Has our economy fully recovered from depths of Great Recession?

Has our economy fully recovered from depths of Great Recession?
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The U.S. labor market has slowly but steadily recovered since the end of the Great Recession in 2009. The unemployment rate dipped below 4 percent for the first time in nearly 17 years in April, and indicators of labor market slack, such as involuntary part-time work and the number of long-term unemployed, have declined as well. However, despite continued improvement in the labor market, wage growth has remained elusive.

So what are we to make of an economy where more people are employed, and yet wages and take-home pay are failing to take off? On average, are workers better off, or is there a sense of frustration that earnings are stagnant? Should the Federal Reserve be cautious in moving forward with interest rate hikes given the uncertainty about how workers are faring?

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Why is the lack of wage growth a mystery? First, by several indicators, labor market slack is low. Involuntary part-time work is still marginally higher than pre-recession levels, but it has declined steeply since its peak during the downturn. Similar declines can be found in the numbers of discouraged workers and long-term unemployed workers in the labor market.

While one could argue that some of these workers are simply dropping out of the labor market, as many did during and immediately following the Great Recession, labor force participation rates have held steady since 2014. As involuntary part-time workers, the long-term unemployed, and discouraged workers find jobs, firms should face greater pressure to increase wages to attract new workers and retain their current ones.

A more direct indicator of labor market slack is the ratio of unemployed persons to job openings. While this ratio peaked during the recession at 6.6 unemployed persons per job opening, it declined to 1.1 in June 2017 and has changed little since then. When there are fewer workers for companies to recruit from for open vacancies, companies should be willing to offer higher wages to employ them.

So why is wage growth not taking off? An interesting explanation for this conundrum might lie in a 2017 study by the Federal Reserve Bank of San Francisco, which finds that while wage growth for continuously employed full-time workers has risen in line with pre-recession trends, aggregate wage growth has been held down by the entry of new or returning workers to full-time jobs. Workers who are moving from involuntary part-time work or unemployment to full-time work are more likely to receive lower wages, relative to workers who have continued in their positions.

Given the trends we document above, this explanation makes sense. Over the last year, the number of involuntary part-time workers fell by more than 6 percent, even as total employment continued to grow. The business cycle recovery has led to substantial increases in full-time employment relative to part-time work. Although the transition from part-time to full-time status may not immediately have an effect, it should eventually increase wages as the pool of slack workers is reduced further.

Building off of this theory, a more disaggregated look across industries also shows that while average wage growth may be low, there is wide variance in nominal wage growth across sectors. Over the last 12 months, usual weekly earnings have grown at 3.2 percent to 4.6 percent in sectors such as finance, construction, transportation and warehousing. Lower-skill sectors, such as retail, leisure, and education and health services, averaged between 2.5 percent and 2.9 percent nominal wage growth.

Construction, transportation and warehousing are also among the sectors with the highest employment growth over this period, while retail, leisure, and education and health services experienced much more modest employment growth. If the economy continues to add relatively more jobs to higher-paying sectors than to lower-paying ones, this should start to show up as an increase in aggregate wage growth as well.

The discussion above suggests that although wage growth has been disappointing during this recovery, there is reason for optimism about the labor market going forward. This has some concerned about an overreaction from the Federal Reserve to preempt rapid wage growth and accompanying inflation by hiking interest rates. Interest rate hikes could slow down the pace of job creation by firms due to the higher costs of financing investments and activities that firms would face as a result.

Such hikes would also increase the costs for the federal government on the more than $16 trillion of federal debt held by the public. This would eventually be paid for by workers, consumers and firms through higher tax payments or other means. Recent statements by Federal Reserve officials, however, suggest that rate hikes will likely be gradual, especially over this year and the next, and they will adjust future policies in response to wage growth and inflation. As of now, there appears to be little concern about a rapid increase in inflation or a sudden slowdown in growth.

Nearly 10 years after the Great Recession, it’s natural to wonder whether the economy ever fully recovered and what the path forward might look like. It’s natural to be anxious whether the new normal is poor wages for workers who struggled to find their way back to a job. Patience is key here. We have come a long way from the depths of the recession. Most indicators are pointing in the right direction. Eventually, so will wages.

Aparna Mathur is a resident scholar in economic policy studies at the American Enterprise Institute. Follow her on Twitter @AparnaMath.