Higher productivity used to mean higher wages. Has that broken down?

For a long time in America, earnings and productivity went hand and hand: The more productive workers got, the more they made, on average. That relationship appeared to break down starting in the early 1970s, as productivity increased but wages flat-lined, and economists have spent several decades debating why.

But what if the mystery was always an illusion - and it distracted experts and policymakers from a more important productivity problem? That's the argument James Sherk, a senior policy analyst at the conservative Heritage Foundation, makes in a new paper. Sherk contends total compensation, properly adjusted for inflation, has kept pace with properly-measured productivity, on average.

The real problem, he says, is that far too many workers are stuck in low-productivity jobs, particularly in the health-care sector; he argues policymakers should be focused on helping those workers gain more skills and move into more productive sectors -- specifically, by looking for ways to reduce the cost and increase the accessibility of higher education.

The productivity-wages divergence chart typically looks something like this:

SherkImage1

Sherk contends it should look more like this:

SherkImage2

The differences in those charts rest on readings of data that matter a lot for employers but won't cheer workers very much; by Sherk's calculations, worker earnings have increased in many ways that don't necessarily boost their buying power.

Sherk contends that the way many people think about “wages” understates what employers pay their employees, because it doesn’t include health benefits, bonuses, retirement contributions and paid time off – non-cash benefits that have risen, by Sherk’s calculations, to make up one-fifth of the average worker’s total compensation.

While average wages have fallen by 7 percent over the last 40 years, Sherk calculates total compensation has risen 30 percent. That’s still well below the 100 percent increase in productivity. To close the remaining gap, Sherk does two things. First, he uses a different measure of inflation to calculate worker compensation from an employer’s point of view.

Instead of using the Consumer Price Index, which measures the cost of goods and services people consume, Sherk uses the Implicit Price Deflator, which includes the cost of the things businesses make. You can dive into his paper for the technical details, but the thrust is, those business costs have risen more slowly than consumer costs, which yields a lower inflation calculation, which, when applied to compensation, makes it appear worker compensation has been stronger than consumer-inflation-based calculations suggest.

Sherk says this makes sense: Productivity is linked to compensation from the business side of the equation. Firms increase pay based on what they can sell their products for, not based on how much more expensive it is for their employees to live.

“Economists would expect a U.S. com­pany to pay more if higher demand raised the price of its goods or services,” he writes. “Economists would not expect the company to increase compensation because, for instance, oil imports became more expensive. To discern whether compensation has kept pace with worker productivity, economists use the prices of the goods or services that employees produce.”

The second thing Sherk does is recalculate productivity to find that it is increasing slower than Labor Department statistics indicate. That’s because of what he calls methodology problems with the current calculations, including overestimating how much American companies pay for imported goods they use in production and underestimating the costs of replacing outdated equipment.

Once he’s done all that – adjusted compensation and adjusted productivity – Sherk finds there’s hardly a gap between the growth in what an average worker earns and the average productivity gains over the last 40 years.

What he finds persists is a gap between productivity and median worker compensation - which is to say, how much the worker smack in the middle of the middle class brings home. Sherk blames this on market forces, including globalization and automation, pushing lower-skilled workers into low-productivity jobs. If those workers could more easily and cheaply gain more skills -- say, through widely available, low-cost online education -- they could compete for higher-productivity jobs.

“The problem is, we need to find ways to make more workers more productive,” Sherk said in an interview. “The focus of policy should be to make it easier for more workers to gain more skills.”

Which would be a very productive goal, indeed.

Jim Tankersley is the editor of Storyline, where he explains complex public policies and illuminates their human impact.
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