Unemployment and Wage Trends: Is There a Connection?

When we heard the bad news about unemployment
over the last few years, wages went down in many industries and towns,
according to our PayScale Index. Do wages always drop when unemployment rises?
Since we’ve been tracking wage trends since 2006, we figured we’d take a look
back six years and see what we could learn about this question.

First, we'll start with a lesson in basic economics.

A Basic Economic Approach to Labor Markets

The PayScale Index tracks the growth or decline of wages for private-industry
workers. For example, we found that in Q3 2012, wages rose approximately 1
percent nationally. Our Index is a direct application of supply and demand in
the labor market; a simple labor and demand economic model.

The supply of labor consists of those who have jobs or are
actively searching for jobs. The demand for labor comes from employers trying
to fill positions that are open due to an increased demand for their
product/service that their current labor force cannot sustain. The equilibrium
point between the supply of labor and the demand for labor is the market price
of labor. (Don’t worry. There is no quiz later and you can ask questions in the
comments section.)

If you make the logical assumption that people are willing
to supply more labor as wages increase and firms demand less labor as wages
increases, you can represent this simple economic model using the standard
supply and demand chart below:

Now,
what happens if demand for a firm’s product or service increases? Let us assume
the firm cannot meet this demand with their current labor force. Then they will
need to hire more workers in order to match this increased demand. This shifts
the demand for labor to the right, which causes an increase in the equilibrium
wage rate:

How Does the PayScale Index Relate to Unemployment?

As seen in our simple example, an increased demand for labor
results in higher wages. Therefore, increases in The PayScale Index, which is a
measure of wages, can correlate with increases in the demand for labor, or in
other words, a fall in unemployment.

Given this relationship, one would expect to see a negative
correlation between the unemployment rate and The PayScale Index in the sense
that an increase in The PayScale Index may be observed congruently with a fall
in the unemployment rate. Below is a chart comparing The PayScale Index and the
unemployment rate for non-farm workers who are 16 and older (not adjusted for
seasonal economic shifts, like the holiday shopping season):

As
unemployment rose in 2008 and 2009, wage increases first slowed and then
dropped. With no significant improvement in unemployment in 2010, wages remained
essentially flat. Towards the latter half of 2011 through Q3 2012, unemployment
fell and wages increased.

Correlation Does Not Imply Causation 

While two variables may trend together, changes in one does
not necessarily cause changes in another. In other words, it is possible to
observe an increase in wages and see no significant increase in hiring.

In fact, this situation did occur with the 2012 September
Jobs Report which, even though it showed falling unemployment,
the number of new jobs added was an unimpressive 114,000.

Though wage trends and unemployment tend to be negatively
correlated, the absence of one does not preclude the existence of the other. In
today’s economy, employers are not ramping up hiring but they want to continue
to increase productivity in order to increase output. That means they need to
incent their current workers to be more productive and ensure they don’t lose
top performers. The key to achieving both of these goals is pay increases,
which can occur without large employment increases.

When you want powerful data on wage trends, you can turn
to The PayScale Index. However, these wage trends may or may not reflect what
is happening in the overall labor market in terms of more or fewer jobs being
created. That being said, understanding what is happening to wages in your
specific industry, job category, metro or company size is the key to evaluating
your current pay and or your potential pay from a job offer.

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