Inequality is Central to the Productivity-Pay Gap

Matt Yglesias is an insightful writer, but his recent article, “Hillary Clinton’s favorite chart is pretty misleading” is itself very misleading. Since the Clinton campaign’s “favorite chart” is an EPI chart, which Jared Bernstein and I originally came up with twenty years ago, I think it’s important to set the record straight. The main problem is that Yglesias does not actually engage with the chart he says he’s criticizing.

The chart compares the growth of average productivity since 1948 with the growth of the hourly compensation (all wages and benefits) of production/nonsupervisory workers, a group comprising 82 percent of payroll employment (blue collar workers in manufacturing and non-managers in services).

The point is to show that the pay of a typical worker has not grown along with productivity in recent decades, even though it did just that in the early post-war period. That is, it shows a substantial disconnect between workers’ pay and overall productivity—a disconnect that has not always existed. We use data on production/nonsupervisory workers because there is no other data series on the pay of a typical worker that goes back to the early post-war period. The point of the chart is to show not only the current divergence but also that it was not always present—also, these data tend to move with the economy-wide median wage.

Yglesias argues that the major reason for the divergence is the different methods that must be used to adjust each line for inflation. This is flat wrong—the vast majority of the divergence is caused by rising inequality (both inequality among wage earners and a shift from labor to capital incomes). Yglesias does not explain why he wipes out the inequality story by shifting the discussion to a comparison of average compensation (the pay of all workers, including the top one percent) and productivity, rather than focusing on the actual lines in the Clinton/EPI graph. A key characteristic of inequality is that the average for all workers diverges from the median, as the former is pulled up by very large values at the top of the scale while the latter is not.

By focusing on the average compensation Yglesias has omitted from his analysis the biggest factor that generates the divergence between the pay of a typical worker and productivity growth portrayed by the Clinton campaign chart: rising inequality of compensation. That’s a pretty big omission. I would say it is very misleading to start with a chart that demonstrates the impact of inequality and then claim there is no big divergence when you make inequality disappear by comparing average pay instead of that of the typical worker.

I quantified the factors behind the divergence of median hourly compensation and productivity for the period between 1973 and 2011 in a 2012 paper, “The wedges between productivity and median compensation growth.” An older version of the Clinton campaign chart is Figure A in that paper. (We are actually in the process updating this analysis, so stay tuned.)

The three wedges that are responsible for the productivity-pay gap are:

  1. Changes in labor’s share: an overall shift in how much income in the economy is received as compensation by workers and how much is received by owners of capital;
  2. Compensation inequality: growinggaps in wages, benefits, and compensations between the top 1 percent, and high, middle-, and lowwage workers;
  3. “Terms of trade”: the faster growth of the prices of what workers buy relative to the prices of what they produce.

My analysis of these three wedges and their importance in particular sub-periods is the table below. The first two items are dimensions of rising inequality, while the third item is the one highlighted by Yglesias as the “big problem.”

Table 1

Reconciling growth in median hourly compensation and productivity, 1973–2011

197379 197995 199500 200011 197311
A. Basic trends (annual growth)
Median hourly wage -0.26 -0.15 1.50 0.05 0.10
Median hourly compensation 0.56 -0.17 1.13 0.35 0.27
Average hourly compensation 0.59 0.55 2.10 0.95 0.87
Productivity 1.08 1.29 2.33 1.88 1.56
Productivity-median compensation gap 0.52 1.46 1.21 1.53 1.30
B. Explanatory factors (percentage-point contribution to gap)
Inequality of compensation 0.02 0.72 0.97 0.59 0.61
Shifts in labor’s share of income 0.03 0.23 -0.40 0.69 0.25
Divergence of consumer and output prices 0.46 0.51 0.64 0.24 0.44
Total 0.52 1.46 1.22 1.52 1.29
C. Explanatory factors (percent contribution to gap)
Inequality of compensation 4.8% 49.6% 80.0% 38.9% 46.9%
Shifts in labor’s share of income 5.5% 15.4% -32.5% 45.3% 19.0%
Divergence of consumer and output prices 89.7% 35.0% 52.5% 15.8% 34.0%
Total 100.0% 100.0% 100.0% 100.0% 100.0%

Note: Totals for panels A and B do not exactly match due to rounding

Source: Analysis of Mishel and Gee (2012) Table 1

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The biggest wedge over the 1973-2011 period was rising compensation inequality, which was responsible for nearly half (46.9 percent) of the total divergence. Changes in labor’s share of income was the least important factor (19 percent), and the “terms of trade” (the factor Yglesias focuses on) was the second most important (34 percent). The results for recent years—the most relevant ones for current policymakers—are different. From 2000 to 2011, the erosion of labor’s share of income was the most important factor (45.3 percent), inequality next most important, and the “terms of trade” the least (15.8 percent). Inequality of compensation contributed 38.9 percent of the divergence between 2000 and 2011. So, the two inequality items (falling labor’s share and rising compensation inequality) explained 84 percent of the divergence in the 2000s, when the pay and productivity divergence was larger than in any other period.

Having set aside the whole issue of rising inequality of compensation, Yglesias identifies the “terms of trade” as the really big deal. This is what he means when he says, “the bigger problem is that both lines are indexed to inflation — using different inflation indexes.” He is referring to the fact that the prices used to adjust productivity (a combination of the prices of consumption, investment, exports, imports and government) differ from the inflation adjustment for compensation, which relies solely on consumption prices. Note that my analysis shows his “bigger problem” was primarily a problem from the 1970s and late 1990s, and has had very little effect since 2000.

Yglesias correctly notes that real wages “really have risen much too slowly over the past 40 years,” but he adds that “Clinton’s version of the chart makes it look like rising productivity isn’t part of the solution.” He’s wrong to suggest that the chart implies that productivity growth is unimportant. Productivity growth is surely important but it is also surely an insufficient way to grow real wages and compensation for the typical worker. There must also be a policy agenda to reconnect productivity and pay. That is why EPI has offered our Agenda to Raise America’s Pay and why our former colleague, Jared Bernstein, has a book on “The Reconnection Agenda.” And that is why the tweet from Hillary Clinton that went along with our chart—“That bargain has eroded. It is our job is to make it strong again”—is right on target. Reconnecting those lines should be the central focus of economic policy and of economic debate during the upcoming campaign.

  • TheBrett

    How does it show it’s mainly a problem from the 1970s and late 1990s? As far as I can tell, your post response has centered around criticizing the average hourly compensation, not about adjusting the productivity and earnings graphs so they use the same deflator.

  • Phil Perspective

    Matt Yglesias is an insightful writer, …

    That’s an interesting comment to make when the rest of the post demolishes that fact.

  • rwclayton7

    Thanks for writing this, since I was unclear on what price indexes the EPI charts were using. The table you’ve posted is very helpful. But I think it would be more helpful still to address the issue of whether the “terms of trade” factor is a real wedge or just a statistical artifact. In his paper on this subject from 2007, Dean Baker opts to use the consumption deflator in GDP to deflate both the nominal productivity and compensation series, which implies that he views the “terms of trade” factor as a statistical artifact (or it does to me anyway. Don’t think DB has ever actually said that). Matt Y suggests that the “terms of trade” factor is real and important, and that it suggests a path to raising real wages by increasing productivity in consumption goods, especially housing, health care, and education. My own sense is that the “terms of trade” factor is telling us something monopoly rents and competition, but in any event I think it would be worth exploring more here on the blog.

  • benleet

    The middle household income of $50,865 a year in 2010 would be $74,440 if the wage/productivity gap had not enlarged, according to this EPI calculator: I use the table 2.2 at State of Working America –Income, for the $50,865 income figure.
    The calculator begins at 1979, showing that the income of the middle quintile rose by 7% since 1979. It would have seen a 46% increase, to $74,440, with no gap between Wages and productivity. In quintiles, the lowest quintile average would have risen 66%, the 2nd up 58%, the middle up 46% (to $74,440), the 4th up 26%, and the last — the calculator fails at that point. I would also guess that the employment to population ratio would still be at the 2007 range, about 5 million more people working. The aggregate household debt would be lower than today’s 102% of GDP. The distribution of wealth would be healthier. Now the lower half own 1.1% of all household net worth. The outstanding debt of domestic financial corporations, would also be lower, it increased from 59% of GDP in 1996 to 156% in 2008, (Table D.3 Flow of Funds report).

  • tedshepherd

    To what extent might the changes in labor’s share of income result from an increase in the capital supporting labor’s productivity? What role has automation played?

  • David Brown

    I would refer readers to the article by Robert Z Lawrence at the “The Growing Gap Between Real Wages And Labor Productivity” at the Peterson Institute For International Economics that clearly refutes Mr Mishal’s arguments.

  • bscook111

    Commodity theory explains the chart. And labor is a commodity… as is capital. Post WWII America had a surfeit of capital and dearth of labor. Labor did very well. That situation is now reversed. Capital is very short for most and labor, other than very highly skilled, is very abundant. Now capital is doing very well. it’s time we set aside the PC BS and examine facts with the skill and dispassion of Thomas Sowell.

  • When you are refering to a workers productivity, are you givning any credit to the capital that a worker is using …. when I had an office worker I could expect a certain output, to make that worker more productive I purchased computers that enable the worker to be more productive in terms of output per worker …. however, is it the worker that is more productive, or is it the capital that the worker is using that is more productive …. then are you counting the complete compensation that a worker is getting? Are you counting the extra taxes that the worker is responsible for like FICA which went from 3% to 14% …. the worker needs to cover the extra cost, the same is true for EPA and OSHA related cost. Then there is workers compensation insurance …. the worker must cover all cost that are related to the worker being employed. These cost do not seems to be covered in your charts.

  • Romulo Maranesi

    I’ve just watched “interstellar” and I found it incredibly interesting. Apparently, the world is going to end, and only the Americans are worried about it. It seems that the Chinese, the Indians, the Latino-Americans, etc. are quite happy to see their children die.

    On the same page, science, by definition, is universal.

    As far as I know, a stone doesn’t fall differently in Chicago, Jakarta, Montevideo o Johannesburg (or Mars, for that matter) – unless the Gravity Law works differently in some places (it would be complicated if the coin at the beginning of the Football match just stays up there, wouldn’t it?).

    There is no such thing as “American Economics”.

    The gap between productivity and pay is so important that we should get all the info we can, from all the sources we can.

    It is a paradox that we won the Cold War, just to see how the productivity – pay gap grows, and thinking that it is just “politics as usual”.
    It is not — it is the whole system at trial (and trust me, my friends wouldn’t call me a liberal).
    For example, in Krugman’s “The Age of Diminished Expectations” graph #5 shows the relation between productivity and pay for the two periods we are talking about (hope somebody can post it), and it’s basically the same info as here.
    First, it would be interesting to see how the 240% is distributed – if only less than half went to this “Hourly Compensation”, where did the rest go? There are places (f. ex. Linked) where the argument goes that the difference didn’t go to the capitalists, but to the executives.
    Second, it’s not true that productivity comes from “Working harder”, so the left title should disappear. In fact, it is muddling the conversation with propaganda, which is what we should avoid.
    Third, I am not an economist, but the relationship between productivity and capital investment, although important, I cannot see how it comes into place here – I mean, McDonalds and WalMart employees are more productive because there was a lot of capital investment in state-of-the-art machines? Or computers and printers (with Microsoft Office, of course) are such capital investment as to make a difference?
    We cannot win the argument if we are not seeing as more serious than the other guys.
    Personally (and this intuition and as such totally un-scientific), I think the answer is minimum wages.
    Romy, from Canberra
    (no, not Austria, Australia… yes, it is a country, really… the new guy in the 49ers comes from here).
    We love you as you are…