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Is there a mismatch between productivity and workers’ income?

By Joshua Anumolu
web posted December 12, 2016

Lance Selfa, a columnist at the Socialist Worker wrote an article arguing that economic growth does not help working people, articulated below.

“One of the orthodox assumptions of both liberal and conservative economics is that a more productive economy leads to higher living standards.  According to the theory, when workers are better educated and better trained, and when technology is intelligently deployed to increase economic efficiency, the overall economy produces more and workers earn more.  Or so the theory goes.  What's the evidence?”

However, this hypothesis has been routinely rejected by economists for the following reasons.

First, the article ignores the law of diminishing returns.  Selfa wrote,

The alleged association between the economy's productivity and workers' wages proved true between 1948 and 1973--productivity increased by about 97 percent and workers' incomes increased by 91 percent, after accounting for inflation.

Thank you for bringing that up! That shows a very strong correlation between productivity and workers’ income.  That would support the theory. 

In the neoliberal era that followed the mid-1970s, productively increased at a slightly lower rate than in the earlier period.  But still, it did rise--and hardly any of the productivity gains found their way into workers' pocketbooks. . . Between 1973 and 2014, the median worker's hourly compensation increased by 8. 7 percent.

The Law of Diminishing Marginal Returns states that increasing additional units of a variable factor add less and less to total output, given constant quantities of other factors.  This is supported by the information above.  Between 1948-1973, there were very high returns to increases in productivity.  However, as productivity kept on improving, the returns to the productivity were slowly diminishing.  However, that does not mean workers did not benefit.  As the article itself admits, research from the Economic Policy Institute demonstrates that workers real median hourly compensation increased by 8. 7%.

Second, the article ignores the power of economic growth.  The main reason why workers’ wages have not grown as quicker to the liking of socialists like Mr.  Selfa is low economic growth.  According to economists Gould and Ruffin, if the US maintained a level of economic growth it experienced in the the 1950s and 1960s, real per capita growth in 1993 would be 11% higher than it really was.  In other words, the reason median income growth has slowed is due to the reduction in economic growth.

Third, the article ignores the important role technology and productivity play in economic growth.  As Gould and Ruffin write, "Maddison (1991) and Romer (1986) have shown that the leading technological country, defined in terms of productivity per worker hour, has experienced increasing rates of growth since 1700."  They cite several other studies affirming that human capital increases economic growth.  Increasing the secondary school enrollment rate from 8 percent to 10 percent, for example, is estimated to raise the average growth rate an estimated 0. 5 percent per year.

Fourth, using the right methodology reveals different results.  The analysis by the EPI only took into account workers’ salaries and wages.  However, workers can receive higher benefits even if their incomes are stagnant.  For example, many employers offer their employees health insurance as a benefit.  Taking into account total compensation reveals a much closer relationship between productivity and returns.  The following graph from Research Fellow James Sherk reveals the correlation between productivity and total compensation.  The graph takes into account inflation by using the Implicit Price Deflator (IPD) to estimate inflation.  The IPD is understood by economist to be more reliable than the widely-used Consumer Price Index (CPI), because the CPI tends to overestimate inflation and fails to take into account the substitution bias.  You clearly can see that using a different calculator of inflation can make it seem that compensation doesn’t keep pace with productivity.

Chart

There is still a missing 23% gap between total compensation and productivity.  What accounts for the missing wealth?  The following graph explains the discrepancies.  44% of the gap is incorrect estimates of inflation.  35% of the gap results from using hourly earnings as opposed to total compensation.  And the remaining 21% is depreciation and mismeasured productivity. 

Chart

Once you consider these discrepancies, there is no difference between productivity growth and income compensation growth. 

Fifth, rising income inequality does not prove the poor are becoming poorer.  Mr.  Selfa tries to put the blame on rising income inequality.  However, just because the richer became richer, does not mean the poor became poorer.  In a free market, the only way for the rich to become richer is to engage in business transactions that benefit someone else.  In other words, the only way for the wealthiest incomes to rise is to make other people richer too.

Why does this matter?  The implications of this article are very significant.  If productivity leads to workers with larger paychecks, increasing productivity is a more efficient way of benefiting America’s working class.  Increasing the productivity of corporations and small business will increase the median wages of American workers without increasing unemployment like minimum wages do.  In other words, it is important to remember that the economy is not improved by raising wages; wages are raised by improving the economy.  ESR

This is Joshua Anumolu’s first contribution to Enter Stage Right. © 2016 Joshua Anumolu

 

 

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