Contestable labor markets

In economics, contestable markets are ones in which, because barriers to entry are non-existent, incumbents are prevented from raising prices (and profits) for fear that in doing so new entrants would flood in.

There has been much hand-wringing lately about the effect of the recent tax cuts. While many feared that companies would use the windfall only to buy back stock or pay dividends, an there has, according to David Brooks on the News Hour, been an appreciable (36%) increase in capital spending.

However reinvesting in building the business hasn't led to an increase in wages even as the labor market tightens to levels not seen in 17 years. With the low levels of unemployment, economists generally predict that as the economy continues to expand, faster than the labor supply, wages will rise. So why are they not?

Several suggestions have been proposed to account for this. The uncertainty surrounding the potential trade disputes with China and NAFTA renegotiation might be causing firms to hold off on hiring; but that's seems inconsistent both with a relatively good jobs report and the spending on capital projects. Another more compelling argument is that the decline of trades unions and a long period in which firms were unable to give any pay raises has blunted labor's ability to bargain effectively. That seems plausible. A third explanation is that the labor pool is larger than the figures suggest with people who had stopped looking for work and were therefore not counted as unemployed not coming back into the market. 

But here's another possible cause; the contestability of labor markets. Although the labor market may be tightening, people looking for work are no longer competing only with other people; they are increasingly competing with automation not to mention off-shoring. Both represent a more significant threat than they did before the great recession. Technology has improved and automation has therefore gotten cheaper; and supply chain logistics has become more robust and cheaper too, facilitating off-shoring. So while a tightening of the labor market 12 years ago might have led to a modest rise in wages, today there are more and more accessible and financially feasible alternatives for firms to consider. That trend is only likely to continue, so while economic growth in a tight labor market is not driving up wages today, expect growth and investment in the future to be met increasingly with labor-saving alternatives which will lead to downward pressure on wages. 

The correlation between unemployment and wage growth will weaken and may even turn negative. When firms are doing well and have money to invest, they may choose increasingly to use that opportunity to restructure, replacing domestic labor with foreign labor and labor in general with machines.