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Wage Against The Machine

BannerPublished: June 24, 2016

Something has the rate of wage growth in a vice grip and labour slack alone can't shoulder the blame. When you consider the anemic wage environment in the G4 – the United States, the Eurozone, Japan, and the UK – only the Eurozone, with its unemployment rate north of 10 per cent, can point a finger in that direction. For the U.S. and UK, with unemployment rates hovering around five per cent, and Japan, where unemployment is currently at 3.3 per cent, the restraints on wage growth are not nearly as obvious.

According to the International Labour Organisation, wage growth globally has slowed and what little growth we have witnessed has been concentrated in emerging markets. Developed market real wages have grown around one per cent annually since 2006, but were close to flat in 2013 and 2014, the last years for which data is available. So what's holding back wage growth?

Headwinds Abound

Several headwinds seem to be constraining wages. These include:

  • Labour slack: High rates of youth unemployment and elevated rates of long-term unemployment are particularly noteworthy in the UK and Europe. Long-term unemployment can be quite damaging as skills can erode, making candidates less effective in competing for jobs requiring high skills.  
  • Globalization: Even the threat of moving jobs offshore can negatively impact wages.
  • Declining unionization: Less than 17 per cent of workers in OECD nations belong to labour unions today, compared to nearly 36 per cent in 1975, resulting in reduced bargaining power.
  • Demographics: An aging workforce is not only less dynamic, but compositionally, retiring high-wage, full-time baby boomers are effectively being replaced by low-wage, part-time millennials.

 

While the labour picture is somewhat better, directionally, Canada is not immune to these headwinds. Both long-term unemployment and youth unemployment hover around 13 per cent – better than the overall OECD – but still concerning. Furthermore, the trend of declining unionization persists in Canada, falling from 37 per cent of the workforce in 1980 to 26.5 per cent today. Consider too, that these headwinds will impact Canada's largest trading partners in the United State, the UK, and the Eurozone.

Embrace The Digital Future, Or Else

But perhaps the biggest secular trend that will affect wage growth in the years ahead is automation, digitization, and artificial intelligence. While workers are getting more expensive relative to capital due to their pricey salaries, benefits, training, the threat of departure, and an expanding regulatory code, equipment and technology are getting cheaper and more dynamic.  Automation is impacting not only the low-tech, unskilled labour force, but increasingly high-wage jobs as well.  Take financial market-making. Once populated by well-paid traders, the markets are increasingly dominated by algorithms today.

A recent study by McKinsey & Company1 suggests that as many as 45 per cent of the activities individuals perform today can be automated by adapting current technologies. These activities represent about $2 trillion in annual wages, according to McKinsey estimates. In the years ahead, automation will affect even the most highly-skilled occupations in the economy. Physicians, managers, and senior executives will not be immune. Even a significant amount of activity undertaken by CEOs can be automated, according to McKinsey.

And the benefits of adopting such technologies, McKinsey estimates, are between three and 10 times their costs. An additional 13 percent of work activities in the U.S. economy could be automated if current technologies that process and understand natural language improve to the median level of human performance, the study projects.

To be sure, automation will touch many occupations over the next few decades. And inevitably there will be winners and losers, as there always are in periods of creative disruption.

Technological Advances

What is unsettling about the current round of dislocation is that it comes amid technological advances in artificial intelligence that, until recently, were only imagined in the realm of science fiction. Technology that can learn, not just do, what it was programmed to do, could dramatically accelerate the rate of change. Against that rapidly shifting landscape, a study2 by Carl Frey and Michael Osborne, of Oxford University, estimates that almost half of U.S. jobs are at risk of being automated over the next 20 years. More alarmingly, the service sector where most of the employment growth over the past several decades has occurred, is highly vulnerable to computerization, the authors conclude.

Predicting the future is hard and inexact. We don't know how rapidly automation, digitization and artificial intelligence will advance, but we can expect that they will indeed progress. They will no doubt destroy existing jobs and new jobs will certainly be created.

During episodes of creative destruction, it is usually easier to see that which will be displaced than to foresee that which will arise from the ashes. But if recent trends hold, more good jobs will be destroyed than created in the process. And that's not likely to create an environment conducive to broad-based and robust wage growth.

Erik Weisman (PH.D.) is chief economist and fixed income portfolio manager at MFS.
1. McKinsey & Company, ‘Four fundamentals of workplace automation,’ McKinsey Quarterly, November 2015
2. ‘The Future of Employment: How Susceptible are Jobs to Automation?’, Carl Frey and Michael Osbourne, September 2013, Oxford University

 

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