Wages and Productivity: The Three Wedges

My weekend reading:

The Three Wedges That Separate Workers From Their Pay

Economists assure us that rising worker productivity is the key to better living. When workers produce more per hour of work, their earnings should go up correspondingly.

Since 1973, that hasn’t been happening. Productivity has risen at a healthy clip, but the pay of the average worker has stagnated. That simple fact explains why younger Americans today aren’t doing any better than their parents’ generation, and sometimes worse. A sense of the part of Americans that they’re not reaping the rewards of hard work fuels the Occupy movement and the cries of “We are the 99 Percent.”

In 1994, economists Lawrence Mishel and Jared Bernstein were first to point out the gap that was already opening up between pay (low) and productivity (high). Bernstein later served as Vice President Joe Biden’s chief economist and is now a senior fellow at the Center on Budget and Policy Priorities. Mishel is president of the Economic Policy Institute.

Now, Mishel has done the most careful study to date of what accounts for the productivity/pay gap...

…Mishel zeroes in on three “wedges” and how much each has contributed during different periods to the growing gap between productivity and pay:

First wedge: Owners of capital are taking a bigger share of income. Ordinary Americans get most of their pay in the form of wages and salaries, while the wealthiest Americans get more of their pay in the form of income on capital, such as dividends and capital gains. The owners of capital have been claiming a bigger share of the national income. That trend shows up in labor’s share of overall compensation, which has fallen from 64.3 percent in 1973 to 58.5 percent in 2011.

Second wedge: Inequality among wage earners has grown. The highest earners have captured a disproportionate share of pay gains. Average pay, which factors in the salaries of chief executive officers and NBA stars, has gone up faster than median pay, which is the pay for the mythical person in the middle. Half of all workers earn more than the median and half earn less. Median hourly compensation isn’t dragged upward by a few big earners at the top. Adjusted for inflation, it grew just 11 percent from 1973 through 2011, while productivity grew 80 percent.

Third wedge: Consumer prices have risen faster than prices of what workers produce. The idea here is that workers’ pay is connected to what they produce, which includes some consumer goods and services but also a lot of things that consumers don’t buy, such as industrial machinery and business-to-business services. Prices of those things have gone up slowly, so the compensation of the workers that produce them has gone up slowly. Consumer prices, meanwhile, have gone up faster. So pay hasn’t kept up with inflation in the consumer’s market basket.

In the 1970s, according to Mishel, the third wedge was the biggest factor in the productivity/pay gap. From 1979 to 2000, the biggest factor was inequality of compensation (the second wedge). Since 2000, both inequality of compensation and shifts in labor’s share of income (the first wedge) have been powerful forces in widening the gap.

While the discussion on the US experience is interesting and pertinent, does this apply to Malaysia? The honest answer is I don’t really “know”, though I suspect it does. We just don’t have very good measures of productivity and wages to make the kind of rigorous approach taken by Mishel in the papers quoted above (see list below for links).

But some of the data certainly points that way – inflation adjusted incomes, at least for some, have not kept pace with inflation and productivity. Overall measures of inequality haven’t budged much in over two decades, but worker compensation for the years where it’s been calculated looks much lower than the norm in developed countries.

And knowing the causes of income and wealth inequality are important, because any counteracting policy needs to specifically target those sources for any progress to be made.

Technical Notes:

1. Coy, Peter, “The Three Wedges That Separate Workers From Their Pay”, Bloomberg Businessweek article, April 27, 2012 (accessed April 29, 2012)
2. Mishel, Lawrence, “Understanding the wedge between productivity and median compensation growth,” The Economic Policy Institute Blog, April 26, 2012 (accessed April 29, 2012)
3. Mishel, Lawrence, “The wedges between productivity and median compensation growth”, The Economic Policy Institute, April 2o12 (accessed April 29, 2012)
4. Mishel, Lawrence & Kai-Far Gee, “Why Aren’t Workers Benefiting from Labour Productivity Growth in the United States?”, International Productivity Monitor, No 23, Spring 2012 (pg31-43), April 2012 (accessed April 29, 2012) (warning: pdf link)