Declining Wages Hurt Consumer Spending, Economic Recovery

Incomes fell in August for the third time in five months, with personal income dropping for the first time in two years, according to a Commerce Department report last week. Meanwhile, household income fell to $49,445 last year, according to the Census Bureau, its lowest in over a decade, while the poverty rate climbed to 15.1%, a 17-year high.

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In terms of wages and employment, the economic recovery is seemingly non-existent. Salary and benefit growth “has been going nowhere,” said Mark Zandi, chief economist at Moody’s Analytics. “One of the key reasons the recovery has stalled is that real incomes have fallen.” Inflation-adjusted weekly earnings have declined for six consecutive months, falling 1.8% in August from the year earlier.

While Federal Reserve Chairman Ben Bernanke and President Barack Obama have been focusing on creating jobs and cutting the high unemployment rate, its the stagnation in wages that is most likely resulting in poor growth coming out of the recession. Until the job market strengthens, workers have little room to negotiate higher earnings, and in the meantime, lower incomes and lower confidence means consumers may retrench.

“Those who are employed are worried about their income and are seeing real purchasing power get squeezed, therefore they’re set to retrench a bit,” said Julia Coronado, chief economist for North America at BNP Paribas in New York and former member of the Fed board’s forecasting team. “That’s the danger right now. It means the recovery remains very fragile.”

Companies like the United Parcel Service (NYSE:UPS) and Kohl’s Corp. (NYSE:KSS) have said they have the flexibility to keep employee earnings down, given uncertain demand and the excess supply of labor with unemployment so high. Higher food and fuel prices have also forced many employers to cut paychecks.

If Congress fails to extend payroll-tax cuts and unemployment benefits set to expire at the end of the year, it will only further cut into Americans’ purchases. “It’s hard to see where consumers are going to get a lot of wherewithal to sustain strong spending,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. “It’s certainly a concern that, rather than sluggish consumption growth, we see flat or declining consumption.”

The decline in incomes will cause “continued pressure on home prices and on the stock market,” said Malcolm Polley, who oversees $1 billion as chief investment officer at Stewart Capital in Indiana, Pennsylvania. Corporate sales may be hurt, people will begin withdrawing from retirement plans and using 401k loans. Even sales at some luxury stores could be hurt because “at the margin, the upper end of the middle class will probably feel less inclined to spend extra money,” said Polley. The only companies that might come out on top are those catering to “the lower end of the earnings totem pole,” like Wal-Mart (NYSE:WMT) and Target (NYSE:TGT).

Consumer confidence has been slipping, with a record 91% of consumers saying they expect growth in their incomes will match or fall behind price gains in the coming year, according to the September Thomson Reuters/University of Michigan sentiment survey, which dates back to 1978. People will be “spending on necessities, not desires,” until the labor market improves, said Chris Christopher, senior principal economist at IHS Global Insights in Lexington, Massachusetts.

Consumer spending rose at a 0.7% annual rate during the second quarter, less than half the 2.1% rate for the first quarter of 2011. Meanwhile, GDP grew less than 1% during the first two quarters. “The economy isn’t growing fast enough to boost job growth to increase incomes,” said Omair Sharif, an economist at RBS Securities LLC in Stamford, Connecticut. “Most workers don’t have a lot of sway in demanding higher wages unless they have very specialized skills.”

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And employees shouldn’t hope for more bargaining power anytime soon, said Harry Holzer, a professor of public policy at Georgetown University and a former chief economist at the U.S. Department of Labor. The economy lost 8.75 million net jobs as a result of the recession, and had only recovered about 1.89 million of those jobs as of the end of August. “There is so much slack, it will keep earnings from rising very much,” said Holzer. “It will take most of this decade” to repair the damage “unless there is a big spurt in hiring.”