Does more labor productivity raise people’s living standards? The conventional wisdom is still “What’re you kidding? Of course it does!” But the evidence on that is pretty sketchy and has been for a while now. So, let’s do a little myth-busting as we explore the so-called productivity-pay gap.
Investopedia nicely sums up the standard line on productivity: “The level of productivity is the most fundamental and important factor determining the standard of living. Raising it allows people to get what they want faster or get more in the same amount of time. Supply rises with productivity, which decreases real prices and increases real wages.”
Just one little problem, of course. The data indicates it’s not true, at least not in the ways it has usually been explained.
We’re A Lot More Productive, But Not Much Richer
In the U.S., productivity has been going up for many years. In fact, it rose a little faster between 2019 and 2022 than it did the previous 12 years. Have a look at this data from the Bureau of Labor Statistics (BLS):
Productivity Change in the Nonfarm Business Sector, 1947-2022
Productivity hasn’t grown as quickly over the last 15 years as it had the previous 17. But from 2019 to 2022, it was still growing at a similar rate as it did from 1973 to 1990. Overall, despite an occasional dip here and there, there’s been steady growth.
Sure, there’s plenty of room for economists to complain, but consider the fact that labor productivity more than doubled between 1979 and 2022!
So, if it’s true that “productivity is the most fundamental and important factor determining the standard of living,” then surely our standard of living also doubled in that same time period, right?
The Productivity-Pay Gap
Well, no, not by a long shot. But the answer requires more nuance than that. After all, there’s no clear definition of “standard of living” and productivity itself comes in various flavors. Let’s stick with labor productivity, which compares growth in output to the growth in hours worked, and let’s use inflation-controlled compensation as a more measurable version of standard of living.
Here’s what we get, according to the Economic Policy Institute:
The idea, of course, is that productivity and compensation rose pretty much in parallel up until the early 1980s and then split off from one another. In fact, productivity rose 3.7 times faster!
Which suggests that something’s wrong with the whole conceit and with the fact that so many trusted sources keep claiming they rise in virtual tandem despite solid evidence to the contrary.
How Do We Explain What Happened?
So, how can we explain the productivity-pay gap? There are various theories, but here are three that, while not necessarily contradictory, stress different facets of the gap.
Theory 1: Policymakers Tore Out the Coupling
The EPI itself, which has a somewhat left-leaning orientation, explains it like this: “Starting in the late 1970s policymakers began dismantling all the policy bulwarks helping to ensure that typical workers’ wages grew with productivity. Excess unemployment was tolerated to keep any chance of inflation in check. Raises in the federal minimum wage became smaller and rarer. Labor law failed to keep pace with growing employer hostility toward unions. Tax rates on top incomes were lowered. And anti-worker deregulatory pushes—from the deregulation of the trucking and airline industries to the retreat of anti-trust policy to the dismantling of financial regulations and more—succeeded again and again.”
In other words, the government allowed the system to get misaligned. Let’s use the metaphor of a coupling. In machinery, a coupling is a device for joining two rotating shafts at their ends so as to transmit torque from one to the other. The goal, of course, is to transmit power fairly evenly. In the coupling of productivity and compensation, however, things fell badly out of whack. One shaft kept spinning like a champ while the other started moving in slow-mo. If the economy were a machine, we’d send it to the shop.
Theory 2: We’re Not Measuring It Right
Another theory is that the pay-compensation gap is real but maybe not quite as large as the consumer-price-indexed compensation rates suggest. The BLS provides the following chart.
In this graph, the bottom dotted line is compensation adjusted using the consumer price index, but the light blue line above that is compensation that’s adjusted using something called the output price index, which is arguably more accurate. The authors of the article “Understanding the labor productivity and compensation gap” explain:
Workers are compensated based on the value of goods and services produced, not on what they consume. Using an output price deflator, a measure of changes in prices for producers, instead of the CPI is an alternative that better aligns what is produced to the compensation that workers receive. Each industry has its own unique output deflator that matches the goods and services that are produced in that industry.
By using these “deflators” for a variety of industries, they find that the size of the productivity-compensation gap “decreased in 87% of industries that previously showed productivity rising faster than compensation.”
To be clear, the gap isn’t going away if you use this technique, but it does typically shrink in most industries.
Theory 3: The Rich Got Most of the Pay Raise
The third and, to me, most convincing theory is that average folk had their productivity lunch eaten by their better off brethren.
This is clear when you look at the work by economists such as Erik Brynjolfsson and Andrew McAfee of MIT. In their book Race Against the Machine, they comment on a graph that shows the amazing and growing disparity between real median household income and real GDP per capita (which is one measure of productivity). Below is a more up-to-date version of the one they point to in their book:
They call it “striking” and then make this observation:
There have been trillions of dollars of wealth created in recent decades, but most of it went to a relatively small share of the population. In fact, economist Ed Wolff found that over 100% of all the wealth increase in America between 1983 and 2009 accrued to the top 20% of households. The other four-fifths of the population saw a net decrease in wealth over nearly 30 years.
Ouch. So, yes, the productivity paychecks are real. And they do raise the standard of living — but not for everybody. Or even most people.
Were Gains by the Rich Earned or Stolen?
Of course, this raises another question: “Did those folks at the top earn that paycheck, or steal it?”
If that’s incendiary phrasing, don’t blame me. Blame the purveyors of conventional wisdom mentioned above. The implication has always been that we all benefit from productivity increases, but, in practice, as Brynjolfsson and McAfee say, “There is no economic law that says that everyone, or even most people, automatically benefit from technological progress.”
Maybe that makes sense? Let’s say a bunch of tycoon types invest in robotics to boost the productivity of the average worker on the line of some manufacturing plant. After the inevitable layoffs of many workers, do the rest of those surviving employees divvy up the compensation of the people who were laid off minus the cost of the machines?
Probably not. Instead, the benefits accrue to the investors and the senior managers (especially CEOs) who made the decision to invest in the robots. That is, the rich get considerably richer while the surviving workers only get a modest increase. And the folks who were laid off? How much of a cut do you think they’re getting?
Yeah, bubkis. Or, in many cases, they actually lose economic ground.
Multiply this dynamic many times over the course of decades, and median incomes stay flat while GDP per person (which is an average rather than a median) goes up.
So, to answer our question, “They earned it, kind of, sort of, in a way, if you squint hard enough and quash any human instinct for justice and fairness.”
But at least we now have a clue about where benefits of the productivity increases go. That is the beginning of wisdom — and a fine antidote to fiscal fairy tales.
Productivity Chickens Coming Home to Roost
Recently, there has been a decline in U.S. productivity. In fact, some analysts claim that the U.S. has now seen five consecutive quarters of year-over-year declines.
The big question is why. There’s lots of finger-pointing. Some high-profile CEOs blame lazy work-at-home employees for the decline. Others argue, to the contrary, that it is the return-to-work policies that are most strongly linked to productivity declines.
There are plenty of other suspects as well. For example, many people switched jobs during the “great resignation” and so stepped into roles where they had to learn the ropes to become more productive again. Or there’s the rapid return of many employees back into the workforce, a dynamic often associated with temporary reductions of productivity.
There’s also the possibility that higher inflation — combined with pay increases that are insufficient to keep up with it — are simply demoralizing workers. Why should they worker harder for smaller paychecks?
And, of course, there’s the idea that younger generations just aren’t as eager as their older baby boomer counterparts to keep their proverbial noses to the grindstone. It’s less that they’re “lazy” and more that they just aren’t as willing to put up with bossism and toxic workplaces.
CEOs Venting Their Spleen
Meanwhile, CEOs have been venting their spleen about declining productivity, so much so that it feels as if there’s a new “leaked video of a CEO having a meltdown each week,” writes AJ Hess in Fast Company.
On one hand, I get their frustration. Their jobs are, of course, to boost the performance levels of their organizations.
On the other hand, what make these meltdowns both funny and sad is the extraordinary pay gaps between typical employees and their bosses. For example, recent figures indicate that S&P 500 CEOs averaged $18.3 million in compensation in 2021. That’s a whopping 324 times the median worker’s pay!
How did their pay get so exorbitant? Well, one answer is, of course, productivity. That is, they (and other upper-class Americans) have enjoyed the fruits of the productivity bumps of workers whose wages have largely stagnated over the last 40 years.
Which makes you wonder: If the typical worker had been receiving their full share of the benefits of productivity increases since the early 1980s, would we be in a position where “quiet quitting” was even a thing?
Maybe not. What we could be seeing is the productivity chickens come home to roost. If the rich get most of the monetary benefits of productivity increases, then let them do most of the work.
Or, at the very least, they — in partnership with the government — should stop whining and figure out a way to make productivity increases benefit everyone in their organizations, not just the investors and executives at the top.