The previous blog in this series showed that a simple three-factorial model can reproduce very faithfully the long-term dynamics of real wages. The model not only explains why the real wages stopped growing in the late 1970s, but also (surprisingly) the ups and downs since 1980. Furthermore, the model predicts the real wage five years in the future (due to the lag time with which the wage responds to current conditions). Unfortunately, the model forecast for 2013–17 is an unrelenting downward trend in wages (mainly due to a combination of stagnating GDP and continuing growth of the labor force).
Although the model is very simple, this simplicity is somewhat deceptive. The model, in fact, combines a number of factors, which have been proposed as explanations for the wage slump, in a very frugal way. Thus, immigration (both legal and illegal) enters the equation by making the labor supply increase faster. Trade deficit, on the other hand, subtracts from the GDP, and thus decreases the demand for labor. Real minimum wage moved in parallel with a number of other indicators reflecting the action of non-market forces. The model, thus, can be used as a common framework within which different explanations can be compared to each other quantitatively.
A disbalance between labor supply and demand clearly played a very important role in driving real wages down. As Harvard economist George J. Borjas recently wrote, “The best empirical research that tries to examine what has actually happened in the U.S. labor market aligns well with economy theory: An increase in the number of workers leads to lower wages.”
Between 1977 and 2012 demand for labor increased only by 31 percent, while supply grew by 56 percent. A big chunk of the increase in the labor supply was simply the overall population growth. Between 1977 and 2012 the population of the United States increased by roughly 42 percent (without immigration it would be less).
But the supply of labor increased much faster. One big factor is immigration. In 2011 the total American work force was 153 million, of which 24.4 million workers (15.9 percent) were foreign-born (this number includes both legal and illegal immigrants).
So immigration had a big effect. But consider the second factor, an increased proportion of women who enter the labor force. Back in the 1970 only 40 percent of women were in the labor force, today it is close to 60 percent. If labor participation rate of native women (so that we don’t double count foreign-born women in the labor force) stayed at its 1970s level, today there would be 20 million fewer workers – an effect of the same magnitude as that of immigration.
Before the turning point of the 1970s the American work force was predominantly male and native-born. In the last decades, the oversupply of labor drove down the wages of males, both for the lowest paid 10 percent and for typical (median) workers:
Source of data: State of Working America
If median wages of men declined, why did the median household incomes continue to rise after 1979, even if much slower than the growth in GDP per capita? The answer is: an increasingly greater proportion of married women working and women earning more, as a result of their wages gradually converging to those of men. As men’s real wages declined, an increasing number of families switched to two-earner households, which allowed them to increase their combined income.
The supply of labor is affected by additional factors, such as changing age composition of the population, but these factors are of much lesser magnitude, so let’s not worry about them. But there are other important factors on the demand side that we need to look at next (in a future blog).