What Drives Up Wages?

Recently on this blog we discussed how the stagnant wages of the United States are finally starting to rise up, and why this trajectory was starting to materialize. Currently, the answer to that question is a very clear case of supply and demand economic, in terms of labor. However, the rest of the answer can be a little more complicated than that, and usually revolves around several factors. So what is it that generally drives up wages? Honestly, it’s hard to nail down specifics that will be universally relevant, because the answer is largely depending on unique circumstances. Generally, though, here’s what causes wages to rise, according to economic theory…

Supply and demand

As we have stated in the past, one case that can raise wages is the relationship between the supply and demand of labor. This is the case that recently caused wages to rise. As jobs continually get added to a market, it causes the demand for labor to rise as the available supply (unemployment) continues to drop. This rise in demand will drive up the price of labor, hence causing wages to rise. This is the most textbook example of how wages can rise, but it shouldn’t be taken as a law, because the only case of wages rising isn’t tied to this principle. Most of the time when wages rise, it actually isn’t tied to the rate of unemployment.

Price/wage spiral

The price wage spiral is the chicken and the egg dilemma of economic thought. Essentially, it describes a never ending cycle where the increases in wages cause prices to rise, since businesses must raise prices to match the rises in labor costs. However, once this occurs, it then causes the cost of living to rise, as well, which will drive up the need for wages to be raised, and thus the cycle continues. Ironically, this dangerous economic conundrum typically only occurs in an economy that is operating quite healthily. In most cases, an economy must be experiencing high demand and have unusually high unemployment, which are both indicators of a healthy economy.

Don’t fall into political traps

Another important thing to remember, when discussing the relationship between wages and associated factors, is to not get stuck with predispositions that align with a political ideology. Real economics isn’t ideological, and also certainly not dogmatic. For example, the minimum wage is always a hot topic when it comes to the relationship between wages and prices. Many people claim that raising the minimum wage causes employment to fall, as well as cause prices to rise. However, there are cases where this has been the case, and also ones where it has not been the case. For example, many predicted the rise in the minimum wage in Seattle would cause the restaurant industry to collapse. However, the number of restaurant jobs has actually risen since the first raise in the minimum wage went into effect. This doesn’t mean the the minimum wage doesn’t have an effect on overall employment and wage stabilization, but it does reflect how multiple factors need to be considered before jumping onto political ideology.