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June 2017 | Macro Insights

Quant Call: United States of Wage Growth


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Time-series and cross-sectional analysis support our expectation for US wage growth to pick up in the near future.

Phillips Curve: Does it Still Hold?

More than 70 years ago, economist A. W. H. Phillips found evidence to support a consistent inverse relationship between unemployment and wage inflation. This concept is intuitive—when demand for workers is strong, employers are willing to pay more to compete for labor. So as unemployment declines, workers are employed at higher wage levels and wage inflation accelerates.

However, though unemployment in the US has fallen closer to pre-financial crisis levels, wage inflation still has ample room to rebound. This slow response in wages has raised doubts about whether the inverse relationship still holds.

Wages Are Sticky

We believe that the relationship between unemployment and wage inflation is still well-founded, albeit exhibiting a time-lag. Relative to unemployment, wages are sticky and take time to adjust. Unemployment in the US hit its peak in 2010, and has decreased in a linear fashion ever since. Wages troughed two years later (see Mind the Output Gaps), and we expect their upward momentum to continue in the next few years.

State-by-state and over time the trend is clearer


Source: Bureau of Labor Statistics, GSAM, as of 2017.

While wages may not appear to be responding typically at a national level, the relationship with declining unemployment is more apparent at the state level. The cross-sectional analysis in the chart above plots the trends in unemployment and wage inflation across 50 US states and the District of Columbia from 2004 to 2016. As shown, states with lower levels of unemployment tend to achieve higher wage growth.

Looking at the recovery from 2010, the heat maps opposite suggest this relationship held in a period of deficient labor demand, as well as when unemployment is in line with the long-term expectations.

For instance, the Midwest has some of the tightest labor markets and strongest wage growth. In May 2016 South Dakota’s unemployment rate was the lowest in the country at 2.8%, reflecting its robust industrial sector and the spread of the shale oil boom from the north. We see a clearer dynamic in Michigan, where wage growth has improved markedly as unemployment has receded. Illinois appears to be the sole exception in this region. While wage inflation seems similar to that of neighboring states, the delayed housing recovery in the Chicago metropolitan area and the decline of Illinois’ market share in the auto industry has hurt its construction and manufacturing sectors, and hindered job growth.

Focusing at the state level across various labor market regimes, our analysis suggests the inverse relationship between unemployment and wage inflation is intact. As a result, we believe the declining trend in the national unemployment rate supports an outlook of strengthening wage growth.

The relationship holds in the latest downturn and recovery


Source: GSAM, Bureau of Labor Statistics, as of 2016.

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