Friday, August 11, 2006

Q2 Labor Costs

By most indications US labor costs rose rapidly (by recent standards) in the second quarter. But something is wrong with this picture. Ordinarily one would like to attribute an increase in the price of something (labor, in this case) to either a leftward shift in the supply curve (decrease in supply) or a rightward shift in the demand curve (increase in demand). In the case of labor, there is no evidence that either of these things happened; indeed, the evidence suggests that the demand for labor declined.

I have noted before the dramatic decline in help wanted advertising. It is not matched by the official data on job openings; the latter are roughly flat but certainly show no sign of increasing. New hires, however, did decline in the official data. And aggregate payroll employment growth slowed to an average of 112,000 per month (not enough to keep up with recent average labor force growth) from 176,000 per month in the previous quarter (which is comparable to the average for the prior two years).

This apparent decline in the quantity demanded might suggest that the labor supply curve shifted. That is, there were fewer workers available at any given wage, so firms both raised wages and reduced hiring. But the direct evidence does not support this hypothesis. Labor force participation actually increased throughout the quarter (and also in July, so one cannot reasonably attribute the increases in May and June to sampling error). There was no increase in the rate of unemployment due to voluntary quits. There was a slight decrease in the overall unemployment rate, but the decrease was reversed in July.

Another explanation for rising wages might be an increase in inflation expectations, or a correction for price increases that had already occurred. The argument, I suppose, would be that employers deliberately raised wages because they realized that, given higher prices or higher expected inflation, they would need to do so to retain their desired workforce. Absent an actual increase in quits, however, I find this explanation implausible. If employers were so scared of quits that didn’t actually happen, why did they simultaneously reduce their help wanted advertising? If they decided to spend less on recruitment, why would they be willing to spend more on wages?

My guess is that the increase in labor costs will turn out to be a statistical illusion. Aggregate compensation per hour is reported to have risen at a 5.1% annualized rate for the business sector, but this number is subject to considerable revision. The employment cost index, which corrects for shifts across industry and occupation, shows an annualized increase of 3.6%, still high by recent standards but not quite as troubling. When incentive-paid occupations are excluded, the increase drops to 2.8%, which is roughly the trend growth rate of productivity.

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9 Comments:

Anonymous Anonymous said...

I appreciate your postings here and on other sites.

Your point in a previous note regarding the noise in short term economic statistics is similar to the reason that many people trading equities lose money ie because they interpret noise as information.

Similarly is it possible that the fed in trying to so fine tune the economy is falling into that trap. It doesn't seem logical, to me, that deflation could have been a threat only a couple years ago whereas now the discussion is inflation?

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