A Visual Essay on the Wage-Productivity Gap

In the late 1970s a gap opened up between the productivity of workers, and the amount they were being paid. The not-so-creative name for this trend is the wage-productivity gap. The causes are hotly debated, but the consequences are straightforward. The economy continues to grow through increases in productivity, but the benefits of increased productivity are not shared by workers. This means real wages stagnate, and inequality increases. It also calls into question the justice of a system in which the production of workers is divorced from the wages of workers.  The Bureau of Labor Statistics has put together a visual essay on wage-productivity gap.

BLS wage prod 1 BLS wage prod 1a

In chart 1 we see the rate of change in productivity growth compared to the rate of change in real (inflation-adjusted) hourly compensation (1). Chart 2 breaks down the trend by selected time periods. We can see that from 1947 to 1979, wages and productivity grew together. They started to separate in the 1970s, and came completely unglued in the 1980s, through the early 1990s.  The late 1990s was the only time in the past 30 years that real (inflation-adjusted) wages grew with productivity, and then in the 2000s wages remained stagnant while productivity continued to increase.

The growing gap is also reflected in the decrease in labor’s share of output.

BLS wage prod 3

 

 

For a long time the labor share was thought to be constant. Here again, the causes are both complex and disputed, but the consequences are clear, less of the work being done by workers is reflected in their wages.

Without really figuring out what’s going on, it’s tough to reverse these trends. Chances are technology, globalization, and loss of union power all play roles in driving down labor’s share of income and opening up the wage-productivity gap. In some cases (technology and globalization) those processes have benefits as well as costs, so the trick is to capture the benefits while reducing or eliminating the costs. This is not an easy task, but there are a few clear implications to these trends.

First, we should support a strong safety net. Stagnant real wages and unemployment are being caused by macroeconomic changes, not individual’s suddenly becoming less productive or less deserving. Second, we can raise the minimum wage to help insure that workers share in the gains of productivity.

 

(1) Technical note: Taking the log of both indexes allows us to see the rate of change presented visually. Instead of each tick mark representing an increase of X  in a meaningless index, each tick mark represents a percentage increase (in this case, each tick mark is a 22% increase). The gap actually looks much larger if you don’t log-transform the data first, as later changes are bigger in absolute terms than they are in percentage terms.

The Fundamental Stupidity of Our Anti-Poverty Policy

Consider a game of musical chairs. Now suppose our goal is to help out the poor people who were unable to find a chair when the music stopped. We could train them to be quicker, or we could make life more miserable for the losers, or try to match them with a particular chair ahead of time. All of these policies are obviously doomed to failure. No matter how much we help individual players in the game, there still aren’t enough chairs. The only solutions are to either have enough chairs for everybody or play a different game.

Now, consider our anti-poverty policy. We could educate people, or deny them unemployment benefits to make their lives miserable, or match them with jobs in a certain sector (of course, after a two-year vocational degree and student loans there’s no guarantee that sector will still be hiring). Ultimately, however, none of these solutions will solve the problem of poverty. In an economy where college-educated individuals are taking jobs that only require a high school education, the idea that additional education will solve poverty is laughable. It might help an individual, but unless there are more total jobs it just means displacing someone else.

There’s a long debate in poverty circles between personal causes of poverty and structural causes of poverty. A personal cause might be failure to show up on time to work leading to being fired, while a structural cause is inadequate access to medical insurance (i.e. the person can’t take a job because they’d lose medicaid but and not have anything to replace it). There are also causes that are a mix of structural and personal, for instance, dropping out of a bad high school is the result of both a personal decision and a structural factor (lack of access to quality education). Increasingly though, even structural diagnoses have focused on the individual. If we remove ‘barriers to work’ by providing proper education, medical coverage, child care, a tax credit that increases wages and so forth we will solve the structural problems that prevent individuals from working.

Unfortunately, this amounts to focusing on the individual players in our musical chairs game, while ignoring the real problem: there aren’t enough (insert expletive of choice) chairs!! “But wait!” I can hear the economists object. In a dynamic economy there’s not a fixed number of chairs. By improving individuals we can increase productivity and so increase the number of chairs. Now, we could get into the nuts and bolts of economic theory, but while that would be fun for me, you’d probably prefer the much more straightforward reply, “look at history.” The economy has grown much, much faster than the population for the past 60 years…and yet there still aren’t enough chairs. In fact, saying 60 years was being generous. The U.S. economist Henry George wrote in 1871:

The past century has been marked by a prodigious increase in wealth-producing power. It was naturally expected that labour-saving inventions would make real poverty a thing of the past. Disappointment, however, after disappointment has followed. Discovery upon discovery, invention after invention, have neither lessened the toil of those who most need respite nor brought plenty to the poor. The association of poverty with progress is the great enigma of our time. (From Our Land Policy)

Since 1871 the wealth of each individual in the United States has increase over 13 times. And as George points out in 1871 we’d just experienced a century of growth that should have eliminated poverty. We had enough wealth in 1871 to eliminate poverty, and today we have thirteen times as much wealth per person as we did then. And yet we still have poverty. What has gone wrong?

As it turns out, poverty is not something that can be solved by technology or economic growth. And while we can (and should!) make life less miserable for the poor by providing a social safety net the roots of poverty go much deeper. We comfort ourselves with the though that poverty in the midst of affluence is an enigma, or a paradox that will go away if only we have enough scientific know-how. Poverty is rooted in the very structure of our political economy. As long as political and economic power is unequally distributed, so too will political and economic outcomes be unequally distributed.

This leaves poverty researchers with some new tasks. As Alice Connor writes in Poverty Knowledge:

The first task is to redefine the conceptual basis for poverty knowledge, above all by shifting the analytic framework from its current narrow focus on explaining individual deprivation to a more systematic and structural focus on explaining- and addressing – inequalities in the distribution of power, wealth, and opportunity. A second is to broaden the empirical basis for poverty knowledge – recognizing that studying poverty is not the same thing as studying the poor – by turning empirical attention to political, economic, institutional, and historical conditions, to the policy decisions that shape the distribution of power and wealth, and to interventions that seek to change the conditions of structural inequality rather than narrowly focusing on changing the poor.

One of the most frustrating things for advocates about going down this path is that the answers aren’t clearly defined. We know that a well-designed social safety net can alleviate misery. We don’t know which institutional reforms can change structural inequality without having intolerable side effects. (There are some pretty good ideas out there, and some of them even have decent evidence from other countries, but we’ll leave that for another time). Of course, what’s frustrating for advocates is exciting for researchers, as long as they remember that the study of poverty is not the study of the poor, but rather the study of a social, political, and economic system that produces poverty. Perhaps at one time poverty was produced by natural scarcity, but that is clearly not the case today. The solutions to poverty exist, but they are political, ideological, and social rather than technological and scientific.

Economics for Advocates: The Tragedy of the Commons

The tragedy of the commons refers primarily to a basic demonstration that pure utility-maximizing economic logic leads to a situation in which everyone winds up worse off than they would have if they had cooperated. The phrase “Tragedy of the Commons” is from Garrett Hardin’s 1968 article of the same name in the journal Science.

Hardin sets up the argument,  “Picture a pasture open to all. It is to be expected that each herdsman will try to keep as many cattle as possible on the commons.” In this situation, each herdsman gains a benefit from grazing an extra animal. They also suffer from overgrazing and depleting the commons. The linchpin of the argument is that the suffering from overgrazing is shared among many people, while the benefit of the additional cattle belongs to the individual. So, “the rational herdsman concludes that the only sensible course for him to pursue is to add another animal to his herd. And another…But this is the conclusion reached by each and every rational herdsman sharing a commons. Therein is the tragedy. Each man is locked into a system that compels him to increase his herd without limit — In a world that is limited.”

In a nutshell, the cost of overusing (or polluting) a resource is smaller than the benefit to the individual, and so the individual overuses the resource. However, because every individual does this, the result is resource depletion.

Hardin originally applied this argument to overpopulation,  however this was shown to be a misapplication as population growth tapered off in rich countries even in the absence of the mutually agreed upon mutual coercion that Hardin recommended. It also did not make sense on a theoretical level, as children do not bring the same economic benefits as cattle. Nonetheless, the general form of the tragedy of the commons does apply to issues like pollution and over-fishing.

In 2009, Elinor Ostrom won a Nobel Prize in Economics for following up on when the tragedy of the commons will take place and how best to manage the commons. Hardin had advocated either turning the commons into private property or strong government regulation on the national or international level. Ostrom instead pointed to the role of social capital and local organizations. Instead of basing her analysis on a the purely rational economic agent, Ostrom looked at actual human beings (Imagine! Why didn’t economists do that years ago?) and found that they were more cooperative and that the indicators of social capital and local institutions often lead to a non-tragic resolution to commons management.

Ostrom’s overall analysis is far too detailed and nuanced for a short blog post, but she did also recognize that not all commons problems could be dealt with on a local level.  One of the most interesting things about the tragedy of the commons argument is that it has been used to justify both pure private-property solutions (by conservatives) and increasing governmental regulation (by liberals). Ostrom challenges both those approaches by pointing to the importance of context and social interaction.

The Tragedy of the Commons is an often-cited and often misused argument. The problems Hardin points to are real, but not insurmountable. The ability of human beings to cooperate to tackle economic problems has significant implications not only for natural resource management but also for fields like poverty. Resources can be shared in a way that is equitable and reduces (or eliminates) poverty in part by strengthening social capital on the local level. There are very real macroeconomic problems that can’t be solved that way (and I write about those a lot) but it’s good to remember that there are also some problems that can be tackled simply by strengthening local institutions and organizations.

Economics for Advocates: Preferences and Social Welfare

A physicist, a chemist, and an economist are stranded on a desert island. A can of beans washes ashore. They debate how to open it. The physicist says, “let’s smash the can open with a rock,” The chemist says, “let’s build a fire and heat it first.” The economist says, “Let us assume we have a can opener…”

The best place to start in understanding economics is by understanding an economic view of well-being. To an economist, people are made better off when their preferences are satisfied. People are rational utility-maximizers (i.e. they know what they want and they set about getting it as efficiently as possible).

For a great many things this works very well. Suppose we’re trying to figure out how much you are going to spend on food, and how much you are going to spend on travel. In real life, of course, you have more than two options, but to simplify (and make it possible to graph) for now we’re going to assume that your money is spent between food and travel.  I’m going to use graphs and intuition so that we can avoid doing too much math (if you’d like to see the math just ask and I’ll put it in the comments).

Food Travel 1 indifference

Here the amount of Food you choose to buy is represented on the vertical axis, and the amount of Travel you buy is represented on the horizontal axis. The mysterious blue line represents that rate at which you would willingly trade food for travel. The technical name for the blue line is an indifference curve. In theory, you are indifferent to any combination of food and travel that appears on the line. Notice that the line curves. When you’re spending a  lot on food, you’d be willing to trade quite a bit of food money for a little bit more travel. Conversely, if you’ve been spending a lot on travel and don’t have much food, you’d be willing to trade a lot of travel for not that much food. This is a result of  the principle of diminishing marginal utility. For any good, like travel, each additional unit is still good, but it’s not as good as the last. If you’ve ever eaten too much pizza you probably understand diminishing marginal utility intuitively, The first slice is good, the second not quite as good, and so on until you’ve overeaten and the joy (utility) you take from the last slice is actually negative, since it causes a stomachache.  (Eating the last slice is irrational, so for now let’s assume human beings don’t do things like that).

Economists assume that more of any given good is better.  So while when you have lots of money for food, you’d willingly trade it for travel, what you’d really like is to have more of both. There is no satiation. The only thing that stops you from increasing both food and travel to infinity is your budget. In general, the market sets prices for food and travel. It doesn’t matter if you’ve gone out for dinner every night for the past week, the price for dinner tonight (at any given restaurant and for any given meal) will be the same as if it’s the first time you’ve gone out in a year. This means that the budget constraint (the red line) does not curve. The number of good meals out at restaurants that the market requires you to give up in order to get more travel stays constant, so we have a budget constraint with a constant slope that stretches from spending all your money on food to spending all your money on travel.

Food travel budget constraint

Okay, now let’s put it all together. On this next graph we have multiple blue indifference curves. Because more is always better, indifference curves to the northeast (upper right) are better than those to the southwest (lower left). Indifference curves don’t ever cross, and are assumed to be everywhere.

Travel Food budget and indifference

Points A (lot’s of food, not much travel) and B (lots of travel, not much food) are both within the budget constraint. (Economists assume you will spend all of your budget. Think of savings as just being another category in the budget, a sort of ‘future spending’ category that also gets traded off with current food, travel, etc.). Although you’d be equally happy with either A or B, point C is better. Here you’ve moved to a higher indifference curve, and so increased your overall utility while staying within your budget. In general, economists argue that you will maximize your utility when the rate at which you are willing to trade off one good for another is equal to the rate at which the market makes you trade off one good for another. This is represented on the graph as point C, where the indifference curve is tangent to the budget line.

Economists think about social welfare in terms of individual utility functions. Each individual wishes to have more of the bundle of goods they have chosen. (We thought just about trading food for travel, but in reality we trade off lots of different goods in order to form a unique bundle of goods). This can be accomplished either by increasing individual income, or by making goods cheaper; both of these have the effect of moving the budget constraint up and to the left, and so allowing the consumer to reach a higher indifference curve.

All of this is very useful up to a point. It is a bad idea to try to tell people how they should make choices between eating out at a fancy restaurant and saving up for a long vacation. Not only does the market overall not work as well this way, but it’s an unnecessary restriction of individual liberty. This is the reason many economists argue that benefits to the poor should be provided in the form of cash, rather than through a myriad of programs. So instead of SNAP (food stamps) and a housing voucher, recipients of aid could choose how much money to allocate to food and how much to housing.

We run into problems once some of these assumptions are used beyond the basic case of an individual choosing among goods. This is probably the primary problem in economics, the extension of simplifying assumptions designed to clarify one point on to another topic, where those assumptions no longer simplify and enlighten, but instead lead to wrong and often harmful conclusions.

The assumption that individuals always want more and are made better off by getting it is challenged by the hedonic treadmill theory in psychology; the idea that people usually adjust their happiness to their level of material well-being. The subjective happiness effects of buying a new car or new house last no longer than a year or two. The effects for other material goods are even smaller. Travel can actually have relatively long-lasting effects because of the memories formed and the socialization experience. In general, socializing and spending times with friends has a much, much stronger link to individual happiness than any level of material well-being.

There is also an assumption buried in the model that preferences are stable, i.e. that people know what they want, and while it may change slowly over the years, its mostly stays the same. Of course, if this is true, then companies are wasting billions of dollars on advertising to try to get people to want things they didn’t want before. In reality, advertising works.  It’s tough to argue that one is better off if you satisfy a preference that was induced by an advertisement. You would have been better off if you’d just never seen that ad. Even in the absence of advertising, there are still good reasons to doubt that human beings have stable preferences, in part simply due to the conditions of uncertainty under which we must make decisions.

Finally, although diminishing marginal utility does imply that there should be a somewhat equitable distribution of resources ($100 dollars is worth more to someone who makes $10,000 a year than someone who makes $100,000), looking at social welfare through the lens of individual utility functions tends to ignore the distribution of resources. Things like the median income and the level of inequality matter not simply for the material well-being that goes along with it, but for the ability to fit into society.

It’s worth pointing out that many economists know this, and are working to correct some of the problems in standard economic theory. (Amartya Sen is a great example). And again, it’s not that there aren’t clear uses to indifference curves, budget constraints, and utility functions. They explain individual micro-economic behavior remarkably well. They’re worth knowing. It’s just also crucial to know their limits.