Why Wages Rise Over Time, Explained With Real Data

7. What is the difference between a raise and a real raise

Over time, pay tends to rise when work becomes more productive. Here is why wages rise, in seven parts. Number seven: what is the difference between a raise and a real raise? In plain words, the nominal wage is the number on the paycheck, and the real wage is what it can buy.

An IMF outlook chapter defines real wages as nominal wages deflated by consumer prices. So a pay rise counts in real terms only when it beats inflation, the topic of part thirteen. By our count, a 3% raise in a year of 2% inflation is roughly a 1% real raise. After rising prices pushed real wage growth below zero, average pay worldwide returned to growing faster than inflation, the International Labour Organization reports.

For most households, income from work is the main, if not the only, source of income, it notes. How pay and raises are set differs where you live. Number six names the long-run link between productive work and pay. Subscribe for the next parts of this series: every source here is the IMF or the International Labour Organization, linked below.

6. Why does more productive work tend to pay more

Number six: why does more productive work tend to pay more? Productivity growth is associated with faster nominal wage growth, the IMF chapter finds. It describes productivity growth as the real return on labor; in plain words, more output from the same work. The International Labour Organization says productivity can grow through better access to finance, innovation and skills.

Productivity growth also requires jobs to gradually move from low-productivity sectors, such as traditional farming, toward higher-value manufacturing and services. Those moves also create more formal wage jobs. Strong labor market institutions and social dialogue can help productivity gains show up in pay, especially for the lowest paid. Lifting low pay takes more than wage rules alone, including productivity growth, the report says.

In high-income countries, productivity grew 29% from nineteen ninety-nine to twenty twenty-four, and real wages grew 15%. Most of that gap opened between nineteen ninety-nine and 2,006, and since then the two have moved in parallel. The only breaks were short ones during the 2,008 financial crisis and the pandemic, the report adds. By our count, real wages grew about half as fast as productivity over that whole stretch.

Job markets and pay rules differ where you live. Productivity links to pay over the long run, and number five shows what moves pay from year to year.

5. Why does pay rise faster in some years than others

Number five: why does pay rise faster in some years than others? Labor market conditions are relevant drivers of wage growth, the IMF chapter says. When labor market slack grows, measured by unemployment and its change, wage growth slows. Slack eases wage pressures because workers find jobs harder to get, the chapter explains.

By the same logic, when jobs are easy to find and workers are scarce, pay tends to rise faster. By the end of twenty twenty-one, wage growth was broadly in line with rising inflation expectations and tighter labor markets. In the average economy, most of the change in overall pay came from wages moving together across sectors, the chapter finds. Shifts of workers between sectors appeared to add little.

Past experiences vary a lot, partly because of differences across economies and over time, the chapter adds. How quickly hiring moves pay differs from one job market to another. Expected prices matter too, and number four shows how.

4. How do expected prices end up in your pay

Number four: how do expected prices end up in your pay? When people expect prices to rise, nominal wage growth tends to speed up, the IMF chapter finds. Workers ask for higher wages when prices are expected to rise, it explains. In advanced economies, a 1 rise in expected inflation goes with close to a 1 rise in wage growth.

In emerging market economies, the same 1 rise goes with a rise of six tenths of a point, it says. The chapter adds that this link weakened after the global financial crisis, when inflation was low and stable. In its twenty twenty-two analysis, expectations had become a more important driver of wages than before. Looking at past episodes in advanced economies when real wages were flat or falling, the chapter found something reassuring.

Inflation tended to fall afterwards, while nominal wages gradually caught up over several quarters. The chapter defines a wage-price spiral as several quarters in which wages and prices both speed up. In those episodes, such a spiral did not tend to follow. In twenty twenty-two, the chapter judged that the chances of lasting wage-price spirals appeared limited.

By our count, a 3% raise in a year of 3% inflation leaves real pay roughly unchanged. And a 5% raise in a year of 3% inflation adds about 2% in real terms. Pay agreements change from one place to the next. That's four of the seven: real and nominal pay, productivity, demand for workers, and expected prices.

Next, how skills and wage rules shape pay.

3. How do skills and wage rules shape pay

Number three: how do skills and wage rules shape pay? Economic transformation requires workers to keep improving their abilities, the International Labour Organization's chief economist writes. Workers are more likely to do so when new skills are rewarded with better pay, greater security or prospects for advancement. When that link is fragile, the chief economist adds, workers have less reason to invest in training.

Wages are also a major subject of collective bargaining, the organization's wages page notes. Setting wages should consider both the needs of workers and their families and economic factors. It calls those two the pillars of wage setting. Minimum wages are a widely used tool to protect the wages of low-paid workers, the wage report says.

They are set by law or negotiated through collective bargaining, it explains. Wage setting should also promote gender equality, equity and non-discrimination, an expert meeting of the organization agreed. Minimum wage adjustments that weigh both pillars can protect the living standards of low-paid workers while keeping businesses sustainable. In normal times, the report calls it good practice to review the minimum wage every year or two.

That helps it keep its value, and small, gradual changes can be easier for small businesses to absorb. In twenty twenty-two and twenty twenty-three, more countries than usual adjusted minimum wages, indicating policies generally responsive to inflation. Minimum wage rules vary from place to place. In one breath: productivity, demand for workers and expected prices are each linked to wage growth, and skills and wage rules matter too.

If you want to see how rising prices affect your money, the video on protecting your money from inflation is linked on screen. Real wages can dip too, and number two shows a recent example.

2. Can real wages fall, and what happens next

Number two: can real wages fall, and what happens next? In twenty twenty-two, global real wages fell 0.9%, the International Labour Organization says. That was a year when high inflation outpaced nominal wage growth, it explains. That same year, an IMF chapter noted that falling real wages were helping to slow inflation.

In twenty twenty-three, global real wages grew 1.8%, and growth stayed positive in the first half of twenty twenty-four. The recovery came as inflation fell, first in twenty twenty-three and more strongly in twenty twenty-four, the wage report says. That decline happened at different speeds around the globe. Even so, in some countries real wage growth stayed close to zero.

How wages moved after prices fell varies from place to place. Before number one, a guess: in twenty twenty-four, how much did real wages grow worldwide?

1. How much more could the average paycheck buy worldwide in twenty twenty-four

Number one: how much more could the average paycheck buy worldwide in twenty twenty-four? The International Labour Organization put real wage growth worldwide at 2.7% for twenty twenty-four. That estimate was based on data for the first half of the year, it notes. That is the largest yearly increase recorded in more than fifteen years.

Falling inflation pushed that growth higher, the report explains. Those figures are world averages, and pay in any one job can move very differently. By our count, 2.7% on pay of $1,000 a month is like $27 more buying power a month. And over twelve months, that $27 adds up to about $324 of extra buying power.

By our count, 2% real growth a year for ten years would add up to about 22% more buying power. Real pay grows when nominal pay grows faster than prices, the idea from number seven. The International Labour Organization adds that wage levels are instrumental to decent and dignified lives for households everywhere. Pay, taxes and rules differ where you live.

And that is why wages tend to rise: more productive work, workers in demand, expected prices, and new skills and fair rules. So, seven parts, starting with real and nominal pay, productivity, demand for workers and expected prices. Then skills and wage rules, how real wages dipped and recovered, and what a paycheck bought in twenty twenty-four. Today, you can open the International Labour Organization's Global Wage Report for twenty twenty-four and twenty-five, linked below.

Which of the seven surprised you most? Tell us the number in the comments. Results vary, rules differ where you live, and this is information only, not financial advice. This is Wealth Filings.

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