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More on Labor Supply (Why Real Wages Stopped Growing V)

The previous blog in this series showed that a simple three-factorial model can reproduce very faithfully the long-term dynamics of real wages. The model not only explains why the real wages stopped growing in the late 1970s, but also (surprisingly) the ups and downs since 1980. Furthermore, the model predicts the real wage five years in the future (due to the lag time with which the wage responds to current conditions). Unfortunately, the model forecast for 2013–17 is an unrelenting downward trend in wages (mainly due to a combination of stagnating GDP and continuing growth of the labor force).

Although the model is very simple, this simplicity is somewhat deceptive. The model, in fact, combines a number of factors, which have been proposed as explanations for the wage slump, in a very frugal way. Thus, immigration (both legal and illegal) enters the equation by making the labor supply increase faster. Trade deficit, on the other hand, subtracts from the GDP, and thus decreases the demand for labor. Real minimum wage moved in parallel with a number of other indicators reflecting the action of non-market forces. The model, thus, can be used as a common framework within which different explanations can be compared to each other quantitatively.

A disbalance between labor supply and demand clearly played a very important role in driving real wages down. As Harvard economist George J. Borjas recently wrote, “The best empirical research that tries to examine what has actually happened in the U.S. labor market aligns well with economy theory: An increase in the number of workers leads to lower wages.”

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Between 1977 and 2012 demand for labor increased only by 31 percent, while supply grew by 56 percent. A big chunk of the increase in the labor supply was simply the overall population growth. Between 1977 and 2012 the population of the United States increased by roughly 42 percent (without immigration it would be less).

But the supply of labor increased much faster. One big factor is immigration. In 2011 the total American work force was 153 million, of which 24.4 million workers (15.9 percent) were foreign-born (this number includes both legal and illegal immigrants).

So immigration had a big effect. But consider the second factor, an increased proportion of women who enter the labor force. Back in the 1970 only 40 percent of women were in the labor force, today it is close to 60 percent. If labor participation rate of native women (so that we don’t double count foreign-born women in the labor force) stayed at its 1970s level, today there would be 20 million fewer workers – an effect of the same magnitude as that of immigration.

Before the turning point of the 1970s the American work force was predominantly male and native-born. In the last decades, the oversupply of labor drove down the wages of males, both for the lowest paid 10 percent and for typical (median) workers.

If median wages of men declined, why did the median household incomes continue to rise after 1979, even if much slower than the growth in GDP per capita? The answer is: an increasingly greater proportion of married women working and women earning more, as a result of their wages gradually converging to those of men. As men’s real wages declined, an increasing number of families switched to two-earner households, which allowed them to increase their combined income.

The supply of labor is affected by additional factors, such as changing age composition of the population, but these factors are of much lesser magnitude, so let’s not worry about them. But there are other important factors on the demand side that we need to look at next (in a future blog).

9 Comments

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9 Comments

  1. Ross David H says:

    Given that it is primarily voices on the political left that wish to draw attention to the problem of rising wage inequality and stagnating wages generally, it is perhaps not surprising that neither rising participation in the labor market by women, nor immigration, have gotten much attention as contributing to the problem.

    However, I wonder if these two factors wouldn’t differ a lot in their particular impact? The jobs which non-immigrant women took in large numbers in the post-70’s labor market, are often not the jobs which large numbers of immigrant workers took. So, they would be affecting different parts of the labor market, in particular non-immigrant women had a much bigger impact on office jobs, and immigrants had a much bigger impact on manual labor. You may not want to break things up to that level of detail, but I wonder if it wasn’t the manual labor job market that has had more problems with wage stagnation during the last few decades?

  2. Ross David H says:

    It occurs to me that I’m just guessing that non-immigrant women had a bigger impact on office work, and immigrants had a bigger impact on manual labor. I don’t really have any data to back that up.

    • Peter Turchin says:

      David, there is definitely good data and analyses on the impact of immigrants on the lower-educated, and therefore poorer, segments of the working force. In particular, the high school dropouts are the worst hit. I referenced the work of George Borjas above – you can take a look at his other articles, available through NBER. Very strong statistical evidence supporting this effect. As to to the impact of women in the workforce, I don’t have a reference off the top of my head, but I seem to remember that I’ve seen such studies, also.

      Note that both the lowest 10% of wage-earners and the typical (median) ones – for men – have declined between 1979 and 2011 about the same amount (although in between they did somewhat different things). This suggests that median-earning men did not escape the stagnating-declining trend post 1970s.

      The bottom line is, as Borjas says, “An increase in the number of workers leads to lower wages.” To this I would add, however, that the prevailing social values, norms, and institutions allow economic forces to act on wages unfettered.

  3. Paul N. says:

    Though I cannot afford the time to answer personally. Here are some interesting facts about work force development from Stefan Molyneux. Enjoy.
    link to youtube.com

  4. Peter Turchin says:

    Thank you for this, but I never watch videos when I want to get information (rather than entertainment). Since I read 3-4 times faster than a person can speak, I find video/audio a horribly inefficient way of learning stuff. Is there an associated text?

  5. Robert H. says:

    I’ve really enjoyed this series. The graph comparing the demand and the supply of labor was quite eye-opening. I have a question, though. How does it relate to unemployment. You can’t tell from the graph that unemployment dropped to historical lows in the late 1990s. You also can’t tell that there was a spike of unemployment in the early 1980s.

    As the demand for labor lagged more and more behind the supply of it, I realize that put downward pressure on wages. But even when workers are cheap, I would think employers tend to hire only the ones they need. Once the demand is fulfilled, extra labor is just surplus, which should be reflected in higher unemployment rates. Yet it doesn’t seem to, at least not in proportion to the gap between supply and demand. How is the unemployment hidden? I know part of the answer is “in prison,” since our incarceration rate has soared in the last 30 years. But what’s the rest of the answer?

  6. I would propose an alternate cultural proxy. Consider a trailing average of Presidency occupation by party. For example a 30 year trailing average started out strongly Republican in the late 1920’s, and falls to neutral at the end of the 30’s and then rises to strong D in the 40’s, where it remains until the mid-to-late seventies. It has been high in R since then. IF (and it is a big if) Dems win in 2016* it promises to move into D territory around 2018. The idea behind this measure is the way media elites perceive the political terrain is influenced by which party has been perceived as dominant during their careers. When elites perceive D dominance they take economically liberal concepts more seriously, policy is more labor friendly. One might see changes in taxation, trade and immigration that favor labor over capital.

    One the other hand when the trialing average favors the Republican views are more sympathetic towards conservative economic arguments. Policy will be more favorable to capital.

    Minimum wage capture the same dynamic, but the electoral measure (if it works) is closer to an actual cultural measure since it is determined from electoral (not economic) data.

    *If Dems win in 2016 this makes 2008 a likely “critical realignment election”, which itself is a semi-cyclical phenomenon from a non-economic discipline.

    • Peter Turchin says:

      I don’t think this is a good proxy for what I need. There are real differences between Dems and Reps, mostly on cultural issues (abortion, rights, etc). But on labor issues they are nigh indistinguishable.

      Minimum wage is set not by an economic process, but by political one. So it’s a good proxy for changing social mood among the political elites.

  7. DavidHopkins says:

    Equal wages for equal work should be followed to avoid the rise of discrimination.

    http://www.convention-collective-auto.fr