Economy: Higher Wages, Spending & GDP

Thanks to the rise of outsourcing and the Great Recession, labor costs have, for some time, barely risen. And while this has caused great pain to workers, it has been a boon to business. To give you an idea of how anemic wage growth has been recently, keep in mind that real compensation per hour rose at an average annual inflation-adjusted rate of 1.6% since record keeping began in 1947. Since 2000, it has averaged slightly less than one percent per year (0.95%), and since the start of the great recession in January 2008, it has averaged a trivial one-seventh-of-one-percent. I now think we are entering a period of more rapid wage growth. This will impact corporate spending on technology, corporate profits and GDP growth.
Due to small wage increases, firms have largely reduced their purchases of technology equipment and software. After all, a major reason firms buy computers and software is to reduce the amount spent on salaries. But with salaries largely stagnant, why buy labor-saving technology? As a result, business spending as a share of GDP has fallen by about 20% since the onset of the recession, and annual increases in corporate spending on technology equipment and software are now lower than they have been in fifty years. While you might think this is because computers continually get cheaper, they have been getting cheaper since they were first built. The key difference this time is that the combination of reduced spending on salaries and technology has boosted corporate profits, despite weak top line sales gains. This golden era of corporate profit is now nearing an end for several reasons.
First, because of limited investment in technology, productivity gains, or increases in output per worker per hour, have steadily declined over the last several years to the point where they are now zero. Second, steady job gains have been slowly chipping away at the unemployment rate. And while much of the reduction has been due to declines in the labor force participation rate, some of that is due to baby-boomers retirements, something which will continue for another decade. Third, outsourcing work to, for example, China no longer packs the profit punch it once did because wages there are rising rapidly, by 14% last year, and 12.3% in 2011.
As a result, US firms will soon be forced to pay higher wages and thus will invest in technology to meet rising consumer demand for goods and services and lessen the impact of higher wages. While this will reduce corporate profits and act as a headwind for stock prices, it will also help the economy tremendously. Here’s why:
Consumer spending is the biggest driver of the U.S. economy, accounting for 69% of GDP. Since the year 2000, wages as a percent of GDP have fallen from 46% to 42.5%. A reversal of this trend, even if small, would boost spending on durable goods, restaurant meals, clothing and more. And we need additional spending, because even though house prices and the stock market are up, many workers own neither. The only way to increase their spending is for their paychecks to grow.
Finally, to get out of a recession it is necessary for all cyclical sectors including housing, automobiles, non-residential private construction, and corporate purchases of equipment and software to increase in unison. While all cyclicals aside from corporate purchases are now contributing to GDP growth, bringing corporate purchases in from the cold would significantly strengthen the recovery and boost GDP.
Elliot Eisenberg, Ph.D. is President of GraphsandLaughs, LLC and can be reached at Elliot@graphsandlaughs.net. His daily 70 word economics and policy blog can be seen at www.econ70.com.