Toy robots of various shapes walk along the floor towards a white door

More jobs are being automated rather than being done by humans

When unemployment rates are near historic lows in much of the western world, why is wage growth so sluggish and inflation so subdued? Japanese wages actually fell this year, even as the jobless rate dropped towards its lowest level since 1994, for instance. Meanwhile, US unemployment is at a 16-year low – but average earnings growth is only 2.5 per cent a year and core inflation just 1.7 per cent.

Understanding this conundrum is crucial because of what low wage growth and low inflation mean for monetary policy, and because government policies must address increased labour-market polarisation and wider income inequality.

Jobs requiring skills that are not easily replaced with machines are showing greater pay growth

Weak wages are partly a legacy of the global financial crisis and subsequent deep recession: labour-market slack, low inflation expectations, more pension-age workers, and regulations that allow flexible working. Public-sector pay curbs and lower union membership also erode labour’s pricing power.

But technological advance is another factor limiting wage growth. Workers displaced from automated sectors are forced to seek lower skill, lower wage-growth jobs. This is happening alongside the rise in the ‘gig’ economy, where many workers are paid per drop or delivery or per task provided online instead of a regular weekly or monthly wage.

Greater automation is not preventing continued strong net job creation. Since even before the industrial revolution, technological advances have created more jobs than were lost, but currently, the failure of robots and other innovations to improve economy-wide productivity is holding down average wage growth.

Why? Today’s weak productivity benefits seem to be concentrated in a few, smaller sectors than in the late 1990s when productivity was strong: a falling capital-labour ratio reflects the inadequate investment. However, a shortage of suitable skills is an issue too. Weak investment may explain poor labour productivity, but if workers can’t use the high-tech equipment effectively, total factor productivity will be weak too.

The dispersion of wage growth across sectors reflects the growing polarisation of labour markets. In the US, jobs requiring higher education or skills that are not easily replaced with machines, such as leisure, are showing greater pay growth than increasingly automated sectors like retail.

So far the impact of technology on labour markets has been more evident in developed markets, but emerging markets will be increasingly impacted too – directly, as routine jobs are automated, and indirectly as Western multinationals automate further rather than employ as many workers overseas. In the future, rather than US jobs being replaced with China jobs or with US machines, it may be China jobs that are replaced with machines – whether in the US or China.

Income inequality will continue to widen as displaced workers re-price themselves back into the labour market. This presents policymakers with challenges. Many of the factors that constrain wage growth, limit inflation and contribute to wealth and income divergences cannot be addressed with monetary policy alone. Governments already face popular demands to address income inequality, whether through ‘robot taxes’ or a universal basic income.

But technological progress cannot be reversed. The focus should thus be on supporting productivity-enhancing investment and raising the skills levels of displaced workers so they can use the technology. That will raise long-term growth and improve public finances.

This research was first published on 22 June 2017.

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