LAST WEEK'S

unemployment numbers, which showed 144,000 jobs added to U.S. payrolls in August, did little to clarify the politically sensitive discussion about the strength of the economic recovery. This ambiguity was evident in campaign stump speeches. While President Bush argued that the unemployment rate fell to 5.4% from 5.5%, John Kerry pointed out that the numbers were below expectations of 150,000 new jobs.

A more detailed analysis of the labor-force situation can be found in a report issued on Labor Day by the Economic Policy Institute (EPI), a nonpartisan think-tank based in Washington, D.C. "The State of Working America 2004-2005," co-authored by Lawrence Mishel, Jared Bernstein and Sylvia Allegretto, shows that the U.S. labor force, while recovering somewhat in 2003, remains on the ropes. Income fell 9.2% for all Americans in 2001 and 2002, according to the Internal Revenue Service, the study points out. And while wage growth steadied in 2003, it failed to keep up with the pace of inflation.

The EPI study, which uses data from sources such as the Federal Reserve Board and the U.S. Census Bureau, also showed that while the growth rate of CEO compensation has fallen off since 2000, it still far outstrips the growth rate in wages of the average worker. CEOs earned 185 times more than the average worker in 2003, the study reported, compared with 71 times in 1989.

Perhaps the primary reason why wage growth hasn't been reflected in the rebound is that a major portion of corporate growth has gone to pad the bottom line, rather than to wages, a trend that differentiates this recovery from past business cycles, the study said. "When you look at the corporate sector, you see that 85% of the economic growth went to corporate profit and interest," says Mishel, president of EPI. "In previous business cycles, it would have been almost the opposite, where corporate profits and interest comprised about 20% of the growth."

SmartMoney.com recently spoke with Mishel to find out more about why the economic recovery from the 2001 recession has failed to translate into significant job and wage growth.

SmartMoney.com: Your study points out that nonadjusted wage growth during the last 1 1/2 years has been at its slowest pace in the last 20 years. Why has wage growth slowed so much?

Lawrence Mishel: Wage growth has slowed because of the persistently loose labor market. Inflation-adjusted wages grew strongly during the 1990s, and the momentum of that growth carried into the early parts of the recession, because there's a lot of inertia in wage growth. It takes a lot of macroeconomic trends to affect wage growth. But starting in 2002 and 2003, wages grew more slowly, and over the last year, wages continued to slow down as inflation picked up, so now we're seeing wages fall behind inflation. Now, the hourly wages of production nonsupervisory workers are generally between 1% and 1/2% behind inflation over the last 12 months.

SM: One sector of the work force that hasn't seen much of a trim is CEOs, and corporate profits have skyrocketed over the past few years. How come that money isn't "trickling down"?

LM: It's true that CEOs have done far better than other workers. CEOs make an amazing amount of money relative to a typical worker. Here's the thing. I think what we have is what I call an "out-of-whack" economy. Since early 2000, we've seen productivity grow by roughly 15%. That's growth between the first quarter of 2001 and the second quarter of 2004. When you look at the corporate sector, you see that 85% of the economic growth went to corporate profit and interest. In previous business cycles, it would have been almost the opposite, with corporate profits and interest comprising about 20% of the growth. So conversely, there's been almost no growth in the total amount of compensation paid out in the corporate sector, which is probably explained by the really miserable job growth, but also hourly pay hasn't grown much at all. So we have the situation where the productivity growth gives us the greatest possibility for income improvement that we've had in decades, yet that doesn't seem to be flowing to the typical worker, generally.

SM: But historically, the unemployment numbers aren't really that much higher than in the past. So what's different now?

LM: If you look at the unemployment rate, on the surface you might think things are OK. But we need to keep a number of things in mind. First, unemployment in 2000 was 4%. So we have an unemployment rate that's roughly 1 1/2 percentage points above that. Second, we've seen that there's been a substantial decline in the labor-force participation rate, the share of the working population employed or unemployed, or working or seeking work, relative to the working age population. In other business cycles, labor-force participation has grown. We calculate that two to two-and-a-half million people are missing from the labor force. If they were counted as unemployed, we'd have an unemployment rate of more than 7%.

SM: Fewer workers seeking jobs is one reason why the unemployment rate has been dropping, right?

LM: Yes, that's what happened last month.

SM: Is part of the reason why wages haven't grown because workers are unsure about the safety of their jobs and are reluctant to push for high compensation?

LM: Yes. A number of factors make people anxious. People are worried about losing their jobs to imports and having their jobs moved overseas. Employers are doing everything they can to not hire people and restrain wages and benefits. There's a sizable amount of job destruction that continues to go on at a pretty high rate. For this level of unemployment, there's a lot of permanent displacement of jobs. People are nervous because there's a lot of involuntary job loss. Amid all this, many people feel that if they lose their current job, they'll end up in a job with lower wages and benefits. In those contexts, people don't feel that they can push for better wages.

SM: You mentioned outsourcing. How much is outsourcing holding down wage growth? Some argue that the case is exaggerated.

LM: In certain sectors, such as information technology and software, it's an important trend. I think the biggest effect it has is that people know it's going on and it's getting bigger. Companies have said that they're going to do more and more outsourcing. So whatever scale it is, it's making people worried. Our statistical infrastructure cannot adequately assess how much offshoring is actually going on. What's affecting workers is how much they fear it, and they hear a lot from their employers. That helps to suppress wage growth.

SM: How have policies by the Bush administration, such as the tax cuts, affected the job market?

LM: Some people say that a president doesn't have much affect on jobs and growth. Whatever the case is for most presidents, this president has said that his plan was going to create a lot of jobs. And he has been able to radically restructure the tax system to lock in trillions of dollars of tax cuts, both in 2001 and 2003.

There's actually a great parallel between what's happened with the war in Iraq and taxes. It seems to me that in both cases, there was a policy that the administration wanted to pursue, whatever arguments got them there were the ones they used. So in the November 2000 election, he said we want to put money back in your pockets because of the huge surplus. Then it was the same tax cuts because we were going into a recession. Their tax policies have never really been driven by the urge to create jobs in the short term. Rather it was an effort to reshape the tax structure to lessen taxes on income from wealth. The tax proposals that they issued didn't make sense as a short-term job stimulus. There were no economists who thought the reduction of taxes on dividends would be good for short-term job growth. In 2003, the president promised that if we passed the tax cuts, we would generate 300,000 jobs a month. He's actually averaged at best half that, and we're more than 2 1/2 million jobs behind the administration's target of nearly four million new jobs added by now. So by their own criteria, their policies have failed.

SM: Some economists have argued that the tax cuts could have been better designed to stimulate job growth.

LM: If you read the recent research by Mark Zandi of Economy.com, he showed that if the president had pursued a different policy of tax cuts that were only temporary, but aimed at the lower and middle classes, and some fiscal relief to the states that were in trouble, adding better labor insurance for those that were unemployed, we would have had two million more jobs created in 2004 with half the fiscal deficit. That shows that the Bush administration's policies were a very ineffective use of our money. Most of the job growth that we've gotten, according to Zandi, comes from refinancing [of homes], lower interest rates and defense spending, and very little came from the tax cuts that went to high-income families and business.

SM: Critics of EPI say the wage and labor numbers are premature and that we won't be able to tell the true state of wage growth right now until sometime next year. They also say the EPI exaggerates the statistics.

LM: It's true that we don't know what a family's income is in 2004, and we won't know that until next year. What we do know is that a typical middle-class family's income has fallen each year from 2000 to 2003. So they've fallen each year, a total loss of about $1,500 a family, or 3.4%. If I had to guess how they're doing in 2004, I'd say that there's probably some positive improvement in terms of total employment and average work by families, but that wages have fallen behind inflation over the past year. I think it's very unlikely that incomes are better off in 2004 than they were in 2003, which would still leave families substantially behind where they were in 2000. People who follow the economy have to use the data that are available, and we've used all the data available to track wages. I think no one would disagree with the fact that wages are falling behind inflation at this point.