Wages - Business in United States of America
Definition: Compensation in money paid to hired labor
Significance: Wages are a major component of business costs, and wage policy is an important tool for management. Wage income is the principal source of consumption spending.
Firms employ labor to produce and earn profits. In a competitive free-market economy, wages are determined by the supply of and demand for labor of various descriptions. Real wages measure the amount of goods and services represented by the money wage. The supply of labor reflects the size, composition, skill, education, and attitudes of the population. Demand for labor reflects labor productivity and demand for the firm’s product.
Although colonial North America was sparsely populated, it possessed a vast amount of fertile land and other natural resources. Consequently, labor productivity and real wages were high relative to their counterparts in European countries. Many Americans were self-employed as farmers, craftspeople, or owners of small businesses. Because land was cheap and fertile, workers always had the option of becoming independent farmers, and employers had to pay a sufficient wage to compete with this opportunity. The exception was the South, where slavery was a response to the labor shortage and less hospitable climate.
Throughout its history, the United States has been a high-wage country. Labor productivity and demand for labor grew steadily, reflecting the upgrading of labor education and skills, growth of productive capital, and improvements in technology and organization. High wages and a freely competitive labor market attracted millions of immigrants, but over the long run, demand for labor outran supply. Researcher Donald Adams estimated that real wages during the 1960’s were about thirteen times as large as those in the first decade of the nineteenth century. Considering the radical change in the items of consumption, these comparisons cannot be very precise. However, it is clear that both the number of hours worked per person and the physical demands of work declined substantially over the same period.
The Nineteenth Century
In 1800, only about 10 percent of the labor force were employees, and that proportion rose only to 30 percent by 1850. At that time, the principal form of wage labor was on farms. Around that time, male farmworkers received about $8 a month plus meals and sleeping accommodations worth another $6 a month. To the modern reader, these seem absurdly low, but prices were correspondingly low. Numerous observers indicated that in 1820-1840, a hired farmworker could earn and save enough in a year or two to purchase a farm productive enough to support a family. Such wage rates were well above the minimum needed for survival.
The earliest major manufacturing industry was textile production, which began in New England. Around 1820, nearly half of the employees of water powered textile mills were children, who were paid about 18 to 25 cents a day. Most of the other textile workers were adult women, who were paid around 40 cents a day. As late as 1910, children constituted as much as one-sixth of the labor force.
For men, construction became a major form of wage employment. There was always a need for houses, barns, and shops, but from the 1820’s, major construction operations extended the nation’s transport systems—first canals, then railways. A dollar a day was a common wage for arduous manual labor. Heavy industry became a major employer, with iron and steel significant industries by 1860. Transport innovation raised the productivity of labor in most sectors. Researchers Adam and Stanley Lebergott estimated real wages rose from 1800 to 1860 by anywhere from 50 to 100 percent.
The U.S. Civil War generated severe inflation, destroyed human and material resources, and disorganized production in the South. Not surprisingly, real wages were lower in 1861-1879, on average, than before the war. From that point, real wages showed steady improvement, rising about 50 percent between 1860 and 1910. This was quite a remarkable achievement. Immigration was high over that entire period, adding to labor supply. Labor unions played only an inconsequential role. The rise in real wages was a testimonial to the effect of competition among employers in a period of rapid technological and organizational improvement.
The Twentieth Century
The powerful and unmistakable improvement in real wages continued into the 1970’s, after which the evidence becomes harder to interpret. Child labor faded away, while female labor-force participation expanded greatly. Henry Ford created a sensation in 1914, when he set wages at $5 a day for his automobile workers. Government became a major employer, leading to the creation of a substantial segment of non-market-determined wages. The number of workers engaged in farming reached a peak in 1920, then declined. Wage and salary employees, who constituted only 46 percent of employment in 1900, accounted for 89 percent in 2005.
The labor market was severely shocked by the major economic depression of 1929-1940. The decrease in aggregate demand led to massive unemployment, reaching a peak level of 25 percent in 1933. Money wage rates fell—but apparently no more than prices, so real wage rates (per hour) hardly declined. Various government interventions attempted to prevent wage declines. Wage policy was an important part of the National Industrial Recovery Act of 1933 and the National Labor Relations (Wagner) Act of 1935. The Davis-Bacon Act of 1931 required firms supplying construction services to the federal government to pay the equivalent of union scale. The Fair Labor Standards Act of 1938 established the federal minimum wage, which began at 25 cents an hour. Creation of the overtime penalty wage helped reduce the average workweek.
Work Time in Minutes Required to Buy Various Products
Source: Data from W. Michael Cox and Richard Alm, Myths of Rich and Poor: Why We’re Better Off than We Think (New York: Basic Books, 1999)
World War II restored full employment, attracted many more women into the labor force, and increased the scope and power of labor unions. Wages came under the same control programs as prices. Income-tax withholding was introduced, and employers were also obligated to deduct wage taxes for Social Security, unemployment compensation, and (after 1965) Medicare. An important response to high income-tax rates and wage controls was the spread of fringe benefits—wage supplements such as paid vacations and sick leave, retirement benefits, and medical insurance.
Modern Wage Issues
One issue commonly discussed is whether real wages continued to rise after 1970. By 2006, money wages were vastly higher than in 1970—hourly earnings rose from$3.40 in 1970 to $16.76 in 2006. However, consumer prices increased as much or more. So estimated real wage rates in 1982 prices actually declined from $8.46 in 1970 to $8.24 in 2006. Real earnings per week show an even larger decline. However, these results, estimated by the Department of Labor, conflict with other data in the national income accounts. Total compensation of employees, divided by total employment and adjusted to remove inflation, virtually doubled between 1970 and 2006. Real personal disposable income per capita and real consumption per capita both more than doubled between 1970 and 2006. Part of the discrepancy arises because the Labor Department wage series does not allow for fringe benefits. The cost of some benefits, such as medical insurance, increased greatly after 1970.
Another way of comparing 1970 with later years is provided by researchers W. Michael Cox and Richard Alm, who estimated the number of hours of work it would take to buy various consumer products in their book, Myths of Rich and Poor: Why We’re Better Off than We Think (1999). Most products required fewer hours of work to purchase, suggesting rising real wages.
The safest conclusion is that real wages after 1976 did not show the same clear-cut increase as in earlier years. Estimated labor productivity roughly doubled between 1970 and 2006, however, many people felt their real wages did not increase. Between 1970 and 2006, the two employer components of fringe costs rose from about 11 percent of total compensation to 19 percent.
Another frequently discussed issue is whether there was significant discrimination in the wages of women and ethnic minorities. Certainly there were significant differences in pay among these groups. According to the Statistical Abstract of the United States (2008), median weekly earnings in 2006 were $671 for all ethnicities and both genders. For men, the median weekly earnings were $743, with whites drawing $761, blacks $591, and Hispanics $505. For women, the median weekly earnings were $600, with whites drawing $609, blacks $519, and Hispanics $440.
Employee Compensation and Principal Components, 1970 and 2006, in Billions of Dollars
Source: Data from Economic Report of the President Transmitted to the Congress February 2008 Together with the Annual Report of the Council of Economic Advisers (Washington, D.C.: Executive Office of the President, Council of Economic Advisers, 2008)
A large part of the observed pay differences can be explained by differences in age, education, experience, and types of work. In earlier times, employment discrimination based on race and gender was widespread. However, economists have long contended that a profit-seeking market economy overrides prejudice because greedy entrepreneurs will be quick to hire undervalued workers, eroding discriminatory pay. Some recent statistical studies (trying to compare workers from the different groups with the same qualifications and job specifications) continue to find discrimination. Others do not. What is evident is that the more clear-cut differences in pay have gradually been reduced by a combination of market competition and government antidiscrimination policies.
Influence of Labor Unions
The relative importance of unions grew after the National Labor Relations Act of 1935, reaching a maximum during the 1950’s, when about one-third of private-sector employees were union members. Since then, the proportion has declined; in 2006, it was only 7 percent. Union strongholds such as the steel and automotive industries have declined in relative importance. Researcher Barry Hirsch provides estimates of the extent to which union wages have exceeded nonunion wages in major sectors. For the private sector as a whole, the union premium was about 40 percent in 1973 and declined only slightly, to about 35 percent, by 2006. Most economists believe these gains come at the expense of consumers and nonunion workers, because unions do not in general raise worker productivity very much. Evidence of the continuing importance of unions was observed in the hardships of unionized Michigan based automobile manufacturers versus the thriving condition of newly established (nonunionized) automobile factories in other areas, particularly in southern states.
Atack, Jeremy, and Peter Passell. A New Economic View of American History. New York: W.W. Norton, 1994. Chapter 19 gives an excellent overview of the market for labor from a historical perspective.
Ehrenberg, Ronald G., and Robert S. Smith. Modern Labor Economics. 6th ed. New York: Pearson/Addison Wesley, 1996. This college-level text puts wages into historical and analytical perspective. There are chapters on pay and productivity, discrimination, and the influence of unions.
Hirsch, Barry T. “Sluggish Institutions in a Dynamic World: Can Unions and Industrial Competition Coexist?” Journal of Economic Perspectives 22, no. 1 (Winter, 2008): 153-176. His short answer is “not very well.” Good historical review of the extent and influence of unionization.
Lebergott, Stanley. Manpower in Economic Growth: The American Record Since 1800. New York: Mc-Graw Hill, 1964. Historical development of wages (there are many examples) is integrated with all elements of labor supply and demand.
“Symposium on Discrimination in Product, Credit, and Labor Markets.” Journal of Economic Perspectives 12, no. 2 (Spring, 1998): 63-126. William Darity and Patrick Mason present evidence of persisting discrimination, while James Heckman takes a skeptical view.
See also: business cycles; farm labor; labor history; labor strikes; Minimum wage laws; National Labor Relations Board; Women in business.