The Wedge between Productivity and Wages

Travel day, so I had this set aside to highlight, and in the interim Paul Krugman beat me to it. But it's still worth noting (and it supports my contention that there has been a "mal-distribution" of income in recent decades):

Understanding the wedge between productivity and median compensation growth, by Larry Mishel: One of the key dynamics of our economy for more than 30 years has been the divergence between productivity growth and compensation (or wage) increases for the typical worker. This divergence between pay and productivity has been increasingly recognized as being at the heart of the growth of income inequality. ...

Understanding the driving forces behind the productivity-median hourly compensation gap is the subject of a new paper, The wedges between productivity and median compensation growth, that previews a portion of the analysis in the forthcoming State of Working America. This research reflects the results in a more technical paper, Why Aren’t Workers Benefiting from Labour Productivity Growth in the United States, that I co-authored with Kar-Fai Gee...

During the 1973 to 2011 period, labor productivity rose 80.4 percent but real median hourly wage increased 4.0 percent, and the real median hourly compensation (including all wages and benefits) increased just 10.7 percent. ... If the real median hourly compensation had grown at the same rate as labor productivity over the period, it would have been $32.61 in 2011 (2011 dollars), considerably more than the actual $20.01 (2011 dollars). Consequently, the conventional notion that increased productivity is the mechanism by which living standards increases are produced must be revised to this: Productivity growth establishes the potential for living standards improvements and economic policy must work to reconnect pay and productivity.

The objective of our new paper is to provide a comprehensive and consistent decomposition of the factors explaining the divergence between growth in real median compensation ... and labor productivity since 1973 in the United States, with particular attention to the post-2000 period. In particular, the paper identifies the relative importance of three wedges driving the median compensation-productivity gap: 1) rising compensation inequality, 2) declining share of labor compensation in the economy (the shift from labor to capital income), and 3) divergence of consumer and output prices....

Growing inequality of compensation and the erosion of labor’s income share are the key overall drivers of the wedge between productivity and median compensation, accounting for two-thirds of the wedge since 1973 and about 85 percent of the wedge since 2000. These factors, in turn, reflect the various ways that the typical worker has lost bargaining power in the economy over the last three decades: excessive unemployment, eroded labor market institutions such as the minimum wage and unions, globalization, deregulation of industries, privatization, and the rising power of finance. The third factor, the fact that output prices (covering investment, exports, imports, government as well as consumption)  grew more slowly than the prices of consumer purchases—sometimes labeled a deterioration in “labor’s terms of trade”—was evident throughout most of the last three decades and was most important in the 1970s and least important in the 2000s.

Maintaining rapid overall productivity growth—through innovation, restoring manufacturing, improved education and skills—is obviously an important policy goal. But if we want to improve the living standards of the vast majority—and we definitely can do so given the expected productivity growth—then we must also place the challenge of reconnecting growth in overall productivity and median compensation at the center of economic policy.

My view on whether this problem will correct itself:

I’ve never favored redistributive policies, except to correct distortions in the distribution of income resulting from market failure, political power, bequests and other impediments to fair competition and equal opportunity. I’ve always believed that the best approach is to level the playing field so that everyone has an equal chance. If we can do that – an ideal we are far from presently – then we should accept the outcome as fair. Furthermore, under this approach, people are rewarded according to their contributions, and economic growth is likely to be highest.

But increasingly I am of the view that even if we could level the domestic playing field, it still won’t solve our wage stagnation and inequality problems. ..

We’ve given self-correction mechanisms 40 years to solve the problem of growing inequality, and the result has been even more inequality. ... Some people say education is the answer, but we have been trying to reform education for decades, yet the problems remain. The idea that a fix for education is just around the corner is wishful thinking.

If we want to preserve a growing and socially healthy economy, and avoid moving to lower growth points on the inequality curve, then we will need to do much more redistribution of income than we have done over the last several decades. We must ensure that the rising economic tide lifts all boats, not just the yachts. That means the wealthy will no longer get it all, they will be asked to share economic growth with the workers who helped to bring it about, workers who ought to be rewarded for their growing productivity.

We can expect considerable protest when the wealthy are asked to give up a portion of the growth that has been flowing exclusively to them for so long, and we’ll hear every reason you can think of and a few more as to why redistributive polices are bad for America. But sharing economic gains among all those who had a hand in creating them is the right thing to do. For the foreseeable future, redistributive polices appear to be the only way to ensure that workers receive their share of the growing economic pie.

And, something I wrote just before the Occupy Wall Street movement broke out:

Many of the policies enacted during and after the Great Depression not only addressed economic problems but also directly or indirectly reduced the ability of special interests to capture the political process. Some of the change was due to the effects of the Depression itself, but polices that imposed regulations on the financial sector, broke up monopolies, reduced inequality through highly progressive taxes, and accorded new powers to unions were important factors in shifting the balance of power toward the typical household.

But since the 1970s many of these changes have been reversed. Inequality has reverted to levels unseen since the Gilded Age, financial regulation has waned, monopoly power has increased, union power has been lost, and much of the disgust with the political process revolves around the feeling that politicians are out of touch with the interests of the working class.
 
We need a serious discussion of this issue, followed by changes that shift political power toward the working class. But who will start the conversation? Congress has no interest in doing so; things are quite lucrative as they are. Unions used to have a voice, but they have been all but eliminated as a political force. The press could serve as the gatekeeper, but too many news outlets are controlled by the very interests that the press needs to confront. Presidential leadership could make a difference, but this president does not seem inclined to take a strong stand on behalf of the working class...
 
Another option is that the working class will say enough is enough and demand change. There was a time when I would have scoffed at the idea of a mass revolt against entrenched political interests and the incivility that comes with it. We aren’t there yet – there’s still time for change – but the signs of unrest are growing, and if we continue along a two-tiered path that ignores the needs of such a large proportion of society, it can no longer be ruled out.