The Productivity–Pay Gap
Economic Policy Institute (EPI)
Most Americans believe that a rising tide should lift all boats—that as the economy expands, everybody should reap the rewards. And for two-and-a-half decades beginning in the late 1940s, this was how our economy worked. Over this period, the pay (wages and benefits) of typical workers rose in tandem with productivity (how much workers produce per hour). In other words, as the economy became more efficient and expanded, everyday Americans benefitted correspondingly through better pay. But in the 1970s, this started to change.
From 1973 to 2016, net productivity rose 73.7 percent, while the hourly pay of typical workers essentially stagnated—increasing only 12.5 percent over 43 years (after adjusting for inflation). This means that although Americans are working more productively than ever, the fruits of their labors have primarily accrued to those at the top and to corporate profits, especially in recent years.
Rising productivity provides the potential for substantial growth in the pay for the vast majority. However, this potential has been squandered in recent decades. The income, wages, and wealth generated over the last four decades have failed to “trickle down” to the vast majority largely because policy choices made on behalf of those with the most income, wealth, and power have exacerbated inequality. In essence, rising inequality has prevented potential pay growth from translating into actual pay growth for most workers. The result has been wage stagnation.
For future productivity gains to lead to robust wage growth and widely shared prosperity, we need to institute policies that reconnect pay and productivity, such as those in EPI’s Agenda to Raise America’s Pay. Without such policies, efforts to spur economic growth or increase productivity (the largest factor driving growth) will fail to lift typical workers’ wages.
Wage inequality continued its 35-year rise in 2015 | March 10, 2016
Although inflation-adjusted wages grew across the board in 2015 (due to a sharp dip in inflation), the trend of rising wage inequality continued unabated. This paper begins by detailing the most up-to-date hourly wage trends through 2015 and examines the continued growth in inequality that began in the late 1970s.
Understanding the Historic Divergence Between Productivity and a Typical Worker’s Pay: Why It Matters and Why It’s Real | September 2, 2015
This paper provides an updated analysis of the productivity–pay disconnect and the factors behind it, and explains the measurement choices and data sources used to calculate the gap.
Raising America’s Pay: Why It’s Our Central Economic Policy Challenge | June 4, 2014
Broad-based wage growth is the key to reversing the rise of income inequality, enhancing social mobility, reducing poverty, boosting middle-class incomes, and aiding asset-building and retirement security.
How to Raise Wages: Policies That Work and Policies That Don’t | March 19, 2015
Wage stagnation is not inevitable. It is the direct result of public policy choices on behalf of those with the most power and wealth that have suppressed wage growth for the vast majority in recent decades. Thus, because wage stagnation was caused by policy, it can be alleviated by policy.
2014 Continues a 35-Year Trend of Broad-Based Wage Stagnation | February 19, 2015
2014 was yet another year of poor wage growth for American workers. With few exceptions, real (inflation-adjusted) hourly wages fell or stagnated for workers across the wage spectrum between 2013 and 2014—even for those with a bachelor’s or advanced degree. Of course, as EPI has documented for nearly three decades, this is not a new story.
The Economy Isn’t Broken
by David Brooks
Middle-class wage stagnation is the biggest economic fact driving American politics. Over the past many years, so the common argument goes, capitalism has developed structural flaws. Economic gains are not being shared fairly with the middle class. Wages have become decoupled from productivity. Even when the economy grows, everything goes to the rich.
This account of reality, which I’ve certainly repeated, explains why the Democratic Party has moved from the Bill Clinton neoliberal center to the Bernie Sanders left. It explains why the Republicans have moved from the pro-market Mitt Romney right to the populist Donald Trump right.
On both left and right, movements have arisen to fix capitalism’s supposed structural flaws, either by radically interfering in the marketplace (Bernie) or by clamping down on global competition (Trump).
But what if there are no structural flaws? What if the market is working more or less as it’s supposed to?
That’s certainly the evidence from the last two years. Over this time, the benefits of economic growth have been shared more widely.
In 2015, median household incomes rose by 5.2 percent. That was the fastest surge in percentage terms since the Census Bureau began keeping records in the 1960s. Women living alone saw their incomes rise by 8.7 percent. Median incomes for Hispanics rose by 6.1 percent. Immigrants’ incomes, excluding naturalized citizens, jumped by over 10 percent.
The news was especially good for the poor. The share of overall income that went to the poorest fifth increased by 3 percent, while the share that went to the affluent groups did not change. In that year, the poverty rate fell by 1.2 percentage points, the steepest decline since 1999.
The numbers for 2016 have just been released by the Census Bureau, and the trends are pretty much the same. Median household income rose another 3.2 percent, after inflation, to its highest level ever. The poverty rate fell some more. The share of national income going to labor is now rising, while the share going to capital is falling.
In a well-functioning economy, workers are rewarded for their productivity. As output, jobs and hours worked rise, so does income. Over the past two years, that seems to be exactly what’s happening.
The evidence from the past two years strongly supports those who have argued all along that income has not decoupled from productivity. A wide range of economists, including Martin Feldstein, Stephen Rose, Edward Lazear, Joao Paulo Pessoa, John Van Reenen, Richard Anderson of the St. Louis Fed and a team from Goldman Sachs, have produced studies showing wages tracking very predictably with productivity.
If anything, as Neil Irwin of The Times’s Upshot has noted, wages are a little higher than you’d expect from looking at the productivity and inflation numbers alone.
The problem of the middle-class squeeze, in short, may not be with how the fruits of productivity are distributed, but the fact that there isn’t much productivity growth at all. It’s not that a rising tide doesn’t lift all boats; it’s that the tide is not rising fast enough.
For those interested, Shawn Sprague has a good summary of the data at the Labor Department’s “Beyond the Numbers.” He shows conclusively that during this recovery we’ve endured a historically low labor productivity growth rate of 1.1 percent. By some estimates if productivity increases had kept pace with the mid-20th-century norm, l median incomes would be $40,000 higher than they are today.
If productivity itself is the problem, not distribution, radically different politics is demanded than we’re seeing today. If productivity is the problem, we need more dynamism, not less, more openness, not less, more growth-oriented policies, not more dirigiste and redistributive ones.
There are a few things government can do to help boost productivity: Increase market competition with more antitrust enforcement and fewer licensing regulations; admit more skilled immigrants; invest more in human capital; deregulate urban land usage back to the 2008 levels; introduce more market incentives into the low productivity sectors, like health care and education; fund more research into promising technologies like new energy storage systems.
Today politics is polarizing to the populist left and the populist right. But if productivity is the problem, what we actually need is a resurgence of the moderates. The moderate-left policies of Barack Obama must have had something to do with the middle-income gains of the last two years. Moderate Democrats can plausibly argue that government should not be interfering in the markets, but it should be addressing the inequalities that are the result of deeper social forces. There is still a yawning gap dividing the median Asian-American household, which makes $81,000 a year; the median white household, which makes $65,000; and the median African-American household, which makes $39,490.
Moderate Republicans can argue that while government should be active in boosting human capital, and in helping rural America, most of what’s needed is more dynamic capitalism — more trade, more immigration, more free competition, fewer regulatory burdens, more growth.
Right now moderates are in retreat. The populist extremes are on the march. But the fact is they are basing their economic and political agendas on a story that is fundamentally untrue.
David Brooks Is Mistaken: The Economy Is Broken
by Steve Denning
David Brooks — who writes on economics though he did not formally study economics—wrote an article defending the economy in the New York Times last Friday entitled, “The Economy Isn’t Broken.”
To make his case, Brooks celebrated welcome gains made by the U.S. economy in 2015 and 2016.
• Median household incomes rose by 5.2% in 2015 and 3.2% in 2016
• The income of women living alone rose by 8.7% in 2015.
• Median incomes for Hispanics rose by 6.1% in 2015.
• Immigrants’ incomes, excluding naturalized citizens, jumped by over 10% in 2015.
• The poverty rate fell in both 2015 and 2016.
Brooks concludes blithely that “the market is working more or less as it’s supposed to.” It is therefore wrong to conclude that the U.S. economy has “structural flaws.” That is “a story that is fundamentally untrue.”
The difficulty with the argument, as Brooks well knows, is that one or two good years don’t make an era. Two years of income growth don’t undo the trauma flowing from 50 years of wage stagnation, much less lead to the conclusion that there are “no structural flaws” in the economy.
As Patricia Cohen’s article in the New York Times the following day pointed out: “Bump in U.S. Incomes Doesn’t Erase 50 Years of Pain.” Thus, “For many Americans… recent progress is dwarfed by profound changes that have been building for nearly a half-century: rising inequality and rusted-stuck incomes.”
Younger Workers Even More Affected
Even more alarming and surprising is the fact that the problem of stagnant or declining income is worse for younger workers. They enter the job market at lower pay and never catch up. Not surprisingly, one finds many disaffected among new entrants to the job market.
“It all starts at age 25,” said the coauthor of the study cited by Cohen, Fatih Guvenen, an economist at the University of Minnesota. “The decline in lifetime earnings is largely a result of lower incomes at younger ages rather than at older ages, he said, and that was very surprising to us.”
Growth Pessimism Is Overdone?
In a similarly defensive crouch, Gavyn Davies in the Financial Times argued on Sunday that “American Growth Pessimism May Be Overdone…Market economists spend … far too little on what really matters in the long run, the growth of underlying productivity… If labor productivity grows at its ‘normal’ post war rate of 2 per cent per annum, then living standards per head double every 35 years.”
However market economists like Davies also need to remind themselves that growth in productivity isn’t automatically passed on to workers and translated into improved living standards.
That used to be case up to the 1970s, but ceased to be the case thereafter, as shown in the following figure.
Davies’ basic argument is that since productivity is not as bad as we thought, due to possible measurement errors, therefore living standards must also be ok. Nothing really to worry about! The article is thus based on a false premise of a tight link between productivity growth and living standards.
But the real social and political problem isn’t the exact rate of productivity growth in the last few years and the possible mis-measurement errors — those are “inside baseball” questions. The brute fact remains that median salaries have stagnated for some 50 years. That’s the real problem of the U.S. economy that economists ought to be talking about.
The End Of Economic Growth?
Equally frustrating to those whose incomes have stagnated for half a century are moderates who simply state that stagnation is now normal. The status quo will remain thus for the foreseeable future. We are living in an state of endless economic stagnation. There is no explanation of why we have ended up in this quandary or what could be done to get out of it. The gist of it is: “Forget the American dream; stagnation is to be expected: get used to it.”
A supporting argument here is that “new ideas are getting harder to find,” This notion is promoted by economics professor Robert Gordon, and others who believe that all the good inventions have already been implemented. Yet the reality is the opposite: perhaps invisibly to some of Professor Gordon’s generation, we are living through a veritable blizzard of innovations flowing from our newfound ability to connect everyone and everything, all the time at low or zero cost. Ideas to exploit these new capabilities are dizzingly abundant. The principal challenge is getting paid for new ideas.
Thus in the 20th Century, a firm could assume that if it produced a better product, it could easily monetize the gain by charging more. That is no longer the case today. That’s because the new connectivity has also led to increased competition and to a shift in power from seller to buyer; the buyer now often has the power to insist that new ideas be provided free, or even lower cost. It’s not that new ideas are scarcer. They’re not. It’s just much harder to monetize them.
The End Of Moderates?
The motivation behind Brooks’ article becomes apparent towards the end of it where he laments that political moderates are not being listened to. Instead, “extremists are on the march.”
Yet when economists don’t seem to have any clue about the nature of the problem, let alone what to do about it, why should those angry at their stagnant incomes pay any attention to them?
Brooks’ article makes the false argument that there are no structural problems in the economy in the apparent hope that people will listen to moderates.
However the writings by Brooks, Davies and Gordon themselves might be offered as exhibits explain why moderates are not being listened to. When moderates deny the obvious, the disaffected inevitably turn elsewhere.
If moderates want to be listened to, they will need to take a harder look at what is going on, come up with coherent explanations for what has gone wrong, and offer plausible remedial action.
Here are three steps to making real progress.
Don’t Search For Culprits
A moderate like Patricia Cohen for instance suggests a list of culprits.
• “As in an Agatha Christie mystery, the potential culprits behind the long-term trends are many — global competition, technological advances, trade imbalances, a mismatch of skills, the tax system, housing prices, factory shutdowns, excessive regulation, Wall Street pressure, the erosion of labor unions and more. Most of the suspects, if not all, are likely to have played some role.”
However the search for “culprits” is not far removed from the extremists’ search for “scapegoats,” whether it’s Trump’s “immigrants” or Sanders’ “Wall Street.”
Culprits are not the answer.
Don’t Produce A Shopping List of Policy Prescriptions
Brooks suggests an equally implausible grab-bag of policy prescriptions:
• “There are a few things government can do to help boost productivity: Increase market competition with more antitrust enforcement and fewer licensing regulations; admit more skilled immigrants; invest more in human capital; deregulate urban land usage back to the 2008 levels; introduce more market incentives into the low productivity sectors, like health care and education; fund more research into promising technologies like new energy storage systems.”
It is not that this grab-bag of policy actions—tiny fixes at the margin—might not be somewhat helpful to the cause of boosting productivity. It is rather that the list is in overall grossly inadequate to deal with the scale and longevity of the problem we are dealing with—wage stagnation over half a century.
Do Look For Root Causes
What is remarkable about the writings of these moderate economists is that they don’t spend much time re-examining the fundamental assumptions of their discipline. They accept the models of macroeconomics as a self-contained universe, as if resting on eternal, unquestionable principles, despite the obvious failure of the models to deliver what is expected of them. There is tinkering with the details, but reconsideration of fundamentals seems to be off-limits.
If we are to get to the bottom of the huge economic, social, and political issue of endemic wage stagnation, we need to be willing to re-think fundamental assumptions, even including drawing on ideas (gulp) from other disciplines.
Thus the nature of any society, its beliefs, its action, its values and its politics, is to a large degree a story of dominant models. In any particular society, there is always a common model that those who are responsible for what is going on are dominated by. To understand what sort of a society it is, what problems it is encountering, and why men and women feel and think and act the way they do, it is key to isolate and examine the dominant model which that society obeys.
In Part 2 of this article, I will explore the dominant model of our current society, as a way of offering a potential explanation of what has gone wrong in the economy and what should be done.
In Part 3, drawing on the brilliant work of Carlota Perez, I’ll take a look at the longer term historical setting of our economy in a way that might help us see our own society a broader context.
The economy really is broken — but we know how to fix it
Median household income is back to its 1999 level. Hooray?
by Matthew Yglesias
Census data released last week revealed that 2016 was a second straight strong year for median household income growth. Consequently, inflation-adjusted median household income is now at an all-time high, finally surpassing the previous record set in 1999.
This is, unquestionably, good news for the American worker. But the rush to proclaim, as David Brooks did in a Friday New York Times column, that the good news shows the American economy “isn’t broken” seems like a serious mistake. That incomes slipped after the bubble peak of 1999 is unsurprising. But for it to take more than 15 years to claw back those losses is shocking.
Anyone who predicted in 1999 that median income would be lower in 2015 would have been regarded as ridiculously pessimistic, and nobody would have thought that quibbling over exactly how we calculate the inflation rate was the difference maker.
Something really is badly wrong.
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