Could a shift in the labor market in the USA explain the low unemployment/wage/gdp/inflation conundrum?

The US central bank’s strategy (keynesian economic theory) should have worked

Wilkins Chung
Jul 24, 2017 · 3 min read

With a decade of low rates, we should be seeing low unemployment, high GDP growth and inflationary indicators (wages and CPI). It seemed to work in the past, but not anymore. The US still lacks wage growth, significant inflation, and has low GDP growth. All we’re getting is historically low unemployment numbers.

Seems odd, but Japan experienced the same for the last quarter century. No wage growth, low/declining GDP, low inflation/deflation, even with persistent low interest rates. Why?

Maybe it all boils down to wages. With no wage growth, you don’t have increased consumer spending and GDP growth for countries that rely primarily on domestic consumption (assuming that GDP is still driven by the masses rather than the 1% whales). So what was different in the past quarter century between the US and Japan, and what has changed in the US recently with respect to the work force?

Theory: Labor unions no longer drive wage growth in the US

Labor unions in Japan are co-operative with the companies, whereas labor unions in the US are adversarial. So in periods of poor economic activity the unions in Japan are willing to accept lower wages to keep people employed, leading to low wages yet low unemployment. So you had 25 years of low unemployment, but it didn’t cause higher wages due to the lack of forced upward wages by organized labor. This led to low consumer staples (since people couldn’t afford much more than what they made), meaning low CPI/deflationary pressure.

In the US, unions typically push for higher wages and are more adversarial in nature even in periods of economic decline. This usually nets overall wage increases, even though there might be a side effect of higher unemployment when the economy is doing poorly. However, the number of unionized workers is shrinking, and with the advent of the sharing economy, there are even more contract workers. This means that unionized labor may no longer be setting the baseline for wages in the US for given labor markets.

With this shift, it seems that similar to Japan, poor economic activity will set a floor on wages, and workers will take the market rates. This could explain why the US currently has historically low unemployment and yet no wage growth and tepid inflation numbers (again, no wage growth -> low inflation -> low GDP).

Does this mean that the US is going to look like Japan?

Japan went through 25 years of stagnant growth (from a GDP standpoint). Is the US in for the same? It’s certainly seems possible. Low wage growth means low GDP growth for countries that rely heavily on domestic consumption.

Also, if this is true and the fed is using inflation/wage growth as a signal to raise rates, it could wait far too long to do so, causing another massive asset bubble (if we’re not there already).

Could there be a worse outcome? Yes.

Consider a scenario where we have low unemployment, low wage growth and low GDP growth, but high inflation. If the economy was self contained, it doesn’t seem possible. However, the US imports a vast amount of its consumer goods, especially from China. Currently, the whole world is engaged in the low rate game, so inflation caused by currency depreciation isn’t that much of a concern. But this could possibly change quickly, especially if the Chinese Yuan appreciates. I would guess that this could be the trigger that causes another recession.

What else could it be?

What else do you think might be causing the low unemployment/low wage/low GDP/low inflation conundrum? What do you think will happen in the next 5–10 years? Please feel free to leave your comments below.

Wilkins Chung

Written by

Co-founder of A Thinking Ape, YC Alumni, Waterloo Grad

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