Wage Growth vs. Productivity Growth: It’s Society’s Choice

It has long been recognized that wage growth has slowed relative to business productivity growth. This divergence began in the 1970s and has continued ever since. Liberals and conservatives argue over whether this represents something that has grown rotten in our economy or whether it is an inevitable outcome from changing economic conditions. Just when one begins to suspect that there is nothing radically new to say on the subject, someone drops a bomb on it and tries to redefine the issue entirely. Scott Winship performed that function in an article in the Wilson Quarterly: The Truth About Jobs.

This chart was produced by Robert Reich for his book Aftershock: The Next Economy and America’s Future. It illustrates the issue.

It is instructive to examine a complementary chart that focuses on family income rather that hourly compensation.

Family income will capture the increase in two-income families as more women entered the workforce. Even that factor provides little help in trying to keep up with productivity growth.

Explanations for this relative decline in wages usually turn on factors like, globalization, automation, the decline of labor unions, greed..... Winship takes another tack. He claims that the data is misunderstood because it is taken out of its proper historical perspective. What appears to be a decline in wage growth is really a return to a historic norm from the postwar years when people were vastly overpaid. Instead of normalizing to the "golden era" of the postwar years, we should be normalizing wages to the true "golden era" represented by conditions from 1900 to 1929!

"The hourly compensation of workers has failed to keep pace with productivity since the mid-20th century, but in the 1930s and ’40s pay raced ahead of productivity gains. By 1950, productivity was 65 percent higher than it had been in 1929, but hourly compensation was 115 percent higher. In contrast, pay and productivity rose by the same amount between 1900 and 1929. Workers in 1950 were making about 30 percent more than their productivity should have dictated. Correcting that overpayment required that compensation growth fall behind productivity growth."

Referring to this wage decline as the "Great Correction," he indicates that there is yet a long way to go.

"As of 2010, workers still made 14 percent more than productivity levels suggested they should have, despite the fact that productivity had grown faster than compensation since 1950."

And we should be of good cheer because things will eventually get better.

"....there is a silver lining to this story. In time, the Great Correction will run its course, bringing productivity growth and compensation back into long-term alignment. At that point, pay and productivity should begin to move in tandem once more, putting Americans’ wages back on an upward trajectory. When will that happen? It would be foolish to attempt a prediction, but the closing of the compensation-productivity gap has proceeded slowly, suggesting that we may have to wait a while for the Great Correction to end."

Winship’s conclusions are absolutely astonishing! There are so many options for replying that one hardly knows how to begin. Ultimately, it seemed best to take a high road.

What seems to be at the heart of his argument is a belief that that there is some fundamental relationship between productivity and wages; a belief that some economic law is at work here. Nothing could be further from the truth.

Businesses intend to hire as few people as possible and pay them as little as possible. That is the way capitalism works. That is the way capitalism is supposed to work. In the period with which Winship is so enamored (1900-1929) the floor on wages was set by human survival. We probably don’t want to go back to that.

Society had not yet evolved to the point where it realized that it could—and must—tame the capitalist beast. It took being led into the Great Depression to mobilize society into action. It was in the 1930s that legislation created the society and working conditions that we take for granted now. Child labor was essentially abolished. The formation of labor unions was facilitated. Minimum wage legislation was passed. In 1938, the Fair Labor Standards Act established the eight hour day, the forty-hour week, and overtime pay.

All the mentioned actions were designed to change the relationship between wages and productivity. In so doing, a foundation was laid for a better society—and a healthier form of capitalism.

The fact that wages and productivity have drifted apart in recent decades is a sign that economic conditions have changed and that society has not yet chosen to respond to the new order. Winship has served a useful purpose by reminding us that we are in danger of returning, in some ways, to the dark days prior to the New Deal. Viewed from that perspective, the need for action becomes more urgent.

The level of wages to be paid and wealth distribution are decisions that society must make. Economists and businessmen will claim that chaos will ensue if the economic system is tinkered with. They said the same thing in the 1930s. They were promoting what was best for them, not what was best for society. They were wrong then, and they will be wrong now.

Economists have been trying for decades to figure out whether raising the minimum wage is a good idea or a bad idea. When it is raised more things happen—some good, some bad—than they can possibly track. Current guessing seems to be leaning in the direction of "it might be a good thing."

Why not really crank up the minimum wage—to somewhere in the range of $12-15 dollars an hour. Higher wages would propagate throughout the economy. People would have more money to spend. Good things would come and the bad things would cause adjustments to be made.

Life would go on.