wage outlook over the entire forecast horizon like this and eliminated any expected recession-related weakness in the underlying trends. To be honest, at the time we developed the forecast – about two months ago – it felt like we were sticking our necks out. Some major national forecasters all had wages reverting to trend. This change is a major reason why the revenue forecast increased so much as well. But now the question is just how strong wage growth will remain, and to what extent those underlying gains offset the industry mix impact in the year ahead.

Finally, these dynamics are good news overall. They also mean the upcoming transition off the enhanced unemployment insurance benefits should be less of a concern. More-plentiful, and better-paying job opportunities are usually the key to drawing folks back into the workforce as well. And given the strong underlying earnings growth, it is possible that housing affordability may not be worsening as much as we think.

Methodology Note: For the decomposition work, I am using CES data for the private sector at a combination of the 3 and 4 digit NAICS level (110 subsectors in all). The earnings data is missing for rail, water, pipeline, and scenic transportation, and for education services, but all other private sector industries are included. This is granular enough to provide a solid look and account for the industry mix changes seen in the past year. To adjust for those, I weight the weekly earnings by sector by their 2019 average employment share of the total, and add them together to create the red line.


Responses

  1. Josh,

    The housing affordability crisis is almost entirely among “Very Low Income” (VLI) and Extremely Low Income (ELI) households.
    Most knowledgeable folks understand that increasing income is the greater “lever” than reducing rental rates to lessen housing cost burden.
    So, can we see an OEA analysis of the impact of wage increases on the (true) housing cost burden among VLI and ELI households (not the million-dollar HHI folks paying more than 30%)?
    Also, OEA would help provide critical, timely analysis regarding housing if you did the kind of analysis reflected in “The U.S. Averted One Housing Crisis, but Another Is in the Wings” article in the June 16, 2021 New York Times. Hint: What’s becoming ever more obvious is that neoliberal deregulation of zoning is simply supplying the feverish demand in the high-cost housing market. The result is doing NOTHING for truly housing-cost burdened households. (And in some cases making things worse.)

    • Hi Paul. Thanks for the comment. Yes, affordability is mostly about our lowest income neighbors. We update income trends across the distribution every year when the Census (ACS) data becomes available. In real time we do not have sufficient data to get a good look at it. The good news today is we think between the various federal aid programs, incomes among the lower tiers did not plunge like in recent cycles. In terms of the comment and link in this post, it was directly referring to the current state of homeownserhip and the fast-rising price of homes sold in today’s market.

  2. Although I subscribe, I somehow missed your May 27 blog post. As usual, there was a lot of relevant information in that post.

    However, I would like to see a sharply focused 360-degree analysis of “housing-cost” burden distribution and degree.

    The well-established fact is that using the “30%” criteria over the general population produces a grossly misleading and skewed summary of housing cost burden. It understates the burden for at lower-income ranges and overstates the burden for higher-income ranges.
    Through the misuse of aggregate “30%” statistics, the neoliberal push for deregulation of zoning and letting investors “solve” the “housing crisis” are implementing deregulation that will so nothing more than provide further financial incentives to demolish older, smaller, less expensive rentals and redevlop with product for the high-end (e.g., Eugene planners’ draft code amendments to implement HB 2001).
    If you track the strategies of private equity funds (e.g., the Blackstone Group, you’ll find its in producing “securitized’ rentals across housing types. The range include whole new “single-family subdivisions all to be rentals, mobile home parks, public rent-controlled apartments, etc. So, for example, statistics on single-family home building have to be divided into targeted for private sale and owner-occupancy versus investor-owned rentals.
    And smack in the middle of the private equity fund strategy is deregulation of large areas of single-family zoning for redevelopment as plexes and smaller apartments. The most profitable approach is finding properties that have a low improvement-to-land value in a desirable area, demolishing it and redeveloping with higher-cost rentals.
    If you dig further, you’ll find that an element of the overall strategy involves cities where single-family supply is and/or can be constrained, which — guess what? — makes the purchase-to-rental cost high and pushes more households into rentals, which the private equity firms are supplying.
    A general criticism I have of the OEA housing analysis is that they seem to be largely based on trailing indicators and have little, if any analysis of major shifts in investor strategies and the leading indicators that reflect these strategies.

    • It will be interesting to see just how much investor activity there is. We’re coming off a decade or multi-decade low for non-owner occupied single family housing. It was low in 2019/2020. So a return to a higher share of SF rentals may be in the works, whether or not that is good news or not, it’s a bit hard to tell in advance. Also it is hard to tell in real time how much these dynamics are changing, unless you have access to Assessor data. If you’re interested in looking at that in Eugene, I would suggest reaching out to the assessor’s office and ask them what they could do to report on it. I would love to see that! In terms of what has been reported publicly, those private equity firms are explicitly targeting places where housing is constrained because it gives you the best return on investment (appreciation). Finally, in terms of trailing indicators, absolutely that is always a challenge. Data only goes out with a lag. Anecdotes are not data. You have to balance the two to produce a forecast. That said, it’s a bit ironic commenting that on this post which leads off with an explicit forecast chart and then discussing the underlying risks to that forecast!

      • Josh,

        “Data only goes out with a lag.”

        Wrong! Certain data, e.g., a new home gets occupancy certification, “lags.”

        But an enormous amount of data provides “leading indicators” (birth rates, aging rates, etc.), as I’m sure you know. By definition, leading indicatiors” don’t provide certainty (except for death and taxes). But in the realm of planning, e.g., for housing, it’s essential to consider leading indicators.

        As to “irony” — that’s an ironic choice of word. šŸ˜‰ A “forecast” based on past data is valuable however, my point was there are other valuable “leading” indicators for considering in forecasts.

      • Ha! OK. Yes there are leading indicators. Our office has OILI (Oregon Index of Leading Indicators) to help us with the direction of the economy. UO has the UO Index as well. Plus a number of US indices like the Conference Board’s LEI. While generally quite helpful, these indices haven’t been great with the pandemic. Traditional economic indicators did not predict the pandemic (technically the yield curve predicted the recession but that was more lucky and tied to the trade war etc than a predictor of what really happened).

        My comment about lagging was about the time lag of when the data becomes available. We get the standard Oregon employment data 3 weeks after the month ends. That’s pretty good for timeliness but those real time estimates are subject to revisions. But a lot of other things take longer. It takes 4-5 weeks for housing permits to come out. It takes 3 months for the state level income data to be released (we get 2021q1 data next week). It takes 3-4 months for the real, good employment data to come out. And so forth. So bridging that time gap is challenging.

    • “A general criticism I have of the OEA housing analysis is that they seem to be largely based on trailing indicators and have little, if any analysis of major shifts in investor strategies ”

      Sorry, trailing indicators is a known known (a la Rumsfeld). Investor strategy is hard to use or quantify as a predictor. As an example, the stock market usually sets frenzied new highs right before a crash. Add in that investor behavior is directly and inversely related to interest rates.

      • Sorry,

        The private equity funds are a) telling their investors about their plans, b) Signing contracts for ownership of entire FUTURE subdivisions that will be all rental, c) Purchasing rent-controlled apartments (see NYC) with clear dates and conditions when units can be changed to market rate, etc., etc.

        You just have to look.

  3. Hmm, have no clue why the housing affordability got inserted, but Josh wrote a good article. As far as housing, since construction has slid and wages are going up, I assume rents will track upward which hits the non- or below-average wage earners disproportionately. I broker apartments and prices are going up a lot for desirable places.

    My big question, are we looking at couple of month inflation pop (like what the Fed and Biden admin are pushing) or is this sustained longer? If it helps, I’m in the latter camp. I think too much easy stimulus has made too much money available in an economy where production was Covid-constrained.

    Other item is interest rates. For some reason, the Fed is scared to death of even suggesting that we’re going to raise rates. What happens if inflation is ongoing for year plus?

    • Dear Anonymous:

      “Hmm, have no clue why the housing affordability got inserted, but Josh wrote a good article.”

      Here’s a clue: Wages are the most important factor in housing affordability. So when there is a report on wages, it’s relevant to learn how the wages are changing for different strata of household income because it’s VLI and ELI households that suffer almost all of the (true) housing-cost burden.

  4. What do you think the probability is that the increase in wages you note is more of a one-time “reset” than the beginning of an ongoing trend of higher wage inflation?

    • Thanks George. It is a risk, no doubt. Now, nobody is really concerned about high rates of inflation on a persistent basis. But something that is a little above target instead of a little below target year after year like last cycle, is certainly possible. We wrote 2 pages on inflation in our latest forecast. See PDF pg 10 at the link below. We get the next PCE data point next Friday. I plan to update and post those inflation comments after the new data comes out. https://www.oregon.gov/das/OEA/Documents/economic%20forecast.pdf

      • Thank you for the reply and the reference.


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