US employers are stepping up hiring, so why aren't they raising their workers' pay?

Lifestyle and Budget Associated Press

Where are the pay raises?

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Employers in the United States are hiring at a brisk pace. Unemployment has sunk to a nearly healthy rate. Jobs are being filled across a range of industries.

Yet the September jobs report released Friday contained a puzzling fact: Paychecks still aren't growing.

Economists regard stagnant wages as a red flag for the 5-year-old recovery. Robust job growth has typically fueled rising wages. And without higher pay, workers have less money to spend and save — and that, in turn, keeps the economy from strengthening further.

Whatever meager pay raises most workers have received in this recovery have been all but eaten up by low inflation. The average hourly wage for non-management workers has remained $20.67 for two months. It's risen just 2.3 percent year-over-year, just slightly above inflation.

It just might be the pivotal challenge for families as well as for the economy. The size of a paycheck shapes budgets for consumers, whose spending accounts for most of the U.S. economy's activity.

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Weak pay gains, along with lower-than-normal inflation, will also influence when the Federal Reserve decides to start raising interest rates. Without more pay raises spreading across the economy, the Fed has less pressure to raise a key short-term rate from its record low near zero.

So why hasn't vigorous hiring led to better paydays?

Three factors help explain the unusual trend:

UNEMPLOYMENT NEEDS TO GO EVEN LOWER

Monthly wage gains last meaningfully outpaced inflation from mid-2006 through 2007, just before the Great Recession started. The unemployment rate then ranged between 4.4 percent and 4.8 percent. If that pattern holds true, unemployment would have to drop another full percentage point from its current 5.9 percent before wages break out of their funk.

Economists note that wages are generally a "lagging" indicator. What they mean is that pay typically starts rising well after the job market has shown significant improvement. As the economy takes off, employers eventually need more workers to meet customer demand. Unless those companies boost pay, they often won't attract enough qualified candidates for the jobs they want to fill.

Some economists think we might be close to that point already but say we might not know until months after the fact.

"We may find out six months from now that 6 percent was the trigger point," said Maury Harris, an economist at the bank UBS.

YOUNGER WORKERS EARN LESS

As older, higher-paid baby boomers retire, they're being replaced by younger workers who earn less. That demographic shift limits how much average pay can grow.

Recent college graduates are earning $692 a week, according to a paper issued this year by the San Francisco Federal Reserve. That's just shy of $36,000 a year. It's also slightly less than the average wage for all non-management workers — most of whom lack a college degree and the additional earnings power it carries.

Based on the jobs report, more young workers are flooding the job market and are willing to work for less, said Diane Swonk, chief economist at Mesirow Financial.

Employers can reduce costs by hiring more 20-somethings who don't have families to support. Or, they can dangle the possibility of replacing their older workers with younger ones to limit pay hikes for their existing employees.

"It's much easier to lower an entry-level wage than a wage for an existing worker," Swonk said. "It's also a bargaining chip that goes to employers over workers."

A HANGOVER FROM THE RECESSION

After the most destructive economic slump since the 1930s, it can take years to heal.

In a speech in August, Fed Chair Janet Yellen floated an intriguing explanation for lackluster wage growth: Employers seldom cut wages during a recession, even though it might, in theory, make financial sense to do so.

The reason they don't is that wage cuts can break employee morale and possibly disrupt business. Since employers shouldered higher wages than they wanted to during the recession, they might be making up the difference by paying workers less during the recovery.

If true, this means wages may lag for a while longer. Yet once they do, they might "increase at a more rapid clip," Bank of America suggested in an analysis Friday.

What's more, lots of people have given up looking for work after being laid off during the recession. The government can track this trend by measuring the percentage of adults who either have a job or are looking for one.

This rate will decline naturally as waves of baby boomers retire. But some economists say the rate fell more during the recession than demographic trends alone would indicate. The rate was 62.7 percent in September, down 3.3 percentage points from just before the recession. A single percentage point represents about 1.5 million potential workers.

Some of the unemployed gave up their job searches long ago. So the government no longer considers them part of the labor force. Still, many of them might still be open to accepting a job if the right one emerges. This means employers might in theory have a deeper supply of possible workers to choose from than the jobs report indicates.

The irony is that these long-term unemployed may be waiting to be offered higher pay. Yet the potential for pay growth is limited when so many people need work.

"The fact that wages remain stuck despite 48 successive months of job gains suggests that employers' bargaining power remains exceptionally strong," said Gary Burtless, an economist at the Brookings Institution.