We are in the midst of an economic paradox.
On one hand, the latest unemployment numbers are lackluster. The May 2021 unemployment rate was 5.8 percent with more than 9 million people unemployed. (In February 2020, those same numbers were 3.5 percent and 5.7 million people, respectively.) The labor force participation rate and employment-to-population ratio have changed little during these early months of the pandemic recovery. The unemployment rate for workers without a high school degree is the same as it was in January 2021: 9.1 percent.
On the other hand, businesses are struggling to find workers. Hard-to-fill positions are not unusual—nurses and engineers are often in demand—but now bars, hotels, restaurants, and retail are desperate to find entry-level workers. How can joblessness be so high when workers of all stripes are so in demand?
There are multiple reasons for the increased scarcity of labor. The lingering difficulty of securing child care, continued concerns about the virus, and extended unemployment benefits all fuel the challenges businesses face in filling positions.
But so does low wages. So why aren’t wages rising enough to bring unemployment down more? It's tempting to dismiss companies as evil and greedy or psychologically unable to move away from low-wages, but the answer is more complicated than that. Companies are hesitant to raise wages because there’s still a lot of uncertainty about what a post-pandemic economy will look like, and it’s hard to reverse a wage increase.
Hesitant Wage Growth
It’s true that some entry-level wages are rising. Amazon, McDonald’s, Chipotle, and Under Armour are all increasing hourly pay. Enough workers are serious about higher pay, and higher pay follows—that’s how the market works.
But other companies favor signing bonuses or interview bonuses. One day in May, Applebee’s gave free appetizers if you interviewed, leading to no shortage of memes complaining these companies should just increase wages. Why aren’t wages rising even more than they are now?
Firms, especially small firms, have good reason to be hesitant about increasing hourly pay, because it’s difficult to go back if demand sours. Understanding why wages don’t fall during a recession helps explain why wages are rising slowly during the pandemic recovery.
Why Wages Don’t Fall During Recessions
During a recession, wages typically don’t fall. Hours may be cut but nominal hourly rates and salaries typically stay the same. Layoffs are the preferred measure for a company to cut costs.
To an economist, this is puzzling. Wheat and copper and oil prices adjust quickly to changes in supply and demand. So with idle workers easy to find, why not hire cheaply and cut costs? Why not slash the wages of employees, allowing firms to keep everyone they’ve hired so they don’t have to go through the expensive process of rehiring when the economy picks up again?
Frustrated by the blackboard explanations his fellow economists favored, Truman Bewley did something unusual: he asked the firms directly.
From manufacturing firms to restaurants, from big companies to small ones, union and nonunion, old firms and new, Bewley asked managers and HR directors and executives why they didn’t just cut wages during recessions. Answers varied, but one theme kept coming up: morale.
Managers are terrified that if they cut wages, worker morale would plummet and what they save in reduced salaries will not be enough to make up for what they lose in productivity. Firing some is better than demoralizing the whole company.
Why Wages Rise Slowly During Recoveries
In short, that’s why commodity prices are free to fluctuate with market conditions while labor is not. Commodity prices can rise with scarcity because no one’s concerned it’ll be stuck too high if conditions change. Copper doesn’t suffer a morale problem if its price falls.
The same cannot be said of workers. If companies are hesitant to cut wages when times are rough, then they may see any increase in wages as a ratchet-effect. If wages are going to rise, you better make sure those higher wages are sustainable.
Morale helps explain why stories about one-time signing bonuses predate stories about increased wages. It sheds light on why large corporations are first to increase wages—they have more ability to absorb over-payment while small and mid-sized companies are naturally going to be more hesitant. It also helps explain why, even in a “normal” recovery, it takes a long time for low-wage workers to see their pay increase.
The Future Is Truly Uncertain
Hesitancy at increasing wages is not a sign of mindless greed but thoughtful caution. As the US recovery begins, questions linger: How much business travel will return? How much remote work will be permanent? How much of the pandemic lifestyle will people want to keep? How much of this surge in demand for services is temporary? No one knows the answers to these critical questions.
The economy is undergoing a massive recalculation, filled with technological and cultural change. Millions upon millions of people are trying to determine how their business should adapt to a post-pandemic world.
It’s no wonder wages are slow to rise.