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:

Katie Chart 1
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:

Katie Chart 2
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):

Katie Chart 3

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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