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Productivity Growth Still Benefits American Workers; Saying It Doesn’t Reduces Support for Technological Innovation

Productivity Growth Still Benefits American Workers; Saying It Doesn’t Reduces Support for Technological Innovation

June 27, 2023

For virtually our entire history, Americans have supported increased productivity, even as it led to some worker displacement, because they have understood productivity is the sin quo non of increased wages and living standards. Unfortunately, over the last decade a dangerous myth has emerged that productivity and wage growth are decoupled. Productivity gains are now portrayed as a tool for greedy corporations to jack up their profits at the expense of workers. So, rather than support productivity, the dominant narrative now favors redistribution.

Case in point the recent statement from The American Compass, a center-right think tank that, “productivity, profit, and GDP have risen in lockstep since the 1960s, while wages stagnated.” The left is even more committed to this narrative. The Economic Policy Institute writes that there has been a “gap between the growth of productivity and that of a typical worker’s pay.” The center-left Brookings Institution writes that “wages have stagnated in recent decades for typical workers.” As powerful as this narrative is, it is deeply flawed. Productivity is still pro-worker.

Why Does This Matter and Where Did the Narrative Come From?

The emergence of this new “productivity doesn’t benefit workers” narrative matters because government policies in a wide array of areas affect productivity growth for good or ill. And if the view is that productivity gains are no longer widely shared, support for growth and progress withers, replaced by a focus on redistribution and stasis.

A key origin story for this myth is from economists Thomas Piketty and Emanuel Suez, who purported to show that U.S. median real income growth declined by 8 percent between 1979 and 2014 during a period when labor productivity more than doubled. If this was true, people would be in fact well justified in turning their backs on productivity. But as we show below it was not.

Why This Is a Myth?

Piketty and Saez really put the idea onto center stage that growth no longer benefited average Americans. However, as labor economist Stephen Rose notes in a study for the Urban Institute, their original study suffers from a number of serious methodological problems, including looking at individual tax files rather than households and not including the value of rapidly growing employer-sponsored health care.

It turns out that measuring real income and wage growth and productivity is fraught with difficulties and chock full of assumptions. As Rose notes, different studies get different answers because they use different definitions of income, price deflators, and unit of analysis. However, there is an internationally agreed upon methodology to measure the growth of income (the Canberra method) and while no U.S. study has exactly met this standard, some come close.

When Rose adjusts for these differences using the Canberra method, he estimates that real median income grew 43 percent over the period from 1979 to 2014. The Congressional Budget Office’s estimate was even higher, 51 percent. Even Piketty and Saez (and Zucman) found in 2017 (using a more appropriate methodology) that median income grew by 33 percent, not a decline of 8 percent as is still widely reported. To be sure, this does not mean that income inequality did not grow—it did—but 33 to 51 percent growth in worker incomes is a far cry from an 8 percent decline.

Other analysts offer similar explanations. Much of this discussion gets technical and in the weeds. But that is where the truth lies. Those who have an interest in advancing the myth that productivity (and profits) grew and wages did not want to use methods to prove that. They do that by undercounting wage growth and overcounting output (productivity) growth.

First, many studies, including the one by American Compass, measure only wage growth, not total compensation growth, which includes health care and retirement benefits. As the Federal Reserve Bank of St. Louis notes, “focusing on AHE [average hourly earnings] rather than total compensation yields an inaccurate picture of labor compensation due to the omission from AHE of employer-provided benefits.” Such non-wage compensation has risen as a share of total compensation from around 14 percent in the 1970s to around 19 percent today. And this does include other forms of non-wage compensation, such as bonuses.

Second, some studies, such as the one by American Compass, include only non-supervisory workers. But there are millions of middle-wage supervisory workers in America and an accurate assessment of wage growth should include them.

Third, the main way redistributionists undercount wage growth is through their choice of the deflator. All monetary measures over time must be defeated to account for inflation. One hundred dollars of income today is worth less than 100 hundred dollars of income 30 years ago. American Enterprise Institute economist Michael Strain rightly notes that when comparing wage growth to output growth, the same deflator should be used (output price index). Those looking to paint a picture of wages not keeping up with productivity growth use the consumer price index for wages and the output price index for output. However, when the same deflator is used for wages and output (producer price), the divergence shrinks significantly.

The same is true if the GDP or personal consumption expenditures deflators are used. As the Bureau of Labor Statistics writes:

The CPI measures price change from the perspective of an urban consumer and thus pertains to goods and services purchased out of pocket by urban consumers. The GDP price index and implicit price deflator measure price change from the perspective of domestic production of good and services and thus pertain to goods and services purchased by consumers, businesses, government, and foreigners, but not importers.

So, when measuring the growth output (i.e., productivity), the GDP deflator is a more accurate measure of how much of that output went to wages.

Fourth, it matters how productivity is measured. Productivity is the amount of goods and services produced in the economy (output) per hour of work. But not everyone agrees how to measure output. The studies arguing for wage and productivity divergence use gross output because it exaggerates GDP growth, and therefore productivity growth. As Strain writes:

Gross output includes capital depreciation, while net output does not. Since depreciation is not a source of income, net output is the better measure to use when investigating the link between worker compensation and productivity.

When using only wages for production and non-supervisory workers, using different deflators for wages and productivity, and using gross output, American Compass claims that wages grew just 1 percent from 1973 to 2012 while productivity grew 140 percent. In contrast, Strain found that when using the appropriate measures as discussed above, wages increased 63 percent and productivity increased around 76 percent. To be sure, it would have been better if wages had grown 76 percent (as workers would have gotten all their “fair share” or productivity growth), but a 13 percentage-point divergence is a far cry from the claim that that productivity no longer benefits workers.

Finally, over the last two decades official government statistics have significantly overstated productivity because of how they measure the output of the computer sector. Measurement of output from the computers and electronics industry (NAICS 334) is a particular problem. “Moore’s Law” has meant that computers get significantly more powerful every year. But when a company makes a computer (or cell phone or other device with a chip in it) that is twice as fast as one made two years prior, the Bureau of Economic Analysis (BEA) counts it as if output doubled. This is why, according to BEA, from 2000 to 2010 U.S. inflation-adjusted output of the computer and electronics sector increased 5.17 times. Compare this with electrical equipment, which saw a decline of 12 percent.

It defies belief that the U.S. computer and electronics sector was producing 5.17 times more in the United States, especially as employment in the sector declined by 43 percent, and according the U.S. Census Bureau the number of units of consumer electronic products shipped from U.S. factories actually fell by 70 percent. When controlling for this overstatement, manufacturing productivity grew just 32 percent, not 72 percent. And this overstatement meant that measured output growth was about 25 percent higher than it really was. When this overstatement of output is factored in, there is no divergence between wage and productivity growth.

Finally, if productivity was growing more than wages, one would expect to see profits growing dramatically. And that is what American Compass claims: Profits up a whopping 200 percent. Yet domestic corporate profits as a share of GDP were about the same in the late 2010s as they were in the 1970s. This is much more in line with the reality that wages and productivity have more or less kept pace, than with the myth that wages are stagnant and profits through the roof.

So Where Are We?

Given the Piketty and Saez updates and numerous other studies have shown that the median worker still benefits from productivity growth, one would think that the current narrative would reflect this reality. As John Maynard Keynes once famously stated after someone accused him of changing his view, “when the facts change, I change my mind.” Apparently, we are not all Keynesians today. Consider David Leonhardt, a New York Times economic columnist, who wrote that before the 1970s workers enjoyed consistently rising wages, but now “profits have soared at the expense of worker pay. The wealth of the median family today is lower than two decades ago.” Leonhardt is not an outlier. Despite solid evidence to the contrary, many people have simply made up their mind that productivity doesn’t benefit most American workers and have turned to redistribution as the only valid economic policy goal.

Why did this pessimistic view become the dominant narrative? One reason is that it seemed to comport with what people experienced. College and housing have become less affordable for most households. But cars, computers, appliances, food, clothing, and many other items have gotten more affordable (with price increases lower than the CPI). But it is human nature to focus on the more expensive items, rather than the cheaper ones.

A second reason is that this pessimistic narrative is fodder for a growing anti-corporate movement that wants to transform American society into something different: government-run industries, heavily regulated corporations, and a mass number of small, individually owned business. If you can advance the narrative that productivity, especially from large companies, no longer helps the average worker, there is little to lose from transforming America.

The reality is if we want higher wage growth we need faster productivity growth, and that has been extremely low in the last 15 years. That, more than any factor, is why wage growth has been slow.

That doesn’t mean we shouldn’t take other steps, especially increasing the federal minimum wage (which will have the added benefit of spurring more automation of low-wage jobs), reducing the financialization of the economy, spurring more private sector unionization, and raising taxes on wealthy individuals. But at the end of the day, without higher productivity, the average worker will see little income growth.

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