No, there isn't a "great decoupling" between pay and production

By Tim Worstall , written on March 19, 2014

From The News Desk

One of the standard tropes of current American economic discourse is that there's been a decoupling between what everyone gets paid and what everyone's producing. In the jargon, that incomes have fallen behind rises in productivity. The implication being, of course, that we proles are getting shafted while the plutocrats soak up all the wealth created by our labour. A reasonable example of the point is here:

The chart shows that productivity, or output per hour of work, has quadrupled since 1947 in the United States. This is a spectacular achievement by an advanced economy.

The gains in productivity were quite widely shared from 1947 to 1980. Real income for the median U.S. family doubled during this time just as output per hour of work performed doubled. The rising tide was lifting all boats.

However, what we want to focus on today is the remarkable separation in productivity and median real income since 1980. While the United States is producing twice as much per hour of work today compared to 1980, a small part of the gain in real income has gone to the bottom half of the income distribution. The gap between productivity and median real income is at an historic all-time high today. As I say, this is an entirely common trope, point of discussion. The problem is that it's not particularly true. The theory says that it shouldn't be at least, as this extract from a truly great Paul Krugman essay shows:

More specifically: the 30 percent productivity increase he cites was achieved only in the manufacturing sector; in the business sector as a whole the increase was only 13 percent. The 13 percent decline in real wages was true only for production workers, and ignores the increase in their benefits: total compensation of the average worker actually rose 2 percent. And even that remaining gap turns out to be a statistical quirk: it is entirely due to a difference in the price indexes used to deflate business output and consumption (probably reflecting overstatement of both productivity growth and consumer price inflation). When the same price index is used, the increases in productivity and compensation have been almost exactly equal. But then how could it be otherwise? Any difference in the rates of growth of productivity and compensation would necessarily show up as a fall in labor's share of national income -- and as everyone who is even slightly familiar with the numbers knows, the share of compensation in U.S. national income has been quite stable in recent decades, and actually rose slightly over the period Lind describes.
Now that's an old essay but we get much the same in a bang up to date one in the WSJ:
The illusion is the result of two mistakes that are routinely made when pay is compared with productivity. First, the value of fringe benefits—such as health insurance and pension contributions—is often excluded from calculations of worker pay. Because fringe benefits today make up a larger share of the typical employee's pay than they did 40 years ago (about 19% today compared with 10% back then), excluding them fosters the illusion that the workers' slice of the (bigger) pie is shrinking.

The second mistake is to use the Consumer Price Index (CPI) to adjust workers' pay for inflation while using a different measure—for example the GDP deflator, which converts the current prices of all domestically produced final goods and services into constant dollars—to adjust the value of economic output for inflation. But as Harvard's Martin Feldstein noted in a National Bureau of Economic Research paper in 2008, it is misleading to use different deflators. We have in fact known all of this for at least a couple of decades. There is no great decoupling.

What we're actually seeing is a quirk of the way that US economic statistics are put together. And, to be frank about it, US economics statistics could be put together in a much better manner.

The first point is that people are comparing productivity to median household income. And the statistics do not adjust for changes in household size: something which has obviously changed over the decades. So we're not counting income per worker here, which might have some connection with productivity, nor are we counting consumption possibilities per person, which would be an interesting thing to measure. Instead we're measuring just income into a household that has changed in size. A second problem with using household income is that it is just income: and that's not what even in theory should track the productivity numbers. That would be compensation that does, what is the total cost of employing someone to gain access to that productivity? The WSJ piece tells how much that has changed.

Then there's the use of two different inflation measures which Krugman and the WSJ highlight. Once we account for all of these then it is indeed true that average wages have been quite closely tracking changes in productivity. As theory tells us it should.

This does not mean that everything is just peachy in our economic orchard of course. It is true that income (and even compensation) inequality has increased over these decades. Thus the wages of the low paid have not kept up with the increase in average productivity while the incomes of the highly so have outraced it. We can complain about this if we want but it's nothing at all to do with anything other than globalisation. Adding a couple of billion of low productivity workers to the global economy is going to do this, there's no doubt about that.

A second often mentioned problem is that the labour share of the economy is falling as the profits share of the economy rises. Thus it's the plutocrats grinding us proles down again. I'm deeply unconvinced by this argument for another technical reason about the statistics being used. The economy as a whole, GDP (or GNP, GNI, whatever) does not divide neatly into labour and capital share. There are two other parts: self employed income and subsidies to and taxation of consumption. And the part of the economy that is devoted to paying those two has definitely risen over the decades. So the labour share could fall but without the profit share rising. And looking at the UK numbers for this this is exactly what has been happening. Yes, the labour share has been falling, the VAT or sales tax number has been rising, self employment has risen and the capital share is around its long term average.

Sadly, the standard US statistics are not compiled in the same manner. The sales taxes and that self employed income are instead allocated on a formula that has remained unchanged over these decades and added, by that old formula, to the labour and capital shares. Exactly what we don't want if we're to be able to tease out whether it is a change in consumption taxation and self employment which is leading to the fall in the labour share. It could be true that there really is a rise in the capital share going on, contrary to the UK experience, but we just don't have the numbers to show it.

Again, none of this is to insist that there are no problems. But while it is true that low end wages have fallen behind average productivity, it is not true to say that average compensation has fallen behind average productivity. There really is no great decoupling.

[Image adapted via thinkstock by Brad Jonas for Pando]