Monday, April 21, 2008

Real Wages Have Kept Up with Productivity?

Martin Feldstein has a new working paper showing that, contrary to conventional wisdom, U.S. real wages have kept up with productivity in the nonfarm business sector.
The level of productivity doubled in the U.S. nonfarm business sector between 1970 and 2006. Wages, or more accurately total compensation per hour, increased at approximately the same annual rate during that period if nominal compensation is adjusted for inflation in the same way as the nominal output measure that is used to calculate productivity.

More specifically, the doubling of productivity since 1970 represented a 1.9 percent annual rate of increase. Real compensation per hour rose at 1.7 percent per year when nominal compensation is deflated using the same nonfarm business sector output price index.

In the more recent period between 2000 and 2007, productivity rose much more rapidly (2.9 percent a year) and compensation per hour rose nearly as fast (2.5 percent a year).

[...]

The relation between wages and productivity is important because it is a key determinant of the standard of living of the employed population as well as of the distribution of income between labor and capital. If wages rise at the same pace as productivity, labor’s share of national income remains essentially unchanged. This paper presents specific evidence that this has happened: the share of national income going to employees is at approximately the same level now as it was in 1970.

Two principal measurement mistakes have led some analysts to conclude that the rise in labor income has not kept up with the growth in productivity. The first of these is a focus on wages rather than total compensation. Because of the rise in fringe benefits and other noncash payments, wages have not risen as rapidly as total compensation. It is important therefore to compare the productivity rise with the increase of total compensation rather than with the increase of the narrower measure of just wages and salaries.

The second measurement problem is the way in which nominal output and nominal compensation are converted to real values before making the comparison. Although any consistent deflation of the two series of nominal values will show similar movements of productivity and compensation, it is misleading in this context to use two different deflators, one for measuring productivity and the other for measuring real compensation.
I want to believe these findings, but they seem too good to be true. What do you think?

3 comments:

  1. Total compensation has kept up with productivity. Workers are compensated with wages and benefits; and with the rising cost of health care, more and more of one's compensation is in the form of benefits.

    Journalists, who generally have no economic training, usually get this story wrong. They write, "See, real wage haven't kept up with productivity". Then they continue on about how there is something wrong with the economy. Some may even add that there is something wrong with economics profession, because economists' theories are all wrong.

    Next, we have a more sophisticated group of economists who also say that even total compensation is not keeping up with productivity. These economists will index the two series at say the year 2000 and watch them diverge. Some in this group will condemn the current economy; others will also condemn economic theory and/or neoclassical economics. But here the problem is, as stated in the article, that they choice of deflator for productivity is the GDP deflator and the total compensation deflator is the CPI deflator. If total compensation and productivity are deflated using the same deflator, then guess what, the two series do not diverge to any great extent.

    If your goal is to deceive then use different deflators for total compensation and productivity. However, if goal is to test economic theory that marginal productivity equals total compensation then use the same deflator.

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  2. Anonymous:

    Interesting points. Do you know anyone else who has looked at this issue and had similar findings?

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  3. Sure. Anyone and everyone can come up with the same findings. The data sets are public information that are easily found on the St.Louis Federal Reserve FRED 2 website. It has been a while since I checked but the following should work:

    For Productivity and Costs try these data sets: For productivity use -> Non-Farm Business Sector: Output Per Hour of All Persons; for compensation use -> Non-Farm Business Sector: Compensation Per Hour; and for the price deflator use -> Non-Farm Business Sector: Implicit Price Deflator.

    Deflate the Compensation Per Hour by the Implicit Price Deflator to get Real Compensation Per Hour. You can then compare the two series (productivity and real compensation) from 1947 to 2006. As you will see compensation is linked to productivity.

    The BLS has Real Compensation Per Hour, but this is deflated by the CPI deflator. However, if you use this series then you will run in to the problem of using the GDP deflator for productivity and the CPI deflator for compensation.

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