Tuesday, November 14, 2006

Productivity is as productivity does

One of my students recently wrote a paper on international labor standards. The primary foundation of his claim that they are not only unnecessary but actually harmful was that there is a very tight relationship between productivity and wages (or more broadly, labor compensation). Thus labor standards will only drive up wages higher than productivity levels will allow, forcing capital to abandon this now higher-cost labor and harm workers' interests overall. In short, there's just no escaping the laws handed down by productivity -- either by labor or capital.

Our measurement of the relationship between productivity and compensation is heavily influenced by the price indexes we use. While poking around the web, I found this on the blog of the esteemed Greg Mankiw (you remember him, don't you? Greg "Former Chair of Dubya's Council of Economic Advisors" Mankiw? Greg "Outsourcing is just a new way of doing international trade" Mankiw? Ah, now you remember . . .):
The price index is important. Productivity is calculated from output data. From the standpoint of testing basic theory, the right deflator to use to calculate real wages is the price deflator for output. Sometimes, however, real wages are deflated using a consumption deflator, rather than an output deflator. To see why this matters, suppose (hypothetically) the price of an imported good such as oil were to rise significantly. A consumption price index would rise relative to an output price index. Real wages computed with a consumption price index would fall compared with productivity. But this does not disprove the theory: It just means the wrong price index has been used in evaluating the theory.
And hence the broad claim from the right that there is not a compensation-productivity gap in the US (or anywhere else for that matter) because those claiming to find it are using the wrong price index -- the CPI -- when they should be using "an output deflator". Douglas "Disciple of Jagdish Bhagwati" Irwin uses the PPI in his book Free Trade Under Fire to show that there is no compensation-productivity gap at all in the US -- something my student seized upon with glee.

But hold on a minute. Productivity is defined as output per hour. So what's the price index for output? A fine question indeed.

It took some digging, but here is what the Bureau of Labor Statistics itself said back in 1999. The "deflation method" is used to calculate 93.3% of real business output (almost all the rest is by "extrapolation"). And what is the business output deflator, you ask? Well, it's a hodge-podge of several price indexes, but the largest component -- 55.9% -- is the Consumer Price Index! Yes, over half of the "output deflator" used to calculate business output per hour (which you can find right here) is actually a "consumption deflator". Well, according to Greg Mankiw that's just a great big no-no! This is despite the fact that, if we search down to little 'ol footnote 12 in the BLS document, we find out that "Based on 1997 current-dollar data, personal consumption expenditures account for about . . . 73 percent of business sector output". Only 15.1% of the business sector output price index is made up by the Producer Price Index -- you remember, the one which Douglas Irwin used to impress my student and "prove" that labor compensation closely and faithfully tracks productivity levels. Another 10.6% is made up of "BEA input-based indexes" -- which sounds like another Mankiw-banned procedure. Then we've got export and import price indexes as well as a slew of other bits and pieces to round out the family.

So what's the upshot? When Mankiw says "the right deflator to use to calculate real wages is the price deflator for output" he's talking past how output data itself is actually measured -- a majority of it using price deflators for consumption.

And the upshot of the upshot? Since 1973 there has been a significant divergence in the US between productivity growth and compensation growth when real compensation growth is deflated even by the PCE index (which understates inflation notably in comparison to the CPI). The only exceptions have been a couple of years in the late 1990s, and 2006. Don't get fooled by the likes of Mankiw, Irwin and the other apologists for capital who want to tell you otherwise.


At 4:19 AM, Blogger Epimethee said...

There s a poitn I do not understand. It has been shown that labor standards often raise productivity. For instance no child work makes more efficient adult workers later, shorter hours make more productive hours etc.

On top of that labor standards are really really basic standards. What makes your student think that full employment with no standard is better than unemployment with standards ?

Finally why should labor standards lead to higher compensation ? There s no world minimum wage as far as I know, so companies have every right to lower wages in order to compensate standards.

A question for you now general. If wages have constantly lagged productivity in the USA, how come wages share in the VA has not fallen ?
After all if all workers are more productive then they each add more VA;

Where lies the mistery

At 9:59 AM, Blogger Guy Barry said...

why don't we all agree?

At 10:55 AM, Blogger eightnine2718281828mu5 said...

If wages are keeping up with productivity, then how are all those profits showing up on corporate balance sheets?

And let's not even get started on distributive effects; when analyzing wages and productivity it might be a good idea to note that wage gains have not been uniform across all classes of labor.

At 12:24 PM, Blogger Epimethee said...

The high profit are a recent phenomena.
I only have this problem. Until 2003 or so, Wages have kept stable within the USA value added.
How is this compatible with wages rising slower than productivity ? That is my question.
Is it that we are comparing industrial wages with industrial productivity ?
Is there some statistical trick somewhere like the use of different indexes ?
I mean if each worker produces more, say 100%, and each is paid only 20% more, then wages within the value added should fall. Why have not they, i mean, not until the 2000 ?
I could understand that wages and produtivity have stalled in the USA, hence the usa have low employement and low wages, while productivity and wages have risen more in Europe especially France and there s lot of unemployment. BUt I can not understand high produtivity growth, low wage growth and a stable wage/gdp ratio.

At 1:22 AM, Anonymous Anonymous said...

oaky well now what

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At 3:25 AM, Anonymous Forex trading systems said...

I don't believe Mankiw and Irwin, either. They are all populists trying to get more publicity...

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At 12:31 AM, Anonymous Anonymous said...

What sort of solution is there? Why not allow people in developing nations to benefit at the cost of the US employees?

The US and its citizens are spoiled. It's about time the wealth was spread around.

At 4:52 AM, Blogger Mark said...

It depends what type of work we do. We may get cheap labour goods from China, but what happens when they all have to go back because of poor standards and lead paint.


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