Wages and the Social Contract

From the end of world war ii through the mid 1970s, the real wages of American workers nearly doubled, moving up in tandem with the growth in productivity. The United States benefited from an implicit social contract: By working hard and contributing to productivity, profits, and economic growth, workers and their families could expect improved living standards, greater job security, and a secure and dignified retirement. This social contract broke down after 1980, as employees lost their bargaining power. Since then, productivity has grown more than 70 percent while real compensation of nonmanagerial workers has remained flat. Wages for the lowest-paid workers have collapsed even more than for average workers.

While conventional explanations for stagnant wages and increased inequality -- such as those that emphasize technological changes and increased premium for skills -- may be part of the story, they fail to take into account the historical policy and institutional forces that created and sustained the postwar social contract, or to understand what needs to be done to restore it in a way consistent with the needs of today's workforce and economy.

The postwar social contract was grounded in New Deal legislation that established a minimum wage, other wage and hour regulations, and labor laws that allowed workers to build the bargaining power needed to enforce wage-determination norms and principles in negotiating with large corporations. The undermining of this system of regulations, and of union bargaining power, accounts for significant portions of the wage lag.

Despite the convention of a poverty "line," the working poor and the near-poor have much in common. After periodically raising the minimum wage from 1938 through the 1960s as prices rose, Congress and several presidents have allowed the real value of the minimum wage to fall about 25 percent since the late 1960s. Econometric estimates indicate that this alone can account for about a 20 percent decline in real wages for those paid at or slightly above the minimum, and for a 6 percent to 10 percent reduction for those earning twice the minimum wage.

The system of collective bargaining that grew out of the New Deal's National Labor Relations Act and the influence of the War Labor Board during World War II likewise get insufficient credit for their role in creating and sustaining the link between productivity and wages. The War Labor Board used wage comparisons to instill the principle of "equal pay for equal work" within industries and occupations. It encouraged negotiations for health insurance, pensions, and other benefits that eventually became sine qua non for a "good job." By the mid-1970s, union members were about 20 percent more likely to be covered by these benefits than nonunion workers.

In the late 1940s, the United Auto Workers and General Motors negotiated contracts that explicitly linked wage increases to productivity growth (the "annual improvement factor") and to increases in the cost of living. These private-sector wage norms reinforced the underlying social contract. From the mid-1940s through the 1970s, unions led the process of improving wages by producing union wage premiums ranging from 10 percent to 25 percent, with the biggest effects for less-skilled jobs and less-educated workers. Union-negotiated wages and benefits spilled over to affect nonunion workers and managers across the economy. For example, managers surveyed in 1978 by the Conference Board reported that wage and benefit settlements in their largest bargaining units affected up to two and a half times as many employees than unionized workers in their firms, and four times as many employees in their local product or labor markets.

Unions have declined for several mutually reinforcing reasons: deregulation, industrial change, globalization, and increased employer resistance (often abetted by lax government enforcement of the right to organize). As the union percent of the workforce declined, first slowly in the 1970s and then precipitously after 1980, so, too, did their ability to enforce the social contract and to bargain for the wages and benefits that rose with productivity. The union wage premium has diminished, and unions have had to fight defensive battles to slow the decline in health care and pension coverage, and to shift the costs and risks of these benefit plans from employers to workers.

The weakening of unions leaves more power in the hands of corporations to determine wages. Three aspects of corporate strategies and policies have particularly affected lower-wage workers.

First, corporations that previously paid relatively high wages for all employees because of either the presence or the threat of unions began to narrow their focus to their "core competencies," outsourcing noncore work that could be purchased at lower wages. This started with outsourcing janitorial and clerical work and then advanced to production, information technology, and other professional services. By outsourcing or offshoring some of this work, companies not only lowered their wage bill; they also further reduced the bargaining power of the workers who feared their jobs might be the next to go.

Second, internal equity norms broke down. Instead of maintaining consistent differentials between top-level executives and other managers and employees, compensation experts began differentiating between top executives, other high talented employees, and everyone else in the firm. Wages of top executives soared to as high as 400-to-1, a differential that would have been unthinkable when unions were stronger.

Third, intensified price competition was experienced in deregulated industries like airlines and trucking, manufacturing industries exposed to global competition, and even domestic industries where large firms such as Wal-Mart dominate. All these factors exerted significant downward pressure on wages. The opening of a Wal-Mart store reduces the wages of retail workers in the area by about 3 percent. A few years ago, food retailers in southern California took a four month strike to cut their fringe-benefit costs in anticipation of a new Wal-Mart in their region. Since 2000, major airlines have responded to the entry of newer, lower-cost competition by cutting $15 billion out of workers' paychecks, not counting the additional financial losses to be endured by employees whose pensions were terminated and turned over to the government.

What can be done to reverse these trends and build a new social contract for today's economy? Might tight labor markets make up for the decline in these institutions and policies? From the end of the recession in 1991, it took five years of declining unemployment before wages of lower-level employees began to grow. This ended with the recession that followed the dot-com bust. It has taken four years into the latest recovery before lower- and average-wage workers have started to see modest improvements in real wages. Given the Federal Reserve's focus on inflation targeting and the unpredictability of world events, it's likely that economic downturns will be as much a part of the future as they have been a part of the past. So while full-employment policies should be a key part of the government's economic and labor-market strategy, labor-market pressures alone will not generate a return to steady wage growth, particularly for lower-paid workers.

Steady progress requires engaging government, business, and labor efforts to build a new social contract tailored to today's economy and workforce. The greater instability of today's job market requires more social protections, not fewer. As in the 1930s, government can take the first step by restoring a floor on minimum wages and family incomes. Increasing the minimum hourly wage from $5.15 to $7.25, as Congress is now considering, would boost by about 32 percent the wages of workers currently at or near the minimum. Those paid twice the minimum would also experience a 3 percent to five 5 percent increase. Low-income working families would further beneļ¬t if increases in the minimum wage were combined with increases in the Earned Income Tax Credit.

A resurgence in unions is also essential, and not just in the model of the 1930s. Unions will need to draw on new sources of power -- as some are doing by building coalitions with other community groups advocating for worker's rights and living wages; negotiating for training, development funds, and job ladders (as is happening in some parts of the health-care and hospitality industries); and building networks that provide benefits, job referrals, and wage information to workers and contractors not attached to a single firm (as is being done by a new media workers' union in New York).

Unions need to continue to lead the way in building productive labor-management partnerships that create value and then share the gains, as they have done over the years with progressive employers in health care, communications, manufacturing, utilities, and other industries. As was the case in the '30s, labor law needs to be fixed and updated so that it will once again protect workers' right to organize, and so that it can open the way for these innovative strategies to spread across the economy.

Finally, building a new and sustainable social contract requires American firms to adopt strategies capable of generating good profits while also sustaining good jobs at fair wages and meeting labor and employment-law standards. This will require a government strategy and a set of policy initiatives as bold and creative as the New Deal, using both carrots and sticks. Tax incentives for research and development and human-capital investments, government contracts, and all other public supports should be made contingent on firms complying with labor laws. At the heart of a new social contract that fights poverty and raises wages is a national strategy to reconnect rising productivity, rising wages, and norms of fairness inside the corporation.