Wages

Wages are the payments an employer makes to a worker in return for labor. In everyday use the word covers all pay for work, but in a narrower sense wages are paid per hour, shift or piece of output, while salaries are fixed annual amounts paid in instalments. Economists treat the wage as the price of labor, set in a labor market where workers supply time and skills and firms demand them.

Wages are the largest single source of household income in most economies and, measured as compensation of employees, make up around half or more of national income in many advanced economies. They matter for living standards, for consumer spending, for tax revenue and for inflation, which is why central banks, governments and employers track wage data closely.

A wage works like the fare on a taxi meter, except the meter runs on a person's time. An employer agrees to pay a set amount for each hour, day or finished task, and the worker agrees to provide the work. What the meter reads depends on how much the work is worth to the employer, how many other people could do it, and what the worker could earn elsewhere.

The number on the payslip is only half the story. If shop prices rise faster than pay, the same wage buys less than before. That is why economists talk about "real" wages, which ask what the pay actually buys, not just how many units of money it contains.

In the competitive model, the wage settles where labor supply meets labor demand, and each worker is paid roughly the value of what they add to output, so pay tracks productivity. In practice several other forces matter:

• Skills and education. Workers with more human capital tend to earn more, and differences in skills explain a large part of pay gaps between people.
• Bargaining. Pay may be set by individual negotiation or collectively through trade unions, which on average raise members' pay relative to similar non-members.
• Employer power. Where workers have few alternative employers, a monopsony can hold pay below the competitive level.
• Law. A statutory minimum wage sets a legal floor, and many countries also regulate overtime and equal pay.
• Efficiency wages. Some firms pay above the market rate to reduce turnover, attract better applicants or encourage effort.

Wages also respond slowly to shocks. Contracts fix pay for a period, and firms are reluctant to cut nominal pay, a form of rigidity similar to sticky prices. One explanation is money illusion: workers resent a visible pay cut more than an equivalent loss of buying power through inflation.

A nominal wage is the amount of money paid. A real wage adjusts it for changes in the price level, usually using the consumer price index, to show wages in real terms:

Here nominal wage growth is the percentage change in pay over a year and the inflation rate is the percentage change in consumer prices over the same year. The approximation works well when both rates are small.

For example, if average pay rises from 20.00 to 21.00 an hour (5%) while prices rise 3%, real wages grow by about 2%. If prices instead rise 7%, real wages fall by about 2%, even though the payslip shows a raise. Many advanced economies saw falling real wages in 2022 when inflation jumped, followed by real-wage recovery as inflation eased. Pay can also be linked to prices formally through a cost-of-living adjustment or other indexation.

Labor costs are a large share of business costs, especially in services, so central banks watch wage growth when judging inflation pressure. The Phillips curve describes the tendency for wage and price growth to rise when unemployment is low. A common rule of thumb is that nominal wages can grow at roughly the rate of productivity growth plus the inflation target without adding to inflation. Sustained faster growth can feed a wage-price spiral, in which higher pay pushes up prices and higher prices prompt further pay claims, although economists disagree about how often such spirals occur in practice.

Pay differs widely by occupation, education, region, gender, ethnicity and firm. Research since the 1980s links the widening of pay between college graduates and others in the United States and elsewhere to skill-biased technological change, globalization and the decline of unions. The gender pay gap has narrowed over decades but persists; Claudia Goldin, awarded the Nobel Memorial Prize in Economic Sciences in 2023, showed that much of the remaining gap arises after the birth of a first child. Wage differences feed into broader economic inequality, usually summarised with measures such as the Gini coefficient.

The way wages are paid has also changed. Most formal employers pay through payroll into bank accounts on a fixed cycle, while earned wage access products let some workers draw pay already earned before payday.

• U.S. Bureau of Labor Statistics: Employment Cost Index
• International Labour Organization: Wages