Navigating the Dynamics of Real Wages in Tight Job Markets

Inflation has been eating away at salaries and incomes. How are people coping with more work, less real pay and greater responsibilities in an era where some tasks are being taken over by AI?

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The COVID 19 pandemic and the recent global downturn with its associated inflation left us with a sticky phenomena related to our livelihoods. In the 37 market-based economies of the The Organization for Economic Cooperation and Development (OECD), we see job markets tightening (employment increasing), paradoxically with a drop in real wages. It feels confusing to traditional economics because the global economy has been slowing down since 2021due mainly to the pandemic and all it accompanying disruption in both supply and demand. Meanwhile employment has rebounded, reaching levels unseen since the early 1970s. I noticed this trend when I still received a fixed salary in Atlanta airport. As the OECD Employment Outlook 2023 reveals, nominal hourly wages have increased, yet they have failed to keep pace with inflation, resulting in a decline in real wages.

As of May 2023, the OECD unemployment rate remains at a historic low of 4.8%, signaling robust labor market resilience. That’s socially good to keep people working rather than idle. Yet, real hourly wages have experienced a decline in numerous industries and countries, coupled with a rise in the cost of living. In the first quarter of 2023 alone, 30 out of 34 countries reported negative real annual wage growth, averaging a decline of 3.8%. This wage stagnation, coupled with the rising cost of living, poses a substantial challenge, particularly for workers in low-income households, or with multiple jobs. Burnout is eminent! 

The OECD Employment Outlook 2023 offers a comprehensive analysis, revealing that profits have often outpaced labor compensation. Most companies are doing well, but there is no trickle-down effect here from the Washington Consensus. Looking ahead, the report suggests there’s room for profits to absorb wage adjustments gradually, mitigating purchasing power losses without generating significant price pressures. But shareholders want growth, so I am less optimistic. 

Addressing the impact of artificial intelligence (AI) on the labor market, the Outlook highlights the potential for an AI revolution. I see adoption of AI in just about every tech I interact with. The rapid progress in AI technology raises important considerations for future policy frameworks, emphasizing the need for international cooperation to maximize benefits while managing risks effectively. As we navigate this evolving landscape, it becomes important for governments to address the challenges posed by AI, ensuring inclusive labor markets and safeguarding worker rights and well-being. I am watching this play out now in the film industry as producers try to get more from less resources and fewer creators (or at lease, pay them less). These are still under negotiations.

“If a writer is asked to rewrite a script created by AI, their rewrite will still be considered an original script. Studios and streamers can’t require writers to use AI tools if they don’t want to and they must disclose to the writer if any material used was generated by AI.” Source: CNBC

I am concerned about inflation, well because I like to cook and eat and food is getting too expensive, but also because with fixed incomes, our available money to spend, what we call our disposable income, is dwindling. The real purchasing power of households is falling. So, that raise you got! Remember real wages, factor in the impact of inflation on nominal wages, providing a more accurate representation of income’s actual value.

I think it’s worth explaining via an example how disposable income and real wages are not keeping up with inflation. Consider a household with an annual income of $50,000. If nominal wages increase by 3% due to a salary raise, it might seem like a positive development. Go thank the boss. She/he is patting themselves on the back and telling you to do more work. However, if inflation is running at 5% during the same period, the real wage increase becomes negative.

Here’s the breakdown:

Nominal Wages Increase: $50,000 + (3% of $50,000) = $51,500

Inflation: 5% of $51,500 = $2,575

Real Wages: $51,500 – $2,575 = $48,925

In this scenario, although the household’s nominal income increased, the impact of inflation eroded the actual purchasing power of the income. The real income, adjusted for inflation, is $48,925, which is lower than the initial income of $50,000.

Now, let’s explore the consequences for the household:

Reduced Purchasing Power: With lower real wages, the household experiences a decrease in its purchasing power. The same amount of money buys fewer goods and services, affecting the standard of living. You can’t replace that busted alternator in your car. You must reduce your luxuries, which has an impact on demand of non-necessities, and even necessities like healthcare.

Financial Strain: If essential expenses like housing, utilities, healthcare and groceries continue to rise with inflation, the household may find it challenging to cover these costs with the diminished real income. 

Savings Impact: The ability to save for future needs or emergencies may be compromised as a significant portion of income goes towards maintaining the same lifestyle. This is where most people burn their savings. We saw savings plummet since COVID-19 pandemic.

Debt Burden: If the household has debts with fixed payments, such as rent, mortgages, school fees, or car loans, the real value of these payments increases, potentially leading to financial strain. So you break out the credit card, and borrow more. 

In essence, when disposable income and real wages do not keep up with inflation, households may experience a decline in their economic well-being. It underscores the importance of not only considering nominal income increases but also understanding the real impact of inflation on purchasing power for a more accurate assessment of financial health.

For your next raise, make sure to ask for an increase that stays ahead of inflation. 

In this blog, I write (less occasionally), about aviation, economic and trade issues. For my my blog on more relaxing stuff, read my articles on Elliott D. Paige blog. There, I write about food, travel, and things that bother me that are less academic. Enjoy.

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